Bitcoin is emerging as a unique asset class, according to a recent report by Chris Burniske, blockchain analyst and products lead at Ark Invest, and Adam White, vice president of business development and strategy at Coinbase.
In their report, titled “Bitcoin: Ringing the Bell for a New Asset Class," the authors argue that bitcoin is investable but differs significantly from other assets in its politico-economic profile, price of independence, and risk-reward characteristics. They believe cryptocurrency's open source software will differentiate it further from other asset classes. They believe it could grow to substantial market capitalization.
Asset Class Characteristics
Asset classes are viewed in different ways. Oftentimes they are seen in terms of investability. They also differ in their politico-economic features and their correlation of price movements and risk-reward profiles. Burniske and White explore bitcoin in the context of all four criteria.
The authors believe an asset class must be investable, providing opportunity to invest and ample liquidity. It should also have a politico-economic profile based on governance, value and use cases. In addition, its market value should fluctuate independently of other assets and exhibit a low correlation of returns.
The three characteristics noted above should provide a differentiated risk-reward profile that can be measured in volatility and returns, a fourth characteristic.
Burniske and Adams, by analyzing bitcoin’s behavior based on these four criteria, attempt to determine its merit as a bellwether for cryptocurrency.
Bitcoin Versus Other Assets
Cryptocurrency as an asset class cannot be considered unique without observing its behavior in relation to traditional classes of assets: bonds, real estate, equities, energy products, precious metals and fiat currencies.
In examining bitcoin’s investability, bitcoin’s average daily liquidity in a three-month period nearly matched the SPDR Gold Shares ETF and was three times that of the Vanguard REIT ETF.
“In our opinion, equal or superior volume with a fraction of the assets under management underscores that bitcoin is punching significantly above its weight,” the authors noted.
Investability To Improve
The authors believe it is likely that as cryptocurrencies mature, bitcoin holders will expand and provide a positive tailwind for investability.
Characteristics of bitcoin’s investability include its censorship resistance and its permissionless and distributed blockchain. As the network’s infrastructure grows, bitcoin could become the most accessible and secure asset available to the public.
While bitcoin is not widely held or the most liquid asset, the authors believe its fringe status is overstated. An institutional infrastructure is emerging for bitcoin with products such as TeraExchange Bitcoin forwards, exchange-traded funds, the Grayscale Bitcoin Investment Trust, and XBT Provider’s exchange traded notes on Nasdaq Nordic in Stockholm.
The politico-economic profile for an asset is driven mainly by its governance, basis of value and use cases. Bitcoin is distinct from major asset classes.
Bitcoin’s basis of value is unique, but its governance is more of an anomaly. Its transactions are verified through an open and decentralized network of computers called miners.
Bitcoin supply is mathematically metered by its software and will converge on a fixed 21 million units in 2140. Its supply characteristics contrast with fiat currencies, which are governed by monetary policies that often lead to supply shocks.
No asset has evolved from concept to billions of dollars in stored value as fast as bitcoin. Nor has any asset followed such a predictable supply trajectory.
In comparing bitcoin’s trading volume to its transactional volume, bitcoin’s use as an investment medium is expanding faster than its transactional applications.
While some are alarmed by bitcoin’s use as a speculative instrument compared to fiat currencies, bitcoin strikes a close balance between transacting and trading.
When people use bitcoin, they are more likely to use it to transmit value for goods and services than as a speculative investment. Coinbase and ARK view bitcoin’s increased trading volume as a healthy sign for decreasing volatility, further catalyzing transactional volume.
Bitcoin trading in the more regulated currencies has been rising at the same rate as its transactional volumes.
The authors noted that bitcoin’s price movements have been distinct from other asset classes in the last five years. Bitcoin is the only asset that maintains low correlations consistently with every other asset: gold, S&P 500, U.S. bonds, U.S. real estate, oil and emerging markets.
In examining risk-reward profiles, the authors noted bitcoin’s volatility has declined. At the start of May 2016, bitcoin’s daily volatility was about a third of that of five years ago and 24% less than early May 2015. The volatility decline is due to stable and liquid spot exchanges, more regulatory approval, broader ownership and more reliable price discovery data.
In examining absolute returns, the authors noted bitcoin has provided investors returns beyond that of any other asset class. They recounted the history of bitcoin’s price changes.
They noted that neither absolute return nor volatility is a sufficient indicator of good investment. An investor must adjust absolute returns for the level of risk.
Also read: Is BTC a safe asset?
A Unique Asset Class
Bitcoin demonstrates characteristics of a unique asset class. It meets the bar of investability, and it differs significantly from other assets in price independence, politico-economic profile, and risk-reward characteristics.
As the analysis encompasses five years, the authors noted it will be important to monitor bitcoin’s behavior in relation to the broader markets.
As the asset’s open source software evolves, bitcoin will distinguish itself further from other asset classes. Innovations like segregated witness can catalyze bitcoin’s more innovative uses cases. Sidechains and smart contracts could allow new financial services such as liquid private markets and peer-to-peer loan issuance.
Coinbase and Ark view bitcoin as the first in a new type of asset class. Because cryptocurrencies are subject to network effects of developers and users, they could submit to a “winner takes most” model, unlike equities and bonds. The cryptocurrencies that foster the flywheel of developer and user engagement can expand to formidable market capitalizations.
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