TWO WAYS OF GAINING EXPOSURE TO THE CRYPTO ECONOMY
Prepared by – GAYAN DINESH PERERA
USQ MBA Student No -U1142643
BUS8203
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INTRODUCTION
The cryptocurrency market has experienced enormous growth ever since the emergence of
Bitcoin in 2009.
The global cryptocurrency market reached a staggering value of US$
1782Billion in 2021. (Yahoo Finance 2022) In this essay, I will be critically evaluating the two
ways that an average investor can gain exposure to the crypto economy. That is by way of
purchasing crypto directly or buying stocks in companies that are involved in crypto industries.
Emphasis will be given to the average investor’s perspective and opinion will be constructed
using appropriate investment management principles such as portfolio theory.
Crypto’s increasingly wide acceptance as a payment method and the anonymity and privacy
embedded in the transactional process has been the key reasons for the popularity of crypto.
Security risk and high volatility have been detrimental factors of crypto popularity.
(cryptopedia staff 2021)
INVESTING IN CRYPTOCURRENCIES VS COMMON STOCK
As an investor, it is pivotal to understand the similarities and differences between trading
cryptocurrencies and stocks. Emerging online marketplaces, trading platforms and mobile
applications have been the positive factors for the growing number of investors in stocks as
well as in crypto. Even though the process of investing in stocks and crypto has several
similarities, there are also some fundamental differences. One of the notable differences in the
regulatory framework. Stocks are generally securities that are regulated by securities and
exchange commissions. (SEC). In contrast, many widely used cryptocurrencies including
Bitcoin are not regulated securities.
The most distinguishing difference between investing in stock and cryptocurrencies is the
fundamental difference in what you are purchasing. Common stocks traded in stock markets
represents a percentage of ownership in an entity and it is embedded with certain benefits such
as dividend, voting rights, etc. In contrast, cryptocurrencies are dependent on how they are
utilized and what they are intended to represent. (Marquit 2021) Many cryptocurrencies are
digital assets that are meant to be used within the blockchain’s ecosystem, hence, do not
represent any legal stake that issued the coin. Ex- Ether (ETH). On the other hand, many
cryptocurrencies do not have a demonstrable value tide to the actual business operation and
hence act as a store of value. Hence, these digital assets are best conceptualized as digital
commodities which do not represent any stake in a business.
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CRYPTOCURRENCY AS A LONG INVESTMENT
Many prominent cryptocurrencies such as Bitcoin (BTC) and Ethereum (ETH) were launched
with lofty objectives to achieve in the long term investment horizon. Bitcoin as per many crypto
investors is the “digital gold”. It has been a notable fact that early investors in crypto projects
have been richly rewarded when the project reaches the maturity stage. For an instance, if an
investor invests in BTC by around 2010 when the price is around US$10 cents, the investor
could have bought about 1000 Bitcoins. Assuming that the investor held the asset the entire
time, the same 1000 BTC would have been worth more than US$61Mn by 2021 when BTC hit
an all-time high of over US$ 65,000 per Coin. (statista 2022). That’s an enormous gain.
However, realistically the no of investors holding into the highly volatile asset such as BTC
for such a long period is smaller. However, the price appreciation of BTC over the last decade
suggests that the longer-term investors would have been rewarded handsomely. However, the
gain or loss of investment is mainly depending on the investor's risk appetite and investment
expertise.
Even though, statics suggest that almost all the key major cryptocurrencies have surged in value
over the years but it’s paramount importance to figure out how they fit into average investors'
portfolios. Investors are expected to strike a balance between risk and return. hence, they are
trying to maximize the gains and limit the losses by estimating the risk and return of various
investments including crypto.
Estimating future returns and the risk associated with such returns can be trickier. Investors
usually rely on historical data. While historical averages are a good gauge for traditional
investments such as stocks and bonds, they may not be effective with cryptocurrencies. Bitcoin
the oldest of cryptocurrencies has only been around for 13 years. Hence, the historical records
are not long enough to rely on. (Kaissar 2022)
According to the Investment giant Goldman Sachs, the ten-year stock market return has
averaged about 9.2% over the last century in the USA. However, Goldman Sachs notes that
S&P 500 has been generating slightly better returns with an average annual return of 13.6% for
the last 10 years. (Business Insider 2021) On the other hand, in USA long term government
bonds have generated about 6% a year over the last century. (The Bloomberg 2022) Meantime,
the oldest cryptocurrency family the Bitcoin has returned about 220% a year during its 13-year
span of the life cycle, which obviously from the average investor's perspective is not
sustainable. Bloomberg notes that the annualized standard deviation is about 200% over the
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same period. (Kaissar 2022) That makes the BTC 15 times more volatile than the S&P 500 and
more than sixty times that of long-term bonds. (The Bloomberg 2022)
One another attractive features of cryptocurrency are its ability to generate a passive income.
As common stocks generate dividends the crypto could also be generating passive income
through various means. One of them is the staking. Staking is a widely known passive income
source for crypto holders with minimal risk. Many crypto exchanges offer the facility of staking
where the holders are required to stake their coins for a set period of time for a return of fixed
or variable interest which will usually be paid in the agreed value equivalent of the coin staked.
Hence, in the longer run staking may work as a reinvestment tool where the revenue generated
is automatically reinvested. (Market Trends 2022) Crypto saving accounts are another passive
income generator of crypto. Rates paid on these crypto saving accounts are often higher than
what you will find in traditional fiat saving accounts. Conversely, crypt flatforms such as
Coinbase, Binance, Aqru, etc generate income by lending out the crypto assets saved with them
and paying out a portion of the interest income to the savers. (Market Trends 2022)
INVEST IN STOCKS IN THE COMPANIES ENGAGED IN THE CRYPTO
INDUSTRY
Investing in equities in the companies of the crypto industry is another option for an investor
to gain exposure to the crypto economy. Several globally acclaimed businesses evolved around
the crypto economy. One of them is the American crypto giant Coinbase Global, Inc which
primarily operates as a cryptocurrency exchange. The entity was founded in 2012 and became
a public entity by listing on the Nasdaq exchange USA in April 2021. (Coinbase 2022)
From an average investor's perspective, we will review the financial position of Coinbase as
our base case to evaluate the investing in the stock of the company.
Financial performance of Coinbase as a case point to predict the market
During the first year after going public, the company has recorded a fifteen-fold increase in
2021 revenue, to $ 7.84B, up from $1.27B the previous year. (Coinbase Inc, Annual Report
2021 2022) similarly, profit after tax (PAT) increased more than 11-fold from $322Mn in 2020
to 3.6B in 2021. This mammoth growth is mainly attributable to the boost in the crypto
economy during the pandemic period. (Nga 2022) During the Covid pandemic global
economies were slowly shutting down and people who had few options for spending their
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discretionary cash and savings ended up buying digital assets such as cryptocurrencies through
flatforms like Coinbase. The increased volume of transactions helped Coinbase generate
monstrous growth in revenue by way of transactional fees. EPS (Basic) shot up to 17.9 from
1.86.
(Coinbase Inc, Annual Report 2021 2022).
Average investors, primarily look for the capital gain through price appreciation of the stock
and dividends. Coinbase stock price has surged up to $ 368 from the IPO price of $ 250 in
April 2021and it has eventually fallen to the lowest of $ 40.83 and currently trading at around
$ 67.87. (Yahoo finance 2022) On the other hand, it has not declared any dividends for the last
few years. Book value per share Q 1,2022 is 29.39 and the price to book value is around 2.28.
(Yahoo finance 2022) As Coinbase benefitted immensely from the surging trading activities
during the pandemic, it was also penalized when the trading volumes fell from the latter part
of 2021. A combination effect of lower crypto prices and lowering volatility factor has reversed
its performance the other way around in Q1 of 2022. Topline fell 27% YOY to $1.2B and net
PAT reversed from $770Mn to minus $430Mn comparatively. (Investing.com 2022) Another
factor that contributed to this shocking performance in Q1 of 2022 is the operating expenses
which have been doubled in comparison to the Q1 of 2021. (Investing.com 2022)
Overall, the market capitalization of Coinbase steeply declined by 80% to $ 17.78B as of 13th
May 2022 from the old-time high of $89.83 in November 2021. (Companies marketcap 2022)
In the same period, the total cryptocurrency market cap fell by 56% to $1.2T from $2.9T in
November 2021 which is an all-time high. (coinmarketcap 2022) One of the main reasons for
the reversal of bullish sentiment of the crypto market was the bank of crypto trading and mining
in China which has wiped out the crypto market by about 40% within a month. (Editor the
Hindu 2022).
Accordingly, it is evident that the near-term prospect of the crypto-economy going to remain
bleak. In short, crypto companies predict lower trading volume for the second quarter of 2022
and the remainder. The ongoing war in Ukraine and other socio-economic factors are also going
to affect this adversely.
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EFFICIENT CRYPTO PORTFOLIO AND MODERN PORTFOLIO THEORY
Irrespective of being risk-seeking or risk-averse, the investors seek to gain profit. In many
cases, the amount of profit or loss has a direct correlation to the amount of risk that the investors
are willing to take. Modern portfolio theory (MPT) primarily assumes that an investor is riskaverse and seeks to find out the balance between optimal return and assumed risk. (Forbes
Editor 2021) MPT involved a process of taking a batch of asset classes and calculating the
weighting using historical data. Riskier investment often has the tendency of generating higher
returns. Hence, modern portfolio theory stive to generate a weighted portfolio with the highest
potential return for the least risk. The ratio between expected return and perceived risk is
commonly known as the Sharp ratio. That can generate an efficient frontier graph which
represents an efficient portfolio for various anticipated returns.
(Forbes Editor 2021)
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Calculating an efficient sharp ratio is highly reliant on historical data. While MPT and sharp
ratios were originally designed for traditional investments such as stock investors can also use
them for crypto investment as well. Unfortunately, the crypto economy is extremely fastmoving and susceptible to many changes. Hence, only a few major cryptocurrencies with
historical data will be eligible for the calculations. i.e- Bitcoin, Ethereum and Litecoin, etc.
Accordingly, moving along the efficient frontier will exhibit the efficient portfolios with the
highest possible risk-adjusted returns.
CONCLUSION
The primary objective of any investment is the return. Investors are having various levels of
risk appetites and accordingly they weigh the expected return against perceived risk and make
the investment decision. As elaborated on the above, the leader of Cryptocurrency Bitcoin has
generated a return of about 220% a year during the short span of its lifecycle. However, that
kind of return is obviously unsustainable. Hence, its standard annualized deviation has been
around 200% over the same cycle. That is approximately about 15 times that of S&P 500 stock
or more than 50 times that of regular bonds. (Kaissar 2022) On the other hand, US stocks have
returned about 9% a year over the last hundred-odd years. Hence, I would recommend for an
average investor to strongly look for the option of buying crypto directly as a short- and longterm investment. In deciding the amount of investment, the average investor may utilize
theories such as the Modern portfolio theory explained above.
Thanks!
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