Introduction
Whenever the topic of crypto arises in an investment conversation, one of the most common reservations undoubtedly will be that cryptos are just too risky to even consider. This notion should however be challenged. When crypto is viewed in the context of an isolated single investment, then it certainly should be regarded as a high risk investment due to the significant amount of capital at risk. However, when crypto is viewed in the context of a portfolio and blended with other assets, then the risks are not only reduced, but in fact the risk is lower than traditional assets. This may seem like an outrageous claim, but the claim has mathematical integrity in its reasoning.
The assertions about crypto being risky all pivots on how we define and view risk. In traditional markets where the market movements are pedestrian, risk is measured as volatility, or possible drawdowns. This is a fairly accurate representation of risk, as asset prices behave in a symmetric way that follows the normal bell curve distribution of returns. This principally means that the upside and downside returns are fairly equal. As the prospect of expected returns increases, then so does the possibility of increased risk increase. However, as the risk increases to a point where capital is at risk, then this tradeoff of risk for return no longer holds as one cannot forfeit risk beyond capital.
Risk redefined
When an asset starts demonstrating exponential returns that are multiples of capital invested, then the measure of risk as volatility no longer applies. This price characteristic of outsized returns relative to capital invested is called asymmetry. The asymmetry exists because the downside is capped to full capital loss, but the upside is virtually unlimited. Crypto assets have historically shown these outsized returns measured in multiples of capital growth.
A more valid approach of measuring risk in these circumstances is to define the ratio of upside returns versus quantum of loss, or the risk-return ratio. Sharpe Ratio , a commonly used ratio, attempts to capture this characteristic, but is again constrained to normal distribution price behaviour typical of traditional assets, and therefore falls short in accurately describing the risk.
Return redefined
Not only should the risk metric be re-evaluated, but the upside return metric inherent in assets showing multiples of capital growth also needs to be reconsidered. In traditional markets where price behaviour is small compared to that of crypto, annualized returns are a fairly accurate and intuitive metric. However, when returns are measured in multiples of capital then the enormous effect of compound interest is not captured. For instance, an asset showing 80% annualized return over 5 years will only yield half the real performance of an asset yielding 100% annualized return over the same period. Crypto return metrics are therefore much better described using an absolute or cumulative return measurement over the entire period.
Risk vs Return
With the risk and return metrics adjusted it is now possible to correctly represent an accurate risk return ratio. It is evident when analysing crypto in this context, that it is on a different risk return scale to traditional assets.
It is common knowledge in portfolio construction theory, that the ultimate objective of any portfolio is to combine assets to deliver the highest possible returns for a defined level or risk. In order to achieve this most effectively, the most desirable assets for the portfolio will concomitantly be the assets that exhibit the highest returns relative to the lowest risk . This characteristic exactly describes the risk return ratio characteristics described previously, and will select crypto to be the most desirable asset available for inclusion in a portfolio.
Coupled with the additional quality, that crypto will exhibit uncorrelated return to traditional assets, which lowers the portfolio risk even further, crypto is simply an asset class that cannot be ignored when constructing well balanced portfolios. The ultimate risk of crypto will boil down to the allocation within the portfolio. Only a very small allocation to crypto will achieve the possibility of very large returns to the portfolio, whilst only have the small allocation amount at risk.
Crypto future performance prospects
The above analysis is largely contingent on Cryptos ability to show similar future exponential performances relative to historical price behavior. It is believed that the stellar historic returns that Crypto assets have exhibited are still repeatable into the future. The phenomenal growth performances were possible because the market capitalizations of the crypto assets were very small, allowing large room for growth before capping out. It is therefore relevant to gain perspective on the current market size, and potential market size.
The total Crypto market capitalization of $3trillion is still relatively small compared to other asset classes, and still has potential for substantial growth.
GLOBAL MARKET CAPITALIZATION COMPARISON
However, this gives a skewed picture as the Crypto universe is completely dominated by Bitcoin and Ethereum which account for 60% of the entire market capitalization. There are over 2000 crypto coins and 98% of these cryptos have market caps less than $5bill. It is evident that the majority of crypto assets are still in a very nascent stage and opportunities for electrifying growth from such a small starting point is therefore still possible.
CRYPTO UNIVERSE COIN MARKET CAPITILIZATION
Asset Classes within Crypto
It is a common misconception that crypto is a single asset class. The term Crypto, Bitcoin and Ethereum are used synonymously and interchangeably to mean the same thing. This is certainly not the case as there very different and uncorrelated applications. There are crypto assets that will be used for very specific use cases, such as medium of exchange, NFT, or Metaverse, and it is expected that the price behaviour will also be different longer term. The growth opportunities within the different asset classes also point to the strong likelihood of asymmetrical price behaviour.
CRYPTO ASSET CLASSES BY MARKET CAPITLIZATION
How to invest in Crypto
It should be evident that the decision to include crypto in the investment universe should not be daunting, as the asset is very well suited within a portfolio, and is in fact a low risk decision.
Any investment should also not just be concentrated on a few assets within crypto, as this will deny access to all the different asset classes. A selection of only a few cryptos will also potentially limit the selection to the more well-known crypto names that have already shown exceptional growth. These larger market cap assets have less potential for performance, as the size may limit growth.
SwissOne Capital offers a very well diversified portfolio of crypto assets that has a balanced weighting across the asset classes, and good exposure to the smaller up and coming crypto assets. This well considered and balanced strategy as a small allocation within a multi asset portfolio is positioned to offer highly favourable risk vs return tradeoffs to enhance ones portfolio performance beyond what is possible with only traditional assets.
Conclusion
In conclusion, it should be apparent that when assets are showing performance returns in multiples of capital invested, then the normal metrics of risk as volatility and returns measured as annualised returns need to be adjusted. It is not possible to apply traditional finance metrics to an asset class where the price behavior is so different. When using a more appropriate and representative measure, crypto is a low risk and sensible investment within the context of a balanced portfolio.
With the added features uncorrelated long term price behavior, prospect of spectacular returns and multiple asset classes within crypto, it becomes a very compelling addition to an investment portfolio.
It is not often that an asset class comes about showing such spectacular prospects for growth, and this is probably a “once in a life time”, or even “once in a couple of lifetimes” opportunity. Crypto as an asset class is becoming increasingly difficult to ignore, and the cost of overlooking crypto will reach a point of culpable deniability. (SwissOne Capital/mc/ps)
