There are clear advantages of investing in crypto assets today: there is a wide field of new types of web3 applications, and this field is growing. Bitcoin and Ethereum alone, both are the top tier landmark projects, have significant upside potential rooted in a slow but worldwide adoption. On the other side, there are significant risks: many projects are opaque or lack transparency; exchanges and other intermediaries have shown to run shady businesses. In all, the entire web3 domain is promising but investors have to be very selective about where to invest and which vehicles to choose. Authors: Maximilian Bruckner, Prof. Dr. Philipp Sandner
Investing in the future of a disruptive technology
Investing in crypto assets isn’t just about making quick profits — it’s about recognizing the enormous potential of this groundbreaking technology. The simple logic behind it is that brilliant technologies like these will be used more and more over time, with startups leveraging their headstart against incumbents to eventually become large companies. And as projects like Bitcoin and Ethereum gain wider adoption, their prices continue to rise.
While many people associate blockchain and web3.0 with the financial system, there is a lot more to this technology than just finance. Smart contract platforms and tokenization offer vast possibilities for various industries, from e-commerce and supply chain management to gaming and CO2 tokenization. On top of that, there’s the emerging sectors of NFTs and the metaverse, which are set to revolutionize the way we interact with digital assets and potentially each other.
By investing in related crypto assets like Ether, investors can potentially reap the long-term benefits of being part of one of the most disruptive technologies of our time. In regard to Bitcoin in particular, its fundamental characteristics cannot be underestimated. Those who understand Bitcoin in its core, believe that it’s in a long-term capitalization phase, slowly spreading and capitalizing on its journey like a newly discovered commodity. And when combined with smart contract platforms, Bitcoin has the potential to transform the way we transact and execute value transfers worldwide — serving as the basic infrastructure for decades to come.
High volatility and diversification of asset classes
Crypto assets are a fascinating but highly volatile investment opportunity. Smaller projects in particular can experience significant fluctuations in value, leading to either massive profits or losses in a very short amount of time. For some institutional investors, this volatility is a showstopper. But for those willing to take on more risks and actively manage their investments, the potential for significant returns is attractive.
One key advantage of investing in crypto assets, for both private and institutional investors, is the opportunity for diversification. Unlike traditional investments such as equities, crypto assets have only a moderate correlation with other asset classes. While recent macroeconomic changes have led to a temporary increase in correlations, this is expected to change over time. In times of crisis, correlations between asset classes may rise in the short term — this is not unusual. In the mid- to long-term, adding a small allocation of crypto assets (e.g. 4% of the portfolio value) can have a consistently positive impact on overall portfolio returns.
That being said, it’s important not to get too greedy. Once the crypto allocation exceeds about 10% of the total portfolio, the high volatility of this asset class can dominate the portfolio, leading to diminishing returns. But with careful management and a keen eye for market trends, investing in crypto assets can be a highly lucrative strategy for investors of all types.
Counterparty risk and regulation
There are a number of unique concerns that investors must be aware of. For institutional investors, one of the most significant is the lack of clear regulation in this fast-moving space. While the technology and assets themselves are innovative and promising, the lack of regulation creates significant counterparty risks that need to be carefully managed. This includes risks associated with exchanges, wallets, and custodians, all of which can pose a significant threat to investors. Unfortunately, there have been some high-profile examples of these risks playing out in the real world, such as the recent scandal surrounding the FTX exchange and its founder, Sam Bankman-Fried.
Furthermore, the tax and accounting treatment of crypto assets can be complex and difficult to navigate. This adds yet another layer of complexity for investors, who must be careful to ensure they are managing their investments in compliance with local regulations.
Despite these challenges, it’s important to remember that progress is being made in terms of regulation. In the EU and Germany, for instance, there are increasingly clear rules regarding the custody of crypto assets, and crypto exchanges that address the local market are heavily regulated. Other jurisdictions, such as the US, are taking a slower approach, hopefully balancing innovation in the technology with the need for clear regulatory frameworks. However, until these rules are fully in place, counterparty risk remains a significant concern for investors, whether they are using centralized or decentralized protocols.
One way to mitigate these risks is to diversify your investments across different crypto exchanges and wallets. This helps to reduce the concentration risk and technology risk that can come with investing in crypto assets. While this can be a daunting task for investors, there are service providers that can help to manage these risks to some extent. Ultimately, the savvy investor must be aware of these risks and take steps to mitigate them in order to invest in crypto assets as safely as possible. This can be well worth the effort!
A growing professional investment offering
With more than 1,000 specialized funds available worldwide today, deeper due diligence becomes much simpler for investors, as they no longer need to worry about special tax rules or having their own custody solution. Instead, they can focus on operational due diligence of the funds and fund managers themselves.
For professional investors, these funds can be easily subscribed through most banks and are provided with an ISIN. Additionally, some funds are domiciled in the EU or Switzerland and are thus also subject to the already progressive regulatory approaches such as MiFID II. This clearly mitigates some of the hurdles faced when planning a crypto asset investment and eliminates switching costs of onboarding to a new platform (like a centralized exchange and custodian setup).
Unfortunately, for private investors, the fund offering may not be accessible due to high minimum investment amounts. However, alternatives such as ETPs (Exchange-Traded Products) can be integrated easily into the existing equity portfolio. These products, similar to well-known ETFs, are physically collateralized, provided with an ISIN, and available on common stock exchanges in Europe. They offer investment in a variety of crypto assets, as well as some passive index models, making them ideal as an admixture to a standard portfolio. The index products eliminate the need for risky crypto picking — investors can simply buy the market on average and bet on an entire area of emerging technology.
These advances in making investing in crypto assets as easy and safe as possible are a sign of the rapidly advancing “professionalization” of the industry, which bodes well for further growth. However, as always, extensive research and moderation are necessary when making any investment decisions.
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21e6 Capital is a Swiss investment advisor, connecting professional investors with tailor-made crypto investment products. We focus on risk management of crypto and digital asset exposure for family offices and institutional investors. Our expertise in crypto asset management stems from a team combining decades of experience in traditional financial services with native and in-depth knowledge in digital assets.
21e6 Capital has analyzed over 1,000 crypto hedge funds across the world and condensed them into a selection that can yield crypto-exposure with minimized downside risk. Our risk management solution, provided by OpenMetrics Solutions, is also trusted by the largest Swiss pension funds.
The 21e6 Capital team builds upon strong academic roots with a track record of leading crypto asset and decentralized finance (DeFi) publications and research, ensuring state-of-the-art crypto investment solutions for professional investors, family offices and asset managers.
Prof. Dr. Philipp Sandner has founded the Frankfurt School Blockchain Center (FSBC). From 2018 to 2021, he was ranked among the “top 30” economists by the Frankfurter Allgemeine Zeitung (FAZ), a major newspaper in Germany. He has been a member of the FinTech Council and the Digital Finance Forum of the Federal Ministry of Finance in Germany. He is also on the Board of Directors of FiveT Fintech Fund and Blockchain Founders Group — companies active in the field of blockchain startups. The expertise of Prof. Sandner includes crypto assets such as Bitcoin and Ethereum, decentralized finance (DeFi), the digital euro, tokenization of assets, and digital identity. You can contact him via mail (firstname.lastname@example.org) via LinkedIn or follow him on Twitter (@philippsandner).
Maximilian Bruckneris Head of Marketing & Sales at 21e6 Capital AG. Prior to this, he was engaged as Executive Director of the International Token Standardization Association (ITSA)where he focused on research and classification of crypto assets according to the International Token Classification (ITC) framework. He was heavily involved in the creation of the world’s largest token database for classification and identification data on tokens (TOKENBASE). Maximilian did academic research in close consultation with Prof. Dr. Philipp Sandner. You can contact Maximilian via e-mail at email@example.com to request more information on 21e6 Capital AG or ask any questions regarding this article. You can also follow Maximilian on LinkedIn( https://www.linkedin.com/in/max-bruckner/) to stay up to date.
This article is an informational document and does not constitute an investment recommendation, investment advice, legal, tax or accounting advice or an offer to sell or a solicitation to purchase any securities and therefore may not be relied upon in connection with any offer or sale of securities. The views expressed in this letter are the subjective views of 21e6 Capital personnel, based on information which is believed to be reliable. Any expression of opinion (which may be subject to change without notice) is personal to the author and the author makes no guarantee of any sort regarding accuracy or completeness of any information or analysis supplied.