Crypto from the Multi-Asset Perspective

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Over the recent years, I had a chance to invest in crypto in both personal and professional capacity. Whether outright BTC and ETH purchases, crypto-oriented hedge funds and venture funds, on-chain DeFi trades, or various NFT-related topics (including renting NFTs to 200+ players for a Pokemon-like game) - there’s few things that I didn’t get to try.

And despite the substantial volatility in prices, regulation and ‘hype’, interest from our client base has remained somewhat steady. It’s rare that we find a tech entrepreneur without an allocation to crypto - and especially as the new US government seems to be more crypto-forward, we are often asked about our view on the asset class.

So today, let’s give you our view on crypto: First, covering the most common ways of investing in crypto we’ve encountered. Second, thinking about how those building blocks might fit into a portfolio. And lastly, thinking about sizing your crypto allocation as a whole.

Please note that the point of this article is not to give a case for or against crypto - it’s intended to show you how we help investors with a particular view on the asset class think about properly reflecting said view in their multi-asset portfolio.

Risks to Crypto Investing

Before we dive into specific examples, a word of warning: In our view, all crypto investments should be seen as high-risk investments. Let us outline why we think so:

• Short Track Record: As crypto has only been around since 2009 years (i.e. ~15 years), we find it does not have sufficient track record to properly assess it - also given the fact that its track record took place during an unparalleled bull run amid (mostly) record-low interest rates.
  

• Volatility: Bitcoin is an extremely volatile asset class. According to a recent primer by BlackRock, Bitcoin’s volatility (i.e. how much it fluctuates around its average return) is a stunning 47% - almost 4 times as high as gold (12%) and global equities (10,2%). We try to limit volatility (and the associated drawdown risk) in our portfolios, which often even leads us to limit public equity allocations - which, as you can see, stand at a fraction of the volatility that Bitcoin has shown.
  

• Security Risks: Do you ever worry about losing access to your ETFs because you lost the password to your brokerage account? No - but in crypto, that is a real risk, as losing access to an on-chain wallet can mean permanent loss of the stored assets. Even ‘off-chain’ (i.e. centrally custodied) assets aren’t fully safe, as visible in the case of FTX.

There’s also the question of crypto’s use case. Despite the significant amounts flowing into the asset class, let us not forget that many of its heralded use cases have so far shown little traction outside the world of crypto. While I personally find a lot of the DeFi concepts promising (i.e. decentralized lending and borrowing), I know just one individual who used DeFi as an alternative to a ‘TradFi’ loan - far from the ‘fully tokenized’ world some crypto evangelists speak of. In regards to the case of Bitcoin as ‘Digital Gold’, there’s also arguments to be made for and against.

Approaches to Crypto Investing

It’s important to not see crypto as one asset class - if anything, it is a theme or technology that can be ‘played’ through a variety of instruments with varying risk-return-trade-offs, as you could do with other ‘trending’ themes such as defense or AI.

It’s hard to categorize all those approaches while being consistent nor leaving certain ‘sub-asset classes’ out - we try to either see the asset class by itself (i.e. buying tokens outright) or in light of an existing, ‘traditional’ asset class (i.e. VCs investing in crypto projects). As follows, you can see our humble attempt at outlining the categories that we most frequently see in portfolios:

Crypto in itself (Token Purchases): The most common example is to buy Bitcoin, the largest and most well-known cryptocurrency. Beyond BTC, there’s an almost limitless number of tokens, ranging from other large projects such as Ethereum or Solana, to project-specific tokens, all the way to the world of ‘meme coins.’ 

Active, Liquid Funds (Long Only, Market Neutral, etc.): All actively managed strategies that aim to invest into crypto and its derivatives (i.e. futures, options, but also ‘DeFi’ lending strategies). They range from strategies as simple as a ‘token fund’ trying to actively trade the largest tokens to extremely sophisticated ‘quant funds’ that make their money by paying to front-run other market participants.

Direct Investments (Venture Capital / Private Equity): Investments in  the equity of companies that are active in the world of crypto. In the private equity sense, that might be investing in infrastructure to mine bitcoin. In the venture capital sense, it could range from investing in crypto technology providers (i.e. wallets, analytics, etc.) or in companies that try to build crypto-native projects (i.e. a new blockchain or a DeFi trading tool).

Illiquid Funds (Direct Investments, Token Investments): As counterpart of the active liquid strategies, (VC) funds make diversified bets into the equity and/or tokens of specific crypto projects/companies. As usual with VC, they might range from early-stage all the way to late-stage, established projects.

Now that we know the categories - how do investors think that they stand to benefit from the crypto theme through the respective sub-asset class?

Outright token purchases are the most straightforward way to benefit from the theme. Investors are directly exposed to (hopefully positive) changes in price of the respective token. The general idea is that especially large tokens such as Bitcoin or Ethereum allow investors to capitalize on the technological trend as a whole, as investors would need the respective token to participate in the use cases built on their respective blockchain.

Active, liquid strategies seek to capitalize according to the underlying strategy. ‘Long-only’ crypto funds try to outperform the outright token purchase through active trading, i.e. achieving higher returns and/or lower risk. ‘Market neutral’ strategies try to implement strategies known from traditional financial markets (i.e. arbitrage, carry trades, etc.) as well as crypto-unique strategies (i.e. DeFi lending, staking) to generate ideally ‘risk-free’ returns, both of which one would expect to be higher given crypto’s novelty. 

Direct investments in equity or tokens, and directly or through a fund, aim to capitalize on specific projects and companies. While also betting on the crypto theme as a whole, they try to make differentiated bets that might generate excess benefits over larger tokens (i.e. a certain DeFi project on top of the Ethereum blockchain) or that might benefit regardless of price movements in the crypto markets (i.e. infrastructure or analytics providers). 

Implementing Crypto in Multi-Asset Portfolios

So let’s get to the final question: How should we implement those sub-asset classes, using our often-mentioned Aspirational Investor Framework? It is worth noting that I always assume that we are talking about properly screened, high-quality investments - if I talk about an actively managed, liquid crypto fund, I assume a product of institutional quality, and not your co-worker’s friend’s cousin trading crypto in his Binance account. Also note that you should think about your overall exposure to crypto - but more on that at the end.

First, market-neutral, liquid strategies. If done right, I would essentially categorize them as hedge fund strategies, which we typically see as a building block in the Market Bucket.

Second, crypto-exposed venture funds. In theory, crypto VC funds should have some mechanism that make them slightly different from regular VC funds, the most important one being token investments, which might offer liquidity in a project/company sooner than would be the case with a regular business. However, in the absence of a ‘crypto summer’, their liquidity profile remains essentially the same, their return profile somewhat dependent on the crypto theme’s performance as a whole (as similar to any other theme, whether it’s defense, longevity, or something else). Assuming you are investing in crypto VC funds as part of a larger VC fund portfolio, I would also categorize them in the Market Bucket - if you are making just an exploratory singular investment, they fit clearly in the Aspirational Bucket.

Third, direct crypto investments. While the underlying risk profile depends somewhat on the respective company, I personally find crypto projects - even revenue-generating opportunities such as crypto miners - to be comparably risky given crypto’s still-not-fully clear direction, and hence, would categorize them in the Aspirational Bucket. But beyond that, it’s worth noting that most direct investment portfolios, crypto or not, tend to be under-diversified - which would also keep us from seeing them as part of the Market Bucket.

And lastly, crypto tokens. Admittedly, a hotly debated topic with clients, at least in the case of major tokens such as Bitcoin or Ethereum (but of course not for meme coins). In their view, BTC and ETH have become so large and wide-spread that it’s unlikely for them to go away entirely, almost becoming something like a digital Gold. On the other hand, as we had said initially, crypto is extremely volatile - which would speak against adding it to a long-term, diversified portfolio. And that is also where we remain sentiment-wise for now: While we do think a small allocation to crypto can make sense as a speculative bet, the combination of volatility, short track record and lack of fundamental value makes it hard for us to properly implement in a diversified portfolio - and thus, leaves us placing it in the Aspirational Bucket.

Sizing Your Allocation to Crypto

But now, to the final question: How should you think about crypto exposure as a whole?

To a degree, this depends of course on the sizing of your respective Buckets. Outside the overall crypto trend, you should always make sure that your Market Bucket is sized in a way in which it can sustain your long-term lifestyle, after inflation, either from today (if you are already investing with a substantial sum) or for your later retirement (if you are still saving up today). 

Take the question of sizing market-neutral crypto funds: First, you need to size your Market Bucket. Second, you need to find your desired illiquidity budget (as most hedge fund strategies are at least semi-liquid). Third, you need to decide how much of the illiquidity budget is allocated to hedge funds - and lastly, how much of that you want to allocate to one crypto-exposed strategy. The same applies to crypto VC funds in a diversified fund portfolio.

To a degree, it becomes easier to think about direct investments in crypto-exposed companies and tokens. All of them are (at least in our view) investments with considerable risk of losing all of your invested capital - which conveniently is not so much of an issue in an appropriately-sized Aspirational Bucket, where you might have that risk level for every investment, ranging from ‘regular’ direct investments to volatile option bets to your own early-stage company.

However, in that case, we should then think about the overall exposure to the crypto theme. With any theme, whether it’s (once again) crypto, defense, longevity, or another topic one might call ‘flavor of the day’, we should make sure that we are not ever overallocated to a singular trend. Admittedly, there is no exact science here in finding the right percentage - it depends heavily on your view on crypto and general readiness to take risks.

Perhaps it helps to finish this article with a data point: In portfolios of investors that we’d categorize as more risk-taking than risk-averse, we typically see crypto allocations ranging from 1 to 5%, with most of that allocation to large coins (BTC, ETH, etc.).  

And instinctively, that seems like the ‘correct’ amount to us as well. If their portfolios are otherwise properly structured (i.e. with a properly sized and mostly liquid Market Bucket) and they are in no need of selling those assets for personal cash requirements, a 1-5% allocation to crypto, whether that’s coins, VC funds, or some other investments seems about right. 

It is more likely that number will change in the future - continuing to be as volatile as the crypto prices. For now, we remain cautiously curious.

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