A recent research paper published by ARK Investment Management LLC (Ark Invest) and Coinbase, Bitcoin: Ringing the Bell for a New Asset Class, makes a strong case that bitcoin is “the first of its kind in a new asset class – cryptocurrency.”
Ark Invest’s blockchain analyst and products lead, Chris Burniske, and Coinbase Vice President of Business Development Strategy, Adam White, co-authored the paper, which explores the merits of cryptocurrency as a new asset class for investors.
“Bitcoin exhibits characteristics of a unique asset class—meeting the bar of investability, and differing substantially from other assets in terms of its politico-economic profile, price independence, and risk-reward characteristics.”
– Burniske and White
While the authors of the paper are not the first to suggest that cryptocurrencies represent a bona fide asset class, that investors should be watching like any other, they do appear to be the first to quantify and qualify that sentiment in an investment bank-ready report.
Burniske and White used the definition of an asset class addressed in Robert Greer’s seminal 1997 paper, What is an Asset Class, Anyway? In his paper, Greer lays out three superclasses of assets; capital assets, consumable/transformable assets, and store of value assets, although “the lines between asset classes can still be fuzzy,” Greer said.
The paper outlined definitions of each superclass of assets. Capital Assets are ongoing sources of something of value. Consumable or Transformable Assets have economic value and can be transformed into another asset “but it does not yield an ongoing stream of value,” the paper defines. The third asset superclass, Store of Value Assets, can neither be consumed nor can they generate an income. “Nevertheless, it has value; it is a store of value asset,” the definition reads. Today’s traditional asset classes, including Equities, Bonds, Income-producing real estate, Physical commodities, Precious metals, Currency and Fine art, all fit within Greer’s three superclasses.
Expanding on Greer’s work, Burniske and White introduce four distinct characteristics to “clarify which assets belong in each class.” The four characteristics are Investability, Politico-Economic Features, Correlation of Returns: Price Independence, and Risk-Reward Profile.
“First, we think that an asset class must be sufficiently investable, providing ample liquidity and opportunity to invest. Second, it should have a distinct politico-economic profile that arises from its basis of value, governance, and use cases. Third, an asset’s market value should fluctuate independently of other assets in the marketplace, exhibiting low correlation of returns. Lastly, the prior three characteristics should lead to a differentiated risk-reward profile, which can be broken down into absolute returns and volatility.”
– Burniske and White
For each of the four characteristics of an asset class, the authors make a compelling case, complete with several pages of analysis, for cryptocurrencies to rise to the standards of their traditional peers.
Ark Invest and Coinbase assert that bitcoin has enough ‘investability,’ which they define as “providing ample liquidity and opportunity to invest.” After exploring trading volumes and the number of investors holding bitcoins long-term vs short-term, Burniske and White concluded that “while bitcoin is not yet the most liquid or widely held asset on the worldwide market, we believe its thin market and fringe status is overstated.”
The networks steadily-growing payment volume was a major factor, especially since volumes have started surpassing $1 billion per day lately. Liquidity was another big consideration, with the cryptocurrency being almost as liquid as gold now and far more liquid than the Vanguard U.S. Real Estate Investment fund VNQ, which has eight times the market cap of bitcoin.
“Globally, bitcoin exchange trading volumes are a good measure of the liquidity available to investors,” the report reads, adding that bitcoin trading volumes have been growing steadily “reaching roughly $1 billion per day through the first quarter of 2016.”
Accessibility is also very desirable to the authors. In fact, due to the peer-to-peer nature of cryptocurrency, “As more support infrastructure is built around the network,” they found, “bitcoin may become the most secure and accessible asset available to the public.”
After five pages of analysis, the authors concluded that bitcoin is underrated when it comes to investability. “A surprisingly robust ecosystem has grown in the seven years since its inception,” Burniske and White explain, “giving retail investors the tools and opportunity to drive over one billion dollars in daily liquidity.”
The politico-economic profile of an asset class is derived primarily from three aspects of the asset; its basis of value, its governance, and its major use cases. The paper stated that “in each, bitcoin is distinct from the other major asset classes,” and spent six pages and eleven graphs showing how and why the new asset class has a desirable politico-economic profile.
Comparing all three aspects to Gold’s profile, bitcoin outperforms the precious metal across the board, although Gold also has a large number of proven use cases. Consequently, the authors asserted upfront that bitcoin’s use “potential lies outside the realm of any other asset class.”
Strong transaction volume growth factored into bitcoin’s desirable politico-economic profile
Burniske and White appeared impressed with the unique basis of value for bitcoin. “Holding bitcoin represents a publicly verified claim on an open but limited resource that can facilitate transactions of all kinds,” the report states. It also looks for past success for measuring the basis of value, and it found a few consequential examples. “Compared to bitcoin,” the report mentioned, “no asset has evolved from concept to billions of dollars in stored value so quickly. Moreover, no asset in history has followed such a predictable supply trajectory.”
Correlation of Returns
The correlation of an asset, or the likelihood of its returns going in the opposite direction of the other assets’ returns, is a very important characteristic to investors. It is this aspect that keeps a diversified portfolio safe from loss, more than any others. Since bitcoin started to gain value and the investing world started to take it seriously, many have noted that bitcoin could be used to balance portfolios, due to the asset’s low correlation with other major asset classes.
“Strikingly, bitcoin’s price movements have been separate and distinct from those of other asset classes during the last five years. Bitcoin is the only asset that maintains consistently low correlations with every other asset.” – Burniske and White
ARK and Coinbase calculated the one-year rolling correlations among the various standard assets over the last five years in order to determine the ‘Correlation of Returns,’ which is the third of their characteristics for any good asset class. Bitcoin also shines in this department.
“Remarkably, the maximum correlation, positive or negative, that bitcoin exhibited with each of the other assets is the minimum correlation that any of the other paired assets displayed with each other.”
– Burniske and White
Despite the popular belief held by many in the investing world that bitcoin’s high volatility would make their portfolio weaker, this report has helped clarify and highlight the fact that bitcoin’s ultra-low correlation with the other asset classes makes it among the safest of all assets to put in any portfolio, even above gold.
Saving the most popular category for last, the Risk-Reward Profile of an asset class is the most direct indicator of profitability. Ark and Coinbase spend five pages of the report investigating the Risk-Reward profile, measuring it using the standardized Sharpe Ratio, a measurement of returns per unit of risk taken.
Bitcoin’s Sharpe Ratio over the last five years, beating some asset classes every year and all of them four out of five years
Dividing absolute returns by the volatility, once again, bitcoin has been among the best-performing assets in the world.
In every way that makes an asset class desirable, according to the report, bitcoin and cryptocurrencies come out at or near the top of all asset classes.
Founded by Catherine D. Wood, the former Chief Investment Officer of Global Thematic Strategies for AllianceBernstein, in January 2014, ARK Invest is a registered investment adviser and privately held investment firm. Headquartered in New York City, the company specializes in thematic investing through its open source research process, identifying companies they believe are leading and benefiting from disruptive cross-sector forces and changing how the world works.
This isn’t Ark’s first experience working with bitcoin. In September 2015, Ark Invest announced that its ARK Web x.0 exchange-traded fund (ETF) (NYSEARCA: ARKW) has become the first public fund manager to invest in bitcoin. The investment was through the purchase of publicly traded shares of Barry Silbert’s Grayscale’s Bitcoin Investment Trust (OTCQX: GBTC).
In the conclusion of the report, Burniske and White reiterate what a clearly defined asset class cryptocurrencies have become and look forward to seeing bitcoin and the ecosystem grow and evolve, “differentiate itself further from other asset classes.” The authors admit, however, that five years of study probably isn’t enough to conclude definitively that cryptocurrencies are a legitimate and useful asset class, and pleads with the community to “continue to monitor bitcoin’s behavior in the context of the broader markets.”
“ARK and Coinbase believe bitcoin is the first of its kind in what is rapidly becoming a distinct asset class… In a world where the trend is clearly offline to online, why should financial assets be excused from the transformation?”
– Burniske and White