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Practice Management

Crypto: Powerful Diversifier or Portfolio Kryptonite?

Ted Godbout

While a growing number of investors are interested in cryptocurrencies and the appropriateness of investing crypto in retirement plans is a hotly debated topic, a new white paper suggests they are a poor choice for long-term investors.

The latest crypto collapse, driven in large part by the design of a so-called “stablecoin,” highlights just one of the many reasons why cryptocurrency is an inferior choice for long-term investors, PGIM contends in the paper.

In its latest installment of megatrends research series, Cryptocurrency Investing, the firm explores why direct investments in bitcoin and its peers are currently unattractive in an institutional portfolio—offering little benefit, while adding considerable volatility and risk. Still, the technologies that cryptocurrencies helped spawn present new opportunities for savvy long-term investors, the paper suggests. 

“As long-term investors and fiduciaries on behalf of our clients, three things need to be true for us to add an asset class into a portfolio: the asset needs a clear regulatory framework, it needs to be an effective store of value, and it needs to have a predictable correlation with other asset classes,” says PGIM CEO David Hunt. “Cryptocurrency currently meets none of these three criteria. It’s much more of a speculation than an investment.”?

The firm’s research suggests that cryptocurrency is an unreliable portfolio diversifier and an inadequate safe-haven asset or inflation hedge. Recent risk-adjusted returns are not much different than other asset classes but with more frequent and greater drawdowns, the paper notes. Moreover, the unsettled regulatory backdrop and the significant ESG concerns pose significant additional headwinds for long-term investors.

“Cryptocurrency may be a heroic quest to build a viable, decentralized peer-to-peer payment system, but its pricing is based on speculative behavior, rather than a fundamental thesis around its value or utility,” adds PGIM Head of Thematic Research Shehriyar Antia. “Furthermore, with little evidence to support it as an effective inflation hedge or safe-haven asset, we see no reason for cryptocurrencies to be a part of institutional portfolios.”

Cryptocurrency Myths

In arguing that cryptocurrency is not an effective hedge against inflation, the paper observes that in 2021, the price of bitcoin and other cryptocurrencies moved with inflation only for a brief time before falling sharply. It adds that gold, on the other hand, has demonstrated since the 1970s that it can be an effective and reliable inflation hedge.

Similarly, bitcoin does not function as a safe-haven asset, the paper asserts, explaining that bitcoin, the most prevalent cryptocurrency, was not a steadying force in early 2020 when global asset prices spiraled downward due to worldwide COVID-induced shutdowns, adding that it held far less of its value than conventional safe-haven assets.

Cryptocurrencies clash with ESG objectives, PGIM suggests. The paper observes that a single transaction on the bitcoin blockchain is equivalent to 2 million transactions on the Visa network, or roughly the same energy needed to power the average American home for more than two months. What’s more, from a governance perspective, the anonymity and difficulty in tracing identity of owners makes it a preferred medium of exchange in illicit activity—such as the potential for skirting sanctions in the wake of Russia’s invasion of Ukraine.

Opportunities in Blockchain

Nevertheless, PGIM suggests that the infrastructure and ecosystem supporting blockchains and future central bank digital currencies are areas for opportunity. Collateral innovation in areas such as fraud prevention, regulatory compliance and other key enablers of the broader crypto ecosystem has the potential to generate attractive returns for owners of the companies that provide these services, according to the paper.

In addition, distributed ledger technology and smart contracts can revolutionize elements of financial services, logistics and supply chain management, as they eliminate the need for counterparty and trade verification as well as transaction and record reconciliation, the paper notes.

The tokenization of real estate and infrastructure assets could also substantially reduce costs from transactions and servicing, increase liquidity, simplify transactions, enhance price transparency, and allow more granular portfolio construction, the paper explains.

“Cryptocurrency gets all the breathless hype, but it’s the underlying technology where we find the most interesting investment opportunities,” says Taimur Hyat, chief operating officer for PGIM. “Firms that enable real-world blockchain applications like clearing and settling transactions, preventing fraud, and tokenizing real assets offer significantly greater creation of value over the next decade. The old axiom applies—when there’s a gold rush, invest in shovels and pickaxes.”