How the investment thesis for crypto has changed

The investment thesis for cryptocurrencies like Bitcoin has changed in 2022 as the sector has plunged alongside tech stocks, experts suggest.

In previous years, Bitcoin has been framed as “digital gold” and an asset class that has little to no correlation to others.

However, in the first half of this year, the digital currency has been increasingly correlated to equities and other risk assets. Despite a slight rally in recent days, Bitcoin was down 36% year-to-date as of market close on Tuesday. Tech stocks such as Amazon, Netflix and Meta Platforms (formerly Facebook) are down about 32%, 68% and 40%, respectively, year-to-date.

Last Thursday, Bitcoin plummeted below US$26,000 for the first time since December 2020. More than US$200 billion was erased from the market that day alone.

Alex Tapscott, managing director of the digital asset group at Ninepoint Partners, which manages the Ninepoint Bitcoin ETF, has observed the increasing correlation this year between Bitcoin and tech stocks.

“That tells me a couple of things: one, it’s an asset class that’s more widely held. It’s held by a lot of institutions, it’s quoted in mainstream media. So it is beginning to trade like a more conventional financial asset,” he said. “But it’s also a little disappointing, because one of the big attributes of Bitcoin, historically, has been that it’s uncorrelated, which can improve measures of risk-adjusted returns when added to a portfolio.”

Tapscott said he thinks Bitcoin will regain that role of being an uncorrelated asset over the medium and longer term. “But it is clear that during times of financial stress, in all markets, that it does begin to converge on the performance of other kinds of assets.”

Greg Taylor, chief investment officer at Purpose Investments, said a certain type of investor could be contributing to Bitcoin’s turbulence.

“It feels like a lot of the investors that took on more risky positions — whether it’s in technology, or startups, or private assets — also hold Bitcoin. So those parts of the portfolio are being hit,” said Taylor, whose firm manages various Bitcoin and Ether ETFs.

“It could also be that they’re just selling anything to make margin requirements or to pay bills.”

According to April Canadian ETF flows data from National Bank, cryptoasset ETFs had the “worst monthly outflow” since their inception in February 2021, with CAD$338 million in outflows.

Despite last Thursday’s dramatic drop in Bitcoin, Taylor said there haven’t been a significant amount of outflows for any of Purpose’s crypto funds. In fact, he said one day last week, the company had its “biggest day of inflows” for its Bitcoin ETF in U.S. dollars.

“Given the space and the volatility that we know, there was probably a little bit of ‘buy the dip.’ People have been targeting Bitcoin to come back to $30,000. So when it hit that level, that’s where we saw some buying come in,” he said.

Amy Arnott, portfolio strategist at Morningstar, wrote an article in April about whether crypto is truly a portfolio diversifier.

Arnott noted Morningstar’s 2022 Diversification Landscape Report, where the firm examined how different asset classes performed and how correlations between them had changed in the past couple of years.

“We found that while cryptocurrency has an unusually low correlation with traditional asset classes, its volatility makes it tough to use in a diversified portfolio,” she wrote.

Arnott cited the CMBI Bitcoin Index’s 2021 performance, noting how it was up 104% in Q1, then dipped 40% in Q2, then gained 25.3% in Q3 before falling into the red in Q4 as high-risk assets sold off in December.

“These dramatic performance swings have continued in early 2022,” she wrote.

“Diversification value is one potential reason to add cryptocurrency to a portfolio, but investors should also consider other factors, such as their ability to hold on through crypto’s periodic downdrafts, which have been unusually swift and severe.”

Despite the recent crypto volatility, Tapscott said Bitcoin has been a good long-term diversifier and has “demonstrated an ability to improve risk-adjusted returns.” And the run-up until the last few months has been astounding, if volatile.

Tapscott cited data released last year by Charlie Bilello, founder and CEO of Compound Capital Advisors, which showed that from 2011 to 2021, Bitcoin was the best performing asset class over the 10-year period, with an annualized return of 230%.

Bitcoin was trading above US$60,000, near its peak, at the time of the study, and a lot of its gains came during the pandemic when tech stocks also soared. At the beginning of 2020, Bitcoin was trading at about US$7,300.

“We’re still believers that crypto is going to be something that’s going to be with us for a long time. It’s not a flash in the pan — there will be some utility that comes out of this,” Taylor said.

He compared crypto to the dot-com bubble in the late 1990s.

“There were a lot of companies that came out, and a lot that failed. But, at the end of the day, you’re still going to get the Amazons, the Facebooks, the Googles that come out of that,” he said. There’s still some “sorting out” of the crypto market’s winners, he said.

Tapscott and Taylor both acknowledged crypto’s volatility, which is why they’d recommend an allocation of 5% or less for the average investor.