The rise of multi-asset crypto ETPs

Industry participants weigh the merits of applying an indexing approach to crypto exposures

Jamie Gordon

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Cryptocurrencies have enjoyed quite the ride since bitcoin launched in 2009, however, is individual coin selection the right route going forwards or should investors opt for a more diversified way of capturing the fast-maturing market’s growth story?

Four years after its debut, the world’s largest crypto was trading at around $4 apiece, just one ten-thousandth of its value today. Over that time period, the market has seen headlines spanning from money laundering, cybercrime and scams to the beginning of institutional adoption, comparisons to stores of value such as gold and most recently, some of the world’s largest asset managers racing to launch their own cryptocurrency exchange-traded products (ETPs).

The virtues of bitcoin and its counterparts remain hotly contested but most are in little doubt the crypto concept is here to stay. The questions many are now trying to answer include whether it is worth capturing the whole crypto market and – more importantly – will bitcoin’s relative maturity mean it cedes its reputation for massive upside potential to one of its more up-and-coming peers?

While a slew of ETPs have launched over the past couple of years offering targeted exposure to individual mid and small-cap coins, another development has been the rise of crypto basket ETPs.

According to James Butterfill, investment strategist at CoinShares, the tenth-largest coin by market cap is only a hundredth of bitcoin’s size. Although this raises potential issues with the liquidity and efficiency of trading such coins, in crude terms, it also illustrates how biased asset flows are to one token – with some sophisticated and still-developing protocols yet to receive even a fraction of this attention.

Already savvy to this opportunity, CoinShares data shows 19% of all new investor money in crypto ETPs went into multi-asset products in 2021. They have also become the weapon of choice for many buy and ‘hold on for dear life’ (HODL) investors during the crypto correction of the last few months, with multi-asset ETPs attracting $59m inflows during the first six weeks of the year while ethereum ETPs suffered $98m redemptions.

Diversification tool

This investing-over-trading behaviour is supportive for the case that crypto has staying power but it also underlines a strength of the multi-asset approach.

Highlighting how baskets seem more “immune” to negative sentiment, Butterfill said: “This suggests that investors are using them for a diversification tool to take advantage of the perceived safety in numbers idea, and also it is likely some are wanting to gain alpha from the smaller coins that have high positive momentum.”

Agreeing with the first point about diversifying risk, Bernhard Wenger, head of Northern Europe at 21Shares, said his firm is seeing “a lot” of client demand for more diverse crypto allocations as most investors are not sure who the next winner in the crypto space will be.

In a similar vein, Martin Leinweber, digital asset product strategist at index provider MVIS, added: “In crypto we are in the equivalent of the early 1990s with the internet. Maybe we have not seen the ‘Google’ of crypto yet.

“An index brings investors many advantages. The composition of our top 10 index in 2014 consisted of bitcoin but then the other coins were just ‘shitcoins’. If investors had bought and held that portfolio rather than adjusting with market caps [as many baskets do], they would have underperformed almost everything.”

However, while saving investors the stress of trying to pick winners, multi-asset crypto ETPs might end up creating opportunities for those who believe bitcoin’s mature protocol status may see it struggle to keep pace with its younger competitors in coming years.

Leinweber continued: “The return potential for bitcoin is going down between halving cycles. As bitcoin is getting larger, investors will not get those 1000x returns again. Upside volatility is lower and lower.

“Last year, bitcoin performed ok but no comparison to other smart contract platforms which outperformed massively. Going forward, if investors want to capture the whole crypto potential, it makes sense to invest in more than just bitcoin.”

Bitcoin by another name?

For now, however, multi-asset ETPs seem to be doing little more than shadowing the performance of bitcoin, albeit with greater volatility.

Jason Guthrie, head of digital assets at WisdomTree Europe, says the whole crypto market is still very correlated.

He explained: “Crypto assets do have a relatively high correlation except for when there are events that affect each individual one, however, events that affect the whole crypto market tend to affect all cryptos in the same direction.

“Bitcoin is typically the least volatile of the assets within a very volatile asset class. When the market is moving up, different coins tend to move upwards quicker than bitcoin. When the market is moving down, they tend to fall faster.”

Over time, Guthrie said the increasing number of coins in a multi-asset crypto ETP will have the traditional impact of diversification by reducing volatility, as sell-offs in one asset are offset by gains in another – unless there is a broad market sell-off, of course.

Butterfill added: “As the crypto market matures, it is likely we will see greater price divergence as investors begin to distinguish the fundamental differences between different coins and other assets.”

Part of this, MVIS’s Leinweber argued, will come from Web3 sectors such as decentralised finance (DeFi) and non-fungible tokens (NFTs) requiring a base layer to perform their applications – a role he does not believe will be fulfilled by bitcoin.

“Bitcoin will not have the flexibility of all the other ‘level-ones’ in terms of building interesting digital applications. The market needs others such as ethereum, solana, cardano or polkadot, for example.”

Looking for diversification from bitcoin elsewhere in the crypto ecosystem, Dr. Mattia Rattaggi, chairman of active crypto ETP issuer FiCAS, said on ‘level-two’ tokens: “We have observed that attempting to achieve effective portfolio diversification by adding to the portfolio second-tier coins and crypto assets or assets that represent business cases in particular trendy sectors has rather increased the volatility of the portfolio – precisely because the asset featuring lower correlation with bitcoin also tend to display a volatility higher than bitcoin.”

Running a multi-asset portfolio

Should an investor decide in principle a multi-asset approach is their preferred way to gain exposure to crypto, the next and less familiar step for many crypto ETP investors is to consider which index methodology suits their needs best – for instance market-cap-weighted, equal weight or mid-caps.

In an asset class as volatile as crypto, how a portfolio manager handles index rebalances will have a significant impact on a product’s performance.

While some favour the more hands-on monthly rebalancing methodology, the consensus from those responsible for creating the products is either quarterly or semi-annual rebalancing is sufficient.

Speaking on the potential dangers of rebalancing too often, WisdomTree’s Guthrie said: “I do not like that something pokes its head into an arbitrary ranking or market cap level and gets included on a monthly basis to then lose 60% the following month.

“What people are after is diversified exposure to the established end of the spectrum and taking out that potential churn from a volatile market is an important feature.”

Guthrie also pointed out the costs inside a product – from fees, trading costs and churn – can “create a drag and they compound over time”.

While these costs are currently dwarfed by the sheer scale of upside and downside volatility, such returns trends could diminish over time as the asset class matures.

For now, though, trading costs within a portfolio are a valid concern, given transacting smaller-cap products means dealing with assets with less volume and liquidity, which could contribute to inefficient trading.

Despite this, Jacob Lindberg, co-founder and CEO of crypto index provider Vinter, argued the methodologies underlying multi-asset baskets are easily worth the money.

“Rebalancing is a net positive as professional investors conduct these processes. It is their sole job to run portfolios and make markets. It would be very hard to run this kind of index fund by themselves.

“They would have to move from cold storage to the exchange, figure out what your current weights are and how much US dollar value you should have in each coin, then rebalance accordingly.

“They might incur not only fees but also slippage. If every investor did that, it would take a lot of time and effort, especially if they are handling five to 10 different coins.”

Lindberg concluded: “A multi-asset approach is more expensive [than single coin ETPs] but honestly they should be even more expensive than single coin, because they are a lot more complex to build and to manage and to think about a reasonable theme.”

What is next?

In the relatively new crypto ETP space and the even newer crypto basket range, it is almost unfathomable to think the market could soon see more innovation in a product class that simply did not exist just a few years ago.

Some of this may come as extensions of innovation already occurring in single coin exposures. For instance, staking is becoming a feature of many ETPs and may act as a way of offsetting the higher fees charged by multi-asset ETPs.

WisdomTree’s Guthrie said: “It is a very interesting area and a unique feature of the asset class – it is definitely something we will see coming into products and something we are actively looking at.”

In fact, both MVIS’s Leinweber and WisdomTree’s Guthrie said their firms are looking at incorporating yield and staking into their index and ETP products.

Last month, CoinShares launched two products advertising potential staking yields of 3% and 5% per year, respectively. These sums are generated by investors putting their assets to work in a pool of the digital currency, which accrues yield by validating transactions.

Another avenue for innovation could be the growth of active or semi-active management of crypto baskets.

On the possibility of launching such products, Wenger said: “That is something that might happen in the future but we believe in passive for the time-being. It is important for the moment that an investor has a transparent allocation to the asset class that does not have too many transactions.”

Unsurprisingly, FiCAS’s Rattaggi thinks the next step for investors after gaining access to crypto ETPs will be to seek out expertise.

“They will be attracted by active management knowledge and knowledge of portfolio compositions,” he argued.

Finally, one key trend to watch in multi-asset crypto will be the arrival of thematic and sector-related products, a consensus across all issuers and index providers.

Leinweber explained: “We are pushing hard for sector indices, where we classify the whole crypto universe into segments such as store of value, smart contracts, infrastructure, DeFi, metaverse and so on.

As part of this, Vinter’s Lindberg said he expects to see the incorporation of a greater breadth of data into index design, ranging from market caps, trading volume, staking yield, blockchain metrics, social data, developer activity data, price and total value locked.

He added we might even see proof-of-stake (PoS) and delegated PoS protocol thematic ETPs, which could claim to be the first diversified, environmentally-friendly crypto products on the market.

This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To access the full issue, click here.

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