Blockchain equities have exploded in recent months, driven by the bitcoin rally which has seen many companies post three-figure returns since the start of 2021. 

One product capturing much of this upside has been Europe’s only ETF offering direct exposure to blockchain, the $1.1bn Invesco Elwood Global Blockchain UCITS ETF (BCHN), which has increased in size by more than 35% year-to-date, courtesy of $382.7m inflows, according to data from ETFLogic.

BCHN’s popularity was most pronounced in the week to 19 February, in which the ETF saw inflows of $163.1m, pushing its AUM up by almost 15%. 

Demand for the product has also been reflected in its performance with returns of 49.6% year-to-date, adding to the 95% rise in 2020.

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Underlining this was the performance of the ETF's top holdings - Canaan, Silvergate Capital, and MicroStrategy - which, at their respective peaks in February, were worth around five times what they were just three months earlier.

Analysts highlighted the main cause of this bullishness as being the feverish surge in crypto valuations, with bitcoin jumping from $9,688 to $54,123 during the twelve months to 22 February. Likewise, the currency has surged 85.1% during the year-to-date. 

The latest bitcoin resurgence was fuelled by reports that institutional investors had begun buying into the currency, with initial excitement compounded by the likes of PwC which pointed to professional buying as the driving force behind crypto hitting “record levels”.   

As this excitement began to wear off, Tesla revived the bitcoin buzz by declaring that it had invested $1.5bn in the alternative currency – which in turn gave its rally enough steam to add an additional $20,000 to its valuation since the start of February. 

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With investors of all levels of sophistication pouring in to chase an opportunity seemingly too good to miss, blockchains – in their capacity as the digital ledger for crypto mining and transactions – have been operating across more than 12,000 nodes to facilitate the safe and traceable trading of bitcoin on a global scale. 

However, despite a number of positive developments in recent months, there is a growing feeling among analysts that the higher bitcoin climbs, the more it will take for the hype train to keep rolling.  

And, should new, sensational headlines fail to materialise to sustain cryptos’ currently inflated valuations, one gets the sense that the ominous dot com bubble comparisons become increasingly apt. 

As Barnaby Barker, investment analyst at SCM Direct, said: “Blockchain technology is undeniably a useful form of encryption, however the recent valuation of both blockchain companies and cryptocurrencies appears to have been driven by speculative excess rather than fundamentals, with FOMO appearing to be a core driving factor. 

“History may not repeat itself but it has a rhythm, and there are many similarities between the current blockchain/crypto boom and the tech boom of the early 2000s.    

“The latest “Fad” ETFs appear to rely on greater fool theory, whereby they can only be justified on the basis that an even greater fool will come along to pay an even higher price.”  

Aside from its high valuation and illiquidity, investors should also be worried about bitcoin’s historical volatility, with the asset having dropped from $18,640 to $6,332 in less than two months between 2017 and 2018. 

Commenting on the crypto’s recent surge, Ben Seager-Scott, head of multi-asset funds at Tilney, said: “The result has been a very volatile ride, and there are vanishingly few assets I know of that have rocketed without a fundamental investment case (including valuation considerations) and have stayed at such elevated levels.” 

With alternative currency trading at unprecedented volumes and crypto ETPs making their debut in North America, investors should also be wary that such activity will attract the gaze of regulators. Should this lead to further, new restrictions – following the FCA’s ban of crypto ETNs being sold to retail investors – this would incur downside risk to the current valuations of crypto assets. 

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Even avoiding a repeat of the events of 2017, bitcoin’s current price is hard to justify. It would not be unreasonable to predict a correction, and this, in turn, would see blockchain equities reverse a good portion of their recent gains. 

It is certainly true that blockchain has applications outside of cryptocurrency and will likely claim an increasing share of financial services’ back-office functions in coming years, as highlighted by Chris Mellor, head of EMEA ETF equity and commodity product management at Invesco.

“BCHN invests in a wide range of stocks exposed to different forms of blockchain technology, from token investment and cryptocurrency mining plays at one end of the spectrum through to enterprise blockchain in financial services and technology at the other,” Mellor added.

One challenge for BCHN, as highlighted by Laurent Kssis, managing director of 21Shares, is the majority of pure-play blockchain companies are yet to publicly list so are not available to be included in the basket.

“Instead, most companies with the potential to generate earnings from blockchain have well-established businesses in other areas, and blockchain merely presents an additional source of revenue,” Kssis said.

BCHN’s top five holdings have all more than doubled in the year-to-date illustrating just how directly the performance of blockchain equities are dictated by the crypto market.

Likewise, with bitcoin falling 5.4% on 22 February, BCHN’s three largest holdings fell by 15.9%, 5%, and 9.1% apiece during the same day.

Unfortunately, this means that for now, we should view the short-term prospects of blockchain the same way we look at assets like bitcoin. While the technology could well have a meaningful role within mainstream finance in the years ahead, its close correlation with crypto currently makes it a speculative investment – and one that is due a decline. 

Offering some hope, Barker concluded: “I wouldn’t be surprised if there is a major correction, but feel that once we do, there will still be underlying demand for these companies (strongest will survive) until the next encryption technology arrives.”

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