The article in front of you offers a comprehensive overview of the current state of the crypto ecosystem, highlighting its dynamic characteristics, financial and investment opportunities, and the challenges it faces. I have written it at this time for three reasons:
- Because the crypto spring is starting, it will be hard to be heard in the noise that will be created, and
- A significant milestone occurred in August, marking five years since the portal 2100News, based on the collection of market data about the crypto ecosystem, established criteria with the family of 2100News crypto indices by which the crypto ecosystem can be measured. Five years of data also mean that the standard conditions for using standardized measures, commonly accepted and used to evaluate the performance, risk, and characteristics of investment portfolio returns, help investors and managers determine how well a portfolio performs compared to specific benchmarks or expectations.
- Because the halving of the reward for mining new blocks (transaction verification and adding to the blockchain) is approaching. This is part of Bitcoin’s monetary policy, built into its code, and is an event that happens approximately every four years. Because this event causes cyclicality in the crypto ecosystem, similar to Earth’s orbit around the Sun, a comparison with the seasons has been born. You have probably heard or read about the crypto winter a year or two ago, but now we can talk about the crypto spring.
Of course, this article is a verbal description of the topic. Still, it must be read and understood in conjunction with the empirical research on the crypto ecosystem: Navigating the Waves (from now on *Research). Therefore, the reader can look at the justifications of the written view in this empirical research, which contains a series of calculations, tables, and comparisons.
Typical critiques of cryptocurrency opponents are:
- Due to volatility, Bitcoin is useless as a means of payment, as almost no one pays for a drink in a tavern or bread in a store with Bitcoin.
- It is a game of greed when, with each cheaper purchase, you hope that with each more expensive sale, you will find someone greedier than yourself, who expects the same for themselves in the next iteration as you did in the previous one.
Unfortunately, such generalized assessments usually rely not on numbers but on people’s perceptions and the repetition of what is heard. Nevertheless, the numbers show an entirely different picture from these general claims. I will not directly respond to these critics in the article but list a series of facts that show my view, and the reader will decide which drawer to put this information in.
The crypto ecosystem is a dynamic and continuously developing space combining technology, finance, law, and community to create a new way of doing business and interacting digitally. It is comprised of the following segments: Blockchain Technology, Cryptocurrencies, Mining and Transaction Validation, Exchanges and Trading Platforms, Wallets, Developers and Innovations, Regulatory Framework, Community and Users, DeFi (Decentralized Finance), NFTs (Non-fungible Tokens).
However, we are interested in the abovementioned elements and how this system operates primarily from a financial and investment perspective. In this view, I present it as a distributed (decentralized) Economic Business Community for global “production” of service execution, which has issued its non-sovereign means of currency (Bitcoin).
It is also essential that the system acts as a global accelerator or promoter of startups (ICOs) for the globalization of services. Many newly established startups that issue crypto tokens try to break through with innovations and energy every year. In the last twelve months, more than 5,500 new tokens and coins have been registered in the 2100News database. These are usually tiny startup companies; the average market capitalization is around half a million dollars. Along the way, two more “innovations” have emerged:
- Tokens, which are traded on exchanges, show the market value of a startup or scaleup company. Before 2017, only a complex evaluation process was conducted, and the market value was demonstrated only during capital injections.
- The token is essentially related to the company’s turnover, while the share is associated with the company’s cash flow or profit. Investors now have the opportunity to invest in an instrument that is tied to turnover. This is particularly important for young companies with potential turnover growth but are not yet profitable and, therefore, have “strange financial indicators,” e.g., P/E 100. Amazon was like this twenty years ago, or Tesla was a few years ago.
Suppose we want to guess the economic mechanisms of the crypto ecosystem’s functioning and use it to gain benefits. In that case, we must decompose it into components during the analysis process, study these components and their connections, and find procedures for gaining benefits.
In the *Research, we have examined the components by various criteria, but here, let’s look at the division by size. On the diagram, “glass,” we have shown volumes, which represent the size of the components of the crypto ecosystem, from top to bottom: Bitcoin – means almost half, Ether one-sixth, followed by the next most significant hundred coins, which compose or are collected in the 2100News index (NWSL100) of large capitalizations, then track those coins and tokens that make up the indices (NWSM200) and (NWSS300).
With the rest, we have marked nine thousand four hundred coins or tokens, which are ranked by size below the 603rd place and represent just over one percent of the crypto ecosystem by size. This part is located in the global accelerator of startups.
The cylinder represents stablecoins, about one-tenth of the crypto ecosystem by size. In content, they usually exchange fiat currencies (mainly dollars) into one of their digital forms (the largest is Tether). These coins represent a transactional connection or bridge between the traditional financial world, where dollars, euros, pounds, etc., are the means of payment, and the crypto ecosystem.
We can quantitatively describe investment characteristics using standardized investment performance metrics in portfolio management and investment analysis. Measurements were conducted within the crypto ecosystem, and calculations were made against the NWST1100 crypto index. The second part of the measurements was carried out by comparison with capital markets and the benchmark of the American index SPX500, which covers almost half of the world’s wealth in the capital markets. From the conclusions in the *Research, we can summarize that crypto investments have proven to be an excellent investment class for supplementing portfolios containing investments in capital markets over five years. Although they are two to three times more risky than capital markets, their profitability is so great that it covers all these risks and adds much greater profitability for the accepted unit of risk than can be achieved on capital markets.
The time dynamics of the ratio between Crypto (digital assets) and global stocks mainly alert us to the magnitude of fluctuations; it’s not just a few percentage fluctuations, but for example, a drop in the ratio from a value of 16.31 to 3.94, which represents a 75% reduction in the ratio. On the other hand, according to the theory of returning to the average, growth is expected in a bullish trend, which can be expected to reach 400%! This considerable dynamic is primarily a result of the structure shown in the figure. During a bull trend, fiat money flows into the crypto ecosystem. It was first accepted by Bitcoin, partly also by Ether. The area below them, which represents scaleup and startup companies, is half their size, so this money causes several times greater pressure on price increases, similar to what we saw last year with the price of gas in the EU. A similar rationale applies to the significant drops in a bearish trend.
Engineering Combinations: Money – Crypto – Stocks
- With the Comb1 portfolio, we confirm the thesis that with the broader spectrum of profitability of the crypto ecosystem, we can make investments similar in risk to those on the capital markets but achieve much better properties by standardized measures. The Comb1 portfolio has only a beta of 0.17, similar risk expressed by the standard deviation, and a similar maximum decline, but the following lines in the column place it on the podium, as it has:
- Two and a half times higher annual profitability, 20.25% higher Jensen’s alpha,
- An incredibly higher reward for the accepted unit of risk (Sharpe and Treynor ratios)
- The Comb2 portfolio shows why the world’s largest capital manager, BlackRock, wants to obtain SEC permission for financial instruments (ETFs) to add Bitcoin and Ether to its clients’ portfolios in the capital markets. By adding one-tenth of crypto investments to such a portfolio, we increase the annual profitability by 40% and, at the same time, increase the profitability per unit of accepted risk. The column shows that this addition is justified and appropriately rewarded.
- The Comb3 portfolio shows that if we want to maintain the portfolio’s beta approximately as SPX500 has, we leave 10% of the money uninvested. This combination is better by all measures than a portfolio composed only of capital investments.
The crypto ecosystem represents a unique and rapidly developing financial sector and is also an emerging class of assets suitable for inclusion in diverse investment portfolios. However, the inherent risks and volatility require a careful and informed approach to investment. This article contributes to a more nuanced understanding of cryptocurrencies, offering insights to investors and financial analysts in navigating this dynamic market, aiming to understand and exploit the complexity of the crypto ecosystem for informed investment decision-making.