The case for strategic allocation to tokens

Hello I’m Inigo Fraser Jenkins from Alliance Bernstein and in this video we discuss our recent research on tokens and their role in investing.

We make the case that crypto, and ultimately other tokens, deserve a place in institutional portfolios. The first step to this is the role of crypto currencies in strategic asset allocation. The second step is the broader role of tokenized assets in a way that ultimately subverts asset classes as a unit of allocation. In our research we also discuss the broader social and political aspect of Crypto.

The starting point for these narratives is the observation that public debt as a proportion of GDP is at its highest level since the end of WWII across the G7. In fact, the level of public debt is at a level for developed economies that has only previously been seen in times of existential conflict.

However, the financialization of the economy and levering up of public finances in recent decades has not resulted in a trend improvement in productivity. Despite some of the recent predictions for AI, we think it is unlikely that it can sufficiently counteract other downward forces on growth such as shrinking working age populations and deglobalization. The result, is that real growth is unlikely to be sufficient to resolve this debt issue. We think that the politically most expedient path will be to let inflation erode the real value of the debt.

We see this as a force that acts in concert with other inflationary forces in the form of deglobalization and demographics and points to a higher level of equilibrium inflation than the norm that has shaped investors expectations in recent decades.

Alongside this, there are geopolitical reasons why the recent elevated level of central bank gold buying is likely to persist. This is linked to the ongoing attempt at de-dollarization and heightened geopolitical tension. While we do not think that de-dollarization will be successful in the near term, it does imply upward pressure on demand for gold.

It would be blinkered to consider only the macroeconomic role of digital tokens, after all part of their role is a social one too.

One big open question is about the future of jobs in a world of AI. We do not yet know what AI does to the bargaining power of labour vs capital. But alongside that issue tokens have a role to play as well. In our research note we discuss cases where workers are paid in tokens and suggest that were that happens it can further diminish the power of labour.

However, crypto currencies in particular, can play a positive social role as well. For example, they can allow access to money for people in parts of the world where the banking system is not well developed. They can be equally essential for those who are denied banking access in countries more generally, often these are some of the most marginalized people in society.

This does has to be offset against concerns over the power consumption of bitcoin at least. Although given the enormous growth in projected power demand of AI, bitcoin mining consumption is now only a small part of tech-led additional power consumption.

The social and political elements of the emerging role of tokens amounts to a challenge to the nature of money. In the age of fiat currencies one of the key features that gives money value is the requirement to pay taxes in it. On that basis crypto has a disadvantage as it is highly unlikely that any major economy would allow that. There has also been a backlash against non-sovereigns that try to launch currencies, as has been the case with Diem in the US and QQ in China.

Nevertheless, gold as similar disadvantages and that has not stood in the way of rising allocations.

Turning to the role of digital tokens in strategic asset allocation, we make the case that there are two distinct steps. The most immediate is the case for crypto currencies, the longer term one though is really a case for tokenized real assets.

We think that the investment case for crypto in SAA is not really the blockchain technology itself, but the macro context of higher inflation and levels of public debt.

This is primarily a case for gold. In a lower real return world, we think that investors may have little choice but to increase their allocation to real assets including public equities. However, as we have explained in other research, bonds are unlikely to perform a diversifying role in the regime that we expect.

A key advantage of gold is that its correlation to equities is invariant to inflation level. If this macro context creates space for gold, can it create space for other non-fiat zero duration assets?

We are suspicious of attempts to value crypto currencies, but instead one can perform a scaling exercise. The value of gold held for private investment, excluding central bank assets and jewellery, is $4 1/2 trillion. The value of all crypto currencies is $3Tn. There is no reason why there has to be a set ratio between the two, but our suggestion is that as the value of gold held for investment rises then it creates more space for the value of crypto to rise.

Over the last two centuries, the real return of gold has been only 0.2% pa, so the main case for it is diversification. Though extra return is possible driven by central bank buying. Likewise for crypto it would be the impact of institutional allocation moving from zero to anything non-zero that is the basis for any additional benefit from returns.

We have long been positive on the case for gold in strategic asset allocation, alongside an overweight in risk assets. We added a position in crypto to this view late last year on the basis that the new US administration likely gives a path to greater regulatory clarity for digital assets. Also supportive for this view - albeit for a less positive reason - is that the policy path in the US also implies greater fiscal uncertainty.

Many meetings with CIOs on this topic in recent months shows that there is no consensus whatsoever amongst institutional investors. Our polling of investors implies an even split between those who think crypto assets offer strong returns and those who think it is worth zero. Unlike the ubiquitous view to overweight US assets, this is a topic on which investors strongly disagree.

Beyond this, though, we think that the larger role of digital tokens in asset allocation lies in the tokenization of real assets

As with crypto, it is not the technology, per se, that is the basis for our view. Instead, the case is grounded in the macroeconomic context of investors needing real assets and at the same time, continual worries about liquidity. Many real assets - aside from public equities - are illiquid. The promise of an ability to fractionalize such assets opens the possibility of improving liquidity. An additional benefit is that it allows investors to more easily craft a desired asset allocation and to adjust it to respond to a different regime.

As mentioned, the bigger picture is that, ultimately, tokens subvert the asset class as a unit of allocation, allowing a shift in the design of portfolios.

Thank you for your time