When Will Digital Assets Be Ready for Portfolio Allocations?

April 06, 2022

7 min read

Inigo Fraser Jenkins| Co-Head—Institutional Solutions

The role of digital assets in portfolio allocations continues to spur questions from investors, even if these assets may not be realistic opportunities in 2022. Crypto assets, for example, face tactical risks around the near-term liquidity of risk assets, but we see a more positive longer-run case. As far as digital assets go, we think the industry’s more significant longer-term focus will be the role of tokenized real assets in asset allocation.

Tokenized assets are in too formative a stage for institutional investment to consider in the near term. However, the time will come for digital assets in portfolio construction, and, despite recent volatility, we think the likely path is toward greater institutional investment in crypto assets. That makes it important for investors to start rethinking their asset-allocation approach to allow for possible future investment—having conversations about critical aspects such as governance, regulation and portfolio design.

We think 2022 is likely to bring investors more clarity in a number of these areas, but here we’ll focus on the role of these assets in portfolio allocations: the scope and pace of central bank digital currency development, more detail on the level of regulatory acceptance for investment in crypto assets and more tangible steps toward truly investable tokenized real assets.

With inflation front and center among investors’ macro concerns, we believe we’ll see an adjustment this year in long-run inflation assumptions. This shift will reflect the likely path of inflation beyond near-term pressures, focusing on labor-market pressures and changing policy orientations. With this, we think portfolios will likely be adjusted to adopt a more strategic allocation to inflation insurance.

Cryptocurrencies in the Portfolio Context

There’s no empirical evidence yet that cryptocurrencies can diversify inflation or equity beta—they are, after all, still very immature assets. Demand for zero-duration non-fiat assets could grow, especially if central bank policy becomes tolerant of—or even implicitly encourages—devaluing currencies as a way out of current debt levels. Gold would likely be the first port of call, but demand could broaden beyond it.

We don’t think empirical evidence of cryptocurrency’s inflation-hedging properties will emerge over the next year—such a shift, if it happens, will take longer. But, in the broader picture, an environment of higher and more volatile inflation may make fixed income less effective at diversifying equity risk, making strategic diversifiers an urgent need. Gold’s near-zero correlation with equities is robust to higher inflation levels, making it one option. Crypto could play a similar portfolio role in the future, though we stress that any role as a portfolio diversifier would very firmly be a strategic move—not a tactical one.

Cryptocurrencies such as Bitcoin and Ethereum remain more volatile than equities and gold (Display). The correlation between cryptocurrencies and US equities, meanwhile, has been declining from its 2020 peak. However, cryptos maintain a slightly more positive correlation to equities than gold, which has a 12-month rolling correlation of nearly zero. This underlines the point that cryptocurrencies’ ability to diversify remains more a question of long-term potential than tangible reality right now.

Volatility and Correlation of Crypto Assets

Trailing volatility and correlation of cryptocurrencies, gold and stocks

Historical analysis and current estimates do not guarantee future results.
From January 1, 2014, through March 4, 2022
Source: Thomson Reuters Datastream and AllianceBernstein (AB)

Since 2015, the correlation of US equities, gold and cryptocurrencies with US inflation expectations has been close to zero, with occasional upward spikes, such as at the end of 2018 and during 2020. On average, Bitcoin and Ethereum had a slightly more positive correlation to the 10-year break-even inflation rate than gold did. But since July 2021 (Display), the correlation between gold and inflation expectations has become more positive, while the correlation between inflation and cryptocurrencies has drifted lower.

Recent Divergence in Correlations

Historical correlations of cryptocurrencies and stocks to inflation

Historical analysis and current estimates do not guarantee future results.
From January 1, 2014, through March 4, 2022
Source: Thomson Reuters Datastream and AllianceBernstein (AB)

We’ve pointed out before that we don’t think it’s possible to value a cryptocurrency like Bitcoin, but one can conduct a “scaling” exercise. One concern for us is that the total value of cryptocurrencies exceeded the value of gold held for investment purposes for the first time in 2021, although in recent months crypto has fallen to around $2 trillion again (Display). There’s no rule dictating how large crypto assets should be relative to gold, but, if crypto assets are significantly larger, it implies that, in some sense, crypto is “better” than gold for investment purposes.

We think it’s more likely that both assets rise together over time, rather than crypto significantly exceeding gold. The exception, in our view, could be if crypto’s main ownership isn’t for investment purposes. In that case (such as gold, where more of that asset is held as jewelry than investment), the value of crypto could rise further.

Cryptocurrency AUM Is Approaching the Value of Gold Held for Investment

Market capitalizations of gold, total crypto and BItcoin

Historical analysis and current estimates do not guarantee future results.
As of December 13, 2021
Source: CoinMarketCap, Metals Focus, Refinitiv, World Gold Council and AllianceBernstein (AB)

There are several links between the strategic cases for inflation and cryptocurrencies—and not just from crypto’s possible future role as a hedge.

A persistent decline in money velocity was one challenge for policymakers trying to raise inflation in the years before the pandemic. It’s been suggested that a technological innovation like the adoption of CBDC or crypto could stop this decline by changing the way money is used. Any shift that increases the velocity of money could be very helpful for policymakers, but we see some circumstantial evidence that the shift to digital currencies won’t increase money velocity.

CBDC Adoption Still a Ways Off

The path of CBDC adoption is another consideration. According to the CBDC tracker website, only a handful of countries, including China, Canada, France, South Africa, Nigeria, Ghana, Uruguay and UAE, have reached the piloting stage for a CBDC program. A few other countries, such as Sweden, South Korea, Turkey, Japan, Ukraine and Thailand, have advanced proof-of-concept projects. Meanwhile, the US, the UK, Australia, India, Brazil and other countries are still only at the research stage. The Bahamas is the only country that has officially deployed a CBDC.

Most nations don’t have a firm timeline for CBDC launch and adoption. However, according to press statements by the European Central Bank, Bank of England and Sveriges Riksbank, those central banks aren’t expected to do so until at least 2025. It’s often noted that the US may have to pursue a CBDC to avoid ceding a significant share of international payments to China. This is part of the broader debate about the potential shift to a less dollarized world. However, that motivation is unclear—China has capital controls, but it’s not evident that a digital yuan could even fill such a role.

More Clarity on Regulation Likely in 2022

This year will likely bring more clarity on the regulatory aspect of cryptocurrencies. Securities and Exchange Commission (SEC) chair Gary Gensler has called for more regulation of cryptocurrencies and related financial products. He recently noted at a meeting of the Investor Advisory Committee that crypto is an “asset class that belongs inside public policy frameworks of looking after investors, guarding against illicit activity, and protecting our financial stability.” Gensler also noted significant gaps in investor protections in decentralized finance platforms, crypto lending and other related financial activities. According to Gensler, platforms offering securities fall under the SEC’s jurisdiction.

Dollar-backed stablecoins have been a regulatory concern in recent months. The President’s Working Group on Financial Markets, comprising the Secretary of the Treasury and heads of all key US financial regulatory bodies, noted that stablecoin issuers should become “insured depository institutions,” on par with banks that offer savings accounts for customers.

Currently, only Bitcoin futures exchange traded funds (ETFs) can trade in the US market, and the SEC continues to reject proposals for ETFs backed by physical Bitcoin. In the past few months, the SEC has rejected several applications for spot Bitcoin ETFs, arguing that the commission still lacked confidence that the Bitcoin market was free of manipulation and fraud.

Tokenization Assets: The Path Toward Tangibility

The next one to two years could be important for making tokenized real assets more tangible (Display). In previous research (Inflation and the Shape of Portfolios), we noted that real estate is particularly well suited for tokenization—that arena should see widespread adoption in the future. Despite a few high-profile efforts at real estate tokenization in recent years, such as the $18 million tokenization of St. Regis Aspen Resort in Colorado, the market is still in its infancy.

A Projected Surge in Tokenized Asset Value

Value of tokenized assets projected through 2027

Historical analysis and current estimates do not guarantee future results.
As of December 31, 2020
Source: Securities Industry and Financial Markets Association (SIFMA), World Economic Forum and AllianceBernstein (AB)

A September 2021 joint study by Hamburg Commercial Bank and the Frankfurt School Blockchain Center think tank suggested that only an estimated 41 companies in 17 countries, including the US, Germany and Switzerland, had been trialing property tokenization. And the overall size of tokenized real estate is still minuscule compared with the real estate or alternatives markets. Estimates are scarce and highly imprecise, but one recent study by Forkast.News estimated the total value of tokenized real estate at around $130 million.

Crypto and digital assets aren’t realistic investment opportunities for many asset owners in 2022. Crypto assets face tactical risks related to the near-term liquidity of risk assets, though we see a more positive longer-term case. In our view, the real longer-term focus for the industry when it comes to digital assets in asset allocation should be the tokenization of real assets. Tokenized assets are too nascent for investment this year, but investors should rethink their allocation approach to allow for possible future investment. That requires conversations today about governance, regulation and portfolio construction.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams. Views are subject to revision over time.

About the Author

Inigo Fraser Jenkins

Inigo Fraser Jenkins is Co-Head of Institutional Solutions at AB. He was previously head of Global Quantitative Strategy at Bernstein Research. Prior to joining Bernstein in 2015, Fraser Jenkins headed Nomura's Global Quantitative Strategy and European Equity Strategy teams after holding the position of European quantitative strategist at Lehman Brothers. He began his career at the Bank of England. Fraser Jenkins holds a BSc in physics from Imperial College London, an MSc in history and philosophy of science from the London School of Economics and Political Science, and an MSc in finance from Imperial College London. Location: London

When Will Digital Assets Be Ready for Portfolio Allocations?

Cryptocurrencies in the Portfolio Context

CBDC Adoption Still a Ways Off

More Clarity on Regulation Likely in 2022

Tokenization Assets: The Path Toward Tangibility

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