Digital Assets and the Future of Investing
Over the last year, we witnessed an unprecedented explosion of investor and mainstream interest in an entirely new asset class. A lot has been said and written about digital assets, decentralized finance (DeFi) and all kinds of blockchain-based applications that promise (or perhaps threaten) to forever change the face of finance and investing as we know it. And yet, there are still a lot of misconceptions and quite a bit of confusion in the minds of many investors, while the full potential of this tectonic technological shift that is already underway is still difficult to grasp.
Beyond Bitcoin and Crypto
For most mainstream investors, as well as for the wider public, the “poster child” of the blockchain revolution is undeniably Bitcoin, and to this day, the technology is most commonly associated with cryptocurrencies. Without a doubt, this one of the most prevalent and relevant applications so far, given the impressive growth of the crypto market and the mainstream and institutional adoption that Bitcoin, Ethereum and other important coins have been increasingly enjoying over the last few years. However, it is imperative for investors to understand that this is merely a single application of the technology.
Beyond currencies and transactions, blockchain has the potential to revolutionize entire industries, as well as the way we all do business and the way we think about investing. The efficiency, speed, security and convenience this technology brings with it is already finding very practical applications in multiple business areas and in different sectors: From “smart contracts” to supply chain operations tools and from data management to cybersecurity applications, blockchain’s disruptive potential already appears formidable.
For many investors, the possibilities that this technology has unlocked and the opportunities it presents, especially beyond crypto, can seem overwhelming and often confusing. Without specialized expertise and a deep understanding of the underlying technical intricacies, it can be challenging to identify individual “winners and losers” in this nascent field, and the myriads of new projects and start-ups are somewhat reminiscent of the DotCom era and the rise of what we know today as the tech sector.
Much like the early days of the internet and all the mainstream hype and investor excitement that surrounded it during the 90s, blockchain-based solutions and innovations abound today, at least in theory, if not always in practice. And much like during the DotCom bubble, picking out the next Amazon at this early stage of the blockchain revolution is certainly much more challenging than investing in the underlying technology itself.
Figure 1: Internet vs. Crypto adoption
Source: World Bank, Crypto.com
Digital Assets and DeFi
Although potential blockchain uses go well beyond finance and investing, this space has attracted a lot of interest not only because of the transformative impact that the technology can have there, but also because numerous use cases have already been successfully introduced. This is also why we decided to publish a detailed Special Report on this topic: to serve as an introductory guide for investors who are interested in the crypto sector and in the new world of digital assets at large.
While the term has been loosely used to describe all kinds of nonphysical alternative assets, cryptocurrencies or tokens, a digital asset can be literally any tangible, intangible, fungible or non-fungible asset that can be digitally represented, stored, bought, sold or used as a form of payment over a decentralized exchange or other digital platform, without the need for intermediaries, regulators, or any other third-party involvement.
This new ability to render an investable and tradeable digital representation of any real asset, or fractions thereof, has momentous implications, especially since the tokenization process, as well as the tools and platforms used to buy, sell and store those assets are increasingly reliable, accessible, secure and efficient. Virtually any illiquid asset can be made liquid, while removing many of the entry barriers that countless investors face today.
This opens the door to an entirely new investment universe, where all kinds of investors, large or small, professional or retail, can participate and access assets and investment vehicles that they previously could not, be it due to regulatory constraints or simply insufficient capital. From real estate to collectibles, we’re already seeing the first attempts to bring this concept from theory to practice. Companies like Finexity or Exporo in Germany are granting retail investors access to all kinds of tokenized and fractionalized alternative investments for as little as €500. Diamonds, art, classic cars and fine wines, all niche investments previously reserved for specialized funds or HNWIs, can now be owned by small individual investors too.
The rise of digital assets also has the potential to deeply and structurally affect traditional investments too, especially on an infrastructure level. There are immeasurable inefficiencies and waste that are associated with the way we invest and trade securities today, mostly having to do with the intermediaries and institutions that form the bedrock of traditional finance (“TradFi”). Due to the centralized nature of our current system, there are relatively high costs and delays in virtually every step of the lifecycle of most securities and assets, from issuance to cross-border trading and settlement. Most of this can be summarily eliminated by employing decentralized structures and blockchain-based solutions.
While still in its infancy, Decentralized Finance (“DeFi”), promises to usher in radical changes to the entire financial system. By allowing people and businesses to freely transact directly through peer-to-peer financial networks and by improving all kinds of security- and compliance-related processes though the use of consensus mechanisms, both the transaction costs and times are set to be cut dramatically, perhaps all the way down to zero in some cases. Other considerations such as a privacy and individual financial freedom are also important reasons behind the optimism and enthusiasm that surrounds the emergence of DeFi.
The not-so-distant future certainly holds great promise of new ways and types of investing, as the underlying technology and its applications mature. As tokenization progresses and goes mainstream, we can expect to see greater investor interest in myriads of previously illiquid or inaccessible assets. However, at this stage, cryptocurrencies continue to be the easiest and more reliable way for investors to enter the digital asset class. And while the sector has matured significantly over the last few years, and while regulation and institutional investment have resolved a lot of early security concerns, it is essential for investors to understand that there is still a higher level of risk involved.
Apart from the notorious volatility levels, investing in cryptocurrencies also comes with a greater degree of complexity that surrounds custody questions, tax implications, safekeeping of private keys and account management in general. For the average investor who lacks the required technical knowledge and sophistication, achieving direct exposure can be particularly challenging. The emergence of passive investment options, as well as active trading strategies and specialized funds addressed most of these concerns, while it also allowed investors to participate in this nascent and rapidly evolving asset class, without the need for specific experience or a detailed understanding of the technological aspects that underpin it. In fact, the demand for access to top managers and strategies has given birth a new hedge fund boom, in many ways similar to the one we saw in the 80s.
By now it is clear that the most appropriate strategic approach to digital asset investing would be thoughtful active management and tactical agility. Focused professional expertise and direct experience in the sector are also essential to compete, as is meaningful diversification and diligent risk management strategies. These were among the chief considerations behind the recently launched crypto fund-of-funds solution by BFI Capital that allows investors to participate in a diversified basket of actively managed strategies, with a low minimum investment and a high level of service quality.