PGIM: Buy the Apps, not the Cryptocurrency
Posted by Colin Lambert. Last updated: August 8, 2022
A new report by investment management firm PGIM, which manages over $1.4 trillion, finds “little evidence that cryptocurrencies offer any meaningful opportunities for institutional investors”, however it does argue that “enduring value” will be found in the real-world applications of blockchains.
The report draws on insights from 30 PGIM investment professionals across fixed income, equity, real estate and alternatives, as well economists, venture capitalists and crypto investors. It says that while “a few” cryptocurrencies will survive on the fringes of the monetary system, they will not replace and succeed fiat currencies. “Powerful headwinds come from both increasing regulatory scrutiny and the growing likelihood of central bank digital currencies, which provide the functional benefits of fiat-linked cryptocurrencies without liquidity or currency risk,” the report argues.
It further adds that Bitcoin “does not meet the basic functions of a currency” in that the high price volatility makes it an inefficient store of wealth, moreover the report says it is “telling” that even after more than a dozen years, few commercial enterprises accept Bitcoin or other cryptocurrencies. While there are those businesses that may accept cryptocurrencies in exchange for goods and services, “outside of the deep digital realm, Bitcoin and other cryptocurrencies are only rarely used to prices goods or services,” it adds.
The report acknowledges that for hedge funds (which presumably includes prop trading firms and market-makers), exploiting inefficiencies and the value available from retail- and momentum-driven flow is an opportunity, but in contrast it says “there is currently not a compelling case and little evidence for direct ownership of cryptocurrencies as a meaningful share of an institutional portfolio.”
To reinforce this argument, the report argues that while it may have been a diversifier in its early days, since 2020, Bitcoin has demonstrated increased correlation with other assets. It adds that while its limited supply and detachment from governments and institutions suggest Bitcoin may be an inflation hedge, “in the lone episode of elevated US inflation since Bitcoin’s inception, it has not held its value well”. The paper makes the same argument against claims Bitcoin is a safe-haven or “digital gold”, observing that at the start of the pandemic, Bitcoin lost value while gold remained steady throughout.
The report also observes that since 2018, Bitcoin’s Sharpe ratio has been similar to equities and bonds, suggesting it does not offer extraordinary risk-adjusted returns – especially when one takes into account the frequency and severity of drawdowns.
Finally, and tapping into an increasingly important issue for investment managers, the report observes that cryptocurrencies are “problematic along multiple dimensions of ESG”, thanks to its high carbon footprint and ability to sidestep sanctions.
On a more positive note, the report sees “several” attractive investment opportunities in the crypto ecosystem. These include private blockchains and smart contracts, noting the former offer a “highly secure and robust system for verifying and recording transactions”, and that the latter are already in use in financial services, logistics and supply chain management.
PGIM points to companies solving issues around interoperability, due diligence, and fraud prevention, suggesting they might have a first mover advancement as the world of digital assets and central bank digital currencies matures.
Finally, the report notes that tokenisation of real assets opens a “simpler, more cost-efficient ways to manage and transact assets and investments”. Once legal, governance and regulatory frameworks become settled this application will substantially reduce frictional costs across financial services and has the impact to reshape the current markets of illiquid assets, PGIM states.