‘Risk profile of crypto as long-term investment is terrible’

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PGIM, Inc is the $1.4 trillion global asset management business of US-based Prudential Financial, Inc.

Shehriyar Antia, vice-president, head of thematic research at PGIM, spoke to Mint about the chances of revival in the crypto market, prospects of bitcoin as a currency and the effectiveness of crypto assets as diversification tool. Edited excerpts:

Crypto market has recovered from every major crash in the past. Can it revisit its all-time highs?

In the past, cryptocurrency prices fell and then rebounded sharply. There was no collateral damage and each rebound inspired greater confidence and optimism from investors. But the most recent crypto crash is rippling across the broader DeFi landscape, revealing vulnerabilities that we highlighted in our research, but that are now no longer hypothetical. The demise of TerraUSD, along with some of the largest lending sites (Celsius) and exchanges (Binance) essentially telling investors: “You can’t get your money out” is evidence that this crash is seismic.

With more than $2 trillion wiped out since the 2021 high-water mark, many investors may be tempted to enter the cryptocurrency orbit at a potentially attractive, lower price point. However, the most profound risks to cryptocurrency investing may lie ahead.

Are inflation and rate hikes weighing down on crypto, just like equities, or there are other fundamental factors behind the slump?

Certainly, the macro environment and risk-off sentiment impact cryptocurrency prices, but it’s also important to recall that bitcoin has had spectacular crashes during periods of low inflation and low rates as well.

Past crashes have been followed by steep rebounds that have drawn in new investors and increased optimism in the space. While it may yet rebound, this latest crash in cryptocurrencies feels different. This time, the vulnerabilities are deeper and are rocking the whole system and will not likely lead to increased confidence and optimism.

Can crypto such as bitcoin replace fiat currencies?

Crypto currencies have yet to make a dent in the domain of fiat currencies. Mostly because they do not meet the basic requirements of a currency. Money has taken different forms through the ages, from cowry shells to peppercorns and from silver coins to the greenback, but they all share three common characteristics: they act as a store of value; they are a widely accepted medium of exchange; and they are a unit of account. Unfortunately, no cryptocurrency to date adequately fulfils these essential functions of a currency.

As Central Bank Digital Currencies (CBDCs) become more commonplace, they present an existential threat to cryptocurrencies, especially stablecoins, as they offer most of the benefits of crytpo, but with almost no liquidity or credit risk. And CBCDs are not a distant prospect; China has already launched the e-CNY, while the Reserve Bank of India, the Bank of England and Banco Central do Brasil are all far along in research around this and some will be launching their own CBDCs in the next year or two.

Any areas in the overall blockchain ecosystem that look interesting from investing perspective?

These are very early days, similar to the late 90s phase of the internet boom, but long-term investors should focus on real-world applications of distributed ledger technology. These ventures are likely to generate attractive risk-adjusted returns – even if crypto-mania itself fizzles. We are particularly interested in the use of private blockchains and smart contracts in financial services, which offers enhanced efficiency in the clearing and settlement of securities. Tokenization, where ownership of real assets is fractionalized into digital tokens on a distributed ledger, is also an important space to monitor. Used in the real estate sector, for example, this could substantially reduce frictional costs from transactions and servicing.

Are cryptocurrencies an effective portfolio diversifier?

No, cryptocurrencies are not effective portfolio diversifiers. They certainly have not provided stability in a portfolio over the last three months of equity turmoil.

In its early days, bitcoin had low correlation with broad equities and commodities, providing the potential for true portfolio diversification. However, as cryptocurrency investing has become more mainstream, and especially since 2020, bitcoin’s correlation with US equities and commodities has spiked sharply and remained consistently elevated.

Will the risk profile of cryptocurrencies improve or worsen going forward?

The risk profile of cryptocurrency as a long-term investment is terrible. Despite the much higher volatility, its risk-adjusted returns are quite pedestrian and, since 2018, are actually comparable to equities and bonds. Furthermore, many of the fundamental risks due to the lack of transparency and regulatory oversight in the crypto ecosystem remain. Without significant efforts to address this lack of transparency and accountability, combined with strong momentum-driven outflows, it’s hard to envision how the risk profile of cryptocurrency investing improves going forward.

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