rewrite this title How Much Crypto Exposure Should You Have If Any? – Nanalyze

We’re holding bitcoin and we never really talk about it. Our aversion to covering cryptocurrencies follows a highway that’s paved with more predictable ways to lose money than a game of three-card monte on the Albanian Riviera. What might change our opinion of this “asset class” would be an increasingly favorable attitude towards cryptocurrencies being taken by institutions and regulatory agencies. These usually go hand in hand, and that’s what we’re seeing today.

This Time is Not Different

We used the term “asset class” in quotes above for a reason. For most assets, there are mature, refined, and generally accepted ways to determine their value. That valuation changes based on inputs that are both objective and subjective. For cryptocurrencies, it all seems to be subjective. “You just don’t understand the genius of crypto,” you’ll hear them say. Another popular retort to those who question the lack of intrinsic value on display? “Okay Boomer. If you want to stay behind the times, then you go right ahead. This time it’s different.” You’ll hear that a lot in bull markets. The four most dangerous words in investing.

A competent institutional investor will always start at the asset class level. Is this class of assets even investable? Remember, those are the people making all the money. Joe Retail is doing horrible as usual. A firm called Dalbar monitors investor performance and found that the average equity investor underperformed the S&P 500 Index by 5.5% in 2023, marking that the third-largest performance gap in the last decade. Even in bull markets retail investors lose money. Now consider an asset class where 50% of all tokens every created went bust. That’s no joke, and it’s a topic we covered in our recent video on why crypto is the worst investment known to man.

What, Where, and How Much?

But all that is changing now. We’re seeing increased interest in cryptocurrencies by large institutions. That’s what we have been waiting for. Institutional legitimization. Every other day we read about some favorable piece of regulation to be passed relating to cryptocurrency. Investors who are understandably looking for exposure to crypto as an asset class have three primary questions:

What crypto assets should I hold?

How should I hold them?

How much of my money should I allocate towards them?

What Crypto Assets Should I Hold?

To evaluate any asset class, start by introducing a method of classification. Size, industry, and growth vs value are all methods to classify equities, for example. What about cryptocurrencies? Well, let’s start with size because it’s about all we have.

The value of all cryptocurrencies right now is around $4 trillion. To put that into context, The S&P 500 has a market capitalization of $54 trillion dollars. Of crypto’s $4 trillion market cap, 58% is the value of bitcoin, presently around $2.4 trillion. And this concentration only gets worse. Around 82% of all cryptocurrency value is concentrated in the top five crypto assets seen below.

So why not invest in all five? Because one of those is extremely problematic. Tether, might be one of the worst things we’ve ever seen. They produce what’s called a stablecoin which is supposed to be backed by equal amounts of U.S. dollars. Like insurance companies, they can use that pool of money – called a float – to generate interest and consequently income. However, they could also lose that money on bad investments. But it is always expected that they have the U.S. dollars to exchange for their coins at any time. In the past they were fined for not having sufficient dollars backing their coin. Today, they still haven’t been audited for the $165 billion they’re supposed to have on their books. There is a very simple solution. Get audited. Until they are, this is an absolute showstopper.

Strangely enough, this doesn’t seem to be a concern for ARK Invest which flaunts Tether as being one of the most profitable companies ever. If a large institution were to create a crypto ETF, then one would expect them to exclude Tether on this basis. And indeed, that’s what we’re seeing. Right now the only approved crypto basket ETF you can trade that contains more than Bitcoin and Ethereum is the Grayscale Digital Large Cap Fund (GDLC). Not surprisingly, they’ve omitted Tether from their core holdings.

We’ll look to dig more into this ETF in a future piece. In the meantime, think about this. What exactly are you getting for that 2.5% expense ratio when you could just buy all the constituents yourself and simply rebalance every quarter following the ETF’s index provider which uses market cap weightings?

Editor’s Note: This ETF was approved, however, the approval was subsequently paused for review. Some speculate this is so the SEC can finalize a framework that can be applied across similar funds.

Let’s say you’ve decided to start aping the Grayscale ETF with a portfolio of your own. Buying and selling these crypto assets on a platform like Coinbase is as intuitive as trading stonks. But is that the safest way to go about investing in crypto?

Where Do I Hold My Crypto?

ETFs are clearly the safest way forward. Any notable ETF provider out there offering digital assets in an ETF wrapper will have the motivation and capability to make investors whole if things blow up. The Grayscale ETF we mentioned earlier should be vetted more, but it’s precisely the profile we want for more broad exposure to this asset class. The key question surrounds which firm you entrust to store your digital assets if you choose to go that route. Investors will be drawn towards rewards offered by various providers attempting to capitalize on the massive amount of money Joe Retail is pissing away spending on stacking crypto coins. Forget about all that.

Given the pervasiveness of scams in this space which always seem to be measured in billions, and a running list of high-profile actors being convicted of fraud, you’re best served sticking with publicly traded digital asset firms. We happen to like Coinbase (COIN), and it’s not just because they’re publicly traded and therefore audited. It’s because institutions are choosing to do business with them as adoption grows. Always invest your money alongside the wealthy. If something goes pear shaped, you’re more likely to be made whole.

We’re not going to talk about how we hold the only digital asset on our books – bitcoin. (You’ve probably already figured that out anyway.) You should NEVER let anyone know what crypto you hold and where you hold it. That’s because this environment is so fragile that simply letting someone know what institution you hold your money with can be problematic. Just be sure that any firm you decide to hold digital assets with is publicly traded so they’re properly audited.

Coinbase is said to keep 98% of digital assets in cold storage, but should you? Weighing the pros and cons of cold storage is a conversation in itself because it introduces additional complexity. If you want to go down that path, make sure you understand it well. If not, sufficiently secure your account, don’t click links in emails coming from your provider, and use two-factor authentication (2FA). You’ll almost certainly be fine. And if this whole thing makes you a bit uncomfortable as it should, then there’s a simple solution. Don’t invest in crypto. Or if you do, don’t invest a lot.

How Much Crypto Do I Hold?

In many cases it’s just Degen John and his $2,420.69 tax return going YOLO/FOMO on the crypto ticker du jour, in which case how much crypto he holds is a moot point. John is best served losing that money ASAP so he learns valuable lessons as early as possible. For those who understand why we would want to think about what percentage of our assets to allocate to crypto, the way to answer this question starts at the asset class level. That means take all your wealth, have your AI algo put it in a spreadsheet, and then classify it by asset class – bonds, stocks, real estate, etc. Now you can see what percentage of your assets belongs to each asset class.

The simplest asset allocation strategy is probably the “100 minus your age” rule. Since today’s investor considers bonds to be return-free risk, we’ll keep it simple. For any portfolio of asset classes, what percentage ought to be in alternative asset classes like crypto? A general rule of thumb is that alternative assets should not make up more than 10% of your total assets. That’s roughly what our asset allocation strategy looks like. We have 10% allocated to wine, gold, art, and bitcoin at roughly the same weightings.

We believe some alternative asset selection should come down to a personal preference. When you have wealth, you ought to enjoy it. If you love wine and art, these can be very fun alternative asset classes to invest in. Gold provides an attractive diversification effect which we’ve talked about before. So, should we consider – at the very least – diversifying our bitcoin position? Probably, and we’ll start to mull that over. But should that overall crypto allocation be increased?

We would argue that a target weighting of 10% for alternatives ought to stay that way. Numerous studies suggest any number of optimal percentages ranging from 5% to 50%, but they’re not apples to apples. In other words, they don’t all use a market cap weighted basket of alternative assets which would look something like this.

Now you can see the problem. Since every study uses a different combination of the above, at different weightings, then of course they’ll all have different outcomes.

That’s why the alternative asset class allocation decision is unique to each investor. Someone who holds shares in a startup they’re working for has seriously overweighted the venture capital asset class. Someone who outright owns a vacation rental is probably overweight real estate. As we said earlier, classify your current assets, then see which of the above alternatives meshes well with your goals and interests. If you really want that entire alternatives basket to only be crypto, fine, go for it. Just set rules around the maximum amount of your assets you want exposed to crypto at any given time.

As cryptocurrencies or digital assets mature, we may allocate more money toward the theme. If we do, it won’t be when bitcoin is hitting all-time highs. That’s always when all the emails start flowing in. And they rarely ask a comprehensive question like, “what is the proper allocation for crypto as an asset class and what should that look like?” It’s usually, “should I buy bitcoin.” And that’s what we did, a while ago.

Our Crypto Position

We’ve decided to target a 10% weighting for alternative assets. Of that, bitcoin occupies 25%. Should we look to expand outside just bitcoin and potentially invest in one of these “basket of crypto” ETFs? Maybe, but we’d like to see a more prominent provider offer something similar with a lower expense ratio. In the meantime, why not just do it ourselves? That’s a question to answer another time.

Our current dilemma is simply this. As institutional participation increases, should we increase the weighting of crypto relative to our other three alternative assets – gold, art, and wine? That’s a tough question to answer until institutions start to put out papers and studies on the optimal weightings for crypto as an asset class. That could provide further direction and also legitimize the entire topic.

There’s no rush people. No FOMO. The time to be adding crypto exposure is when everyone is condemning it. And they will, because that’s the nature of a volatile asset class. Also remember that a key value proposition of an alternative asset is that it’s not correlated to – or perhaps even negatively correlated to – popular asset classes like stocks and bonds. Correlation studies rely on historical data. How much historical data do we have for crypto? Not very much.

Crypto Exposure in Equites

Crypto exposure through the stock market is another topic that comes up often. Perhaps the most popular name, Microstrategy (MSTR), has more red flags than a Chinese phone book. And there are an increasing number of names coming online here, think Circle’s recent IPO. Then you have bitcoin miners towing the crypto line when it favors them and pivoting into “AI infrastructure” when it doesn’t. One suitable way to play the pick-and-shovel theme is Coinbase which we happen to be holding as a way to play the growth of institutional participation in crypto.

Just remember, in a bull market investors will buy just about anything. Always think at an asset class level. If you want exposure to crypto, then invest directly in these assets through a large reputable financial institution directly or using a reasonably priced ETF wrapper.

Conclusion

Most investors have very strong opinions about crypto from two opposing sides. Either they think crypto is rat poison (yes, Buffett said that) or they think bitcoin will reach $13 million per coin by 2045 (yes, Saylor said that). And if someone says something you disagree with, just call them a moron and don’t bother engaging in constructive dialog. You will see a lot of this in the crypto world, but not around here.

Staunch bull, or enlightened bear? The answer is somewhere in between, where institutions are poking the tires right now. They’re starting to take crypto assets for a drive, and that’s where we’ll be tagging along. While we mull over possible changes to our own portfolio, we’re not going to increase our crypto-related content outside from some video topics which might reinforce some of these same points.

Should crypto/blockchain start to become more mainstream with institutions, then it would start to mature. And if it should sufficiently mature, we might even consider developing a vertical around that similar to what we’ve done with disruptive growth (Nanalyze) and dividend growth (Quantigence). In the meantime, always think about crypto investing at an asset class level. Be like the institutions that make all the money. Be calculated.