- PGIM recently released a bearish industry report on the cryptocurrency market.
- They wrote that bitcoin is neither a sufficient store of value nor a macroeconomic hedge.
- However, they believe crypto has 4 key “collateral innovation” investment opportunities.
PGIM, the $ 1.5 billion investment arm of life insurance company Prudential, just released a report on the state of the crypto industry, and they are far from fans.
In their wide-ranging study, PGIM outlined their view of why institutions have begun investing in cryptocurrencies and why they’re skeptical of the popular investment theses revolving around them. While the firm concluded that cryptocurrencies are unlikely to replace fiat anytime soon, they do think that there are four segments of the space that could create alpha for investors in the future.
What’s going on
According to PGIM, there are five factors that have caused crypto to become too big for institutional investors to ignore.
In March 2020, bitcoin crashed to $ 4,904. One year later, bitcoin hit a peak of $ 60,031 in March of 2021. With that stratospheric rise came plenty of attention, and for a while it seemed as though everyone, ranging from members of r / wallstreetbets to Elon Musk, was talking about crypto. Analysts at PGIM wrote that this seemed to inspire a “fear of missing out” among investors who heard tales of “overnight bitcoin millionaires,” which in turn only spurred the crypto market to new heights.
PGIM also noted a decline in faith in financial institutions among the general public as another cause for people to invest in crypto. In fact, a 2020 Axios / Ipsos poll showed that only 34% of Americans trust the
. Moreover, with inflation at a 40-year high, many have looked to cryptocurrencies like bitcoin – with its built-in scarcity – as a way to combat inflation.
Carry trades for cryptocurrencies with high staking rewards like AAVE or the now infamous Luna provides lucrative arbitrate opportunities for savvy investors. Another arbitrage opportunity exists with “market dislocations,” where crypto’s volatile pricing creates asymmetric prices for cryptocurrencies on different exchanges. For example, bitcoin could cost $ 29,900 on Binance and $ 30,000 on Coinbase, creating a $ 100 arbitrage opportunity for investors to exploit.
Finally, crypto has a presence in other emerging technology markets, such as gaming and the metaverse. PGIM cited Fortnite’s use of its digital currency V-Bucks as an analogue for cryptocurrencies, since it’s a digital currency used in a multiplayer online game, the type of game that many believe is a precursor to the metaverse.
All of these reasons, combined with the market now being a sufficient size for investing, have contributed to institutions beginning to take positions in these digital assets.
However, despite its allure PGIM believes crypto fails to provide sufficient market use-cases for institutions to take it seriously.
Where crypto fails
PGIM gave four reasons why cryptocurrencies will not replace fiat, and why it disagrees with several of the leading bullish macroeconomic theses for the asset class.
In the report, PGIM writes that no cryptocurrency fulfills the three essential functions of money: as a store of value, a medium of exchange, and a unit of account.
means that it fails as a store of value. Even with record high inflation, crypto is significantly more volatile than fiat currencies. In addition, crypto isn’t a medium of exchange like fiat currencies are because so few stores actually accept crypto payments at this time, and crypto isn’t a unit of account, since almost no products are priced in a specific cryptocurrency.
Moreover, PGIM notes that the costly transaction fees of flagship cryptocurrencies like bitcoin preclude widespread adoption from ever occurring.
PGIM also wrote that stablecoins, an ostensibly less-volatile form of cryptocurrency that are pegged to a fiat currency, would be effectively rendered useless upon the creation of a central bank digital currency, or CBDC.
PGIM rebutted macroeconomic ideas surrounding the most popular cryptocurrency, bitcoin, disputing the idea that it is an inflationary hedge akin to “digital gold.” While they say bitcoin is deflationary, they add that it has only provided “limited inflation protection in the lone episode of elevated US inflation since its inception.”
Finally, they noted that bitcoin’s skewed ownership – the top 0.25% of owners held about 20% of bitcoin – means that it isn’t the decentralized dream many espouse. Moreover, they noted how bitcoin’s environmental costs fall below ESG standards, which should be a major concern for institutions considering investing.
PGIM believes that while cryptocurrencies are not good investments, institutional investors will find value in four of the primary applications they foresee emerging from the “remarkable accidental by-products and breakthroughs” of the crypto ecosystem.
Private blockchains / smart contracts
PGIM writes that the use of centralized, private blockchains can provide efficiencies and a visible public record for the “origination, servicing and trading of assets” that have many different participants across the value chain.
A centralized blockchain, in tandem with self-executing smart contracts, creates a quicker and more transparent settlement of securities. PGIM cited Onyx, an ethereum-based blockchain built by JP Morgan that “uses smart contracts to swap digitized Treasury collateral and digitized cash instantaneously and clears, settles and records billions in daily repo trading” as an example of a traditional finance company that is already leveraging crypto innovations.
PGIM wrote that as blockchains start to produce use cases in real estate, law, and healthcare, the ability for blockchains to be “interoperable” – or for them to “talk” to one another – grows. In other words, data that is stored in one blockchain will need to be leveraged by the functionality that another provides.
They cited Polygon, Polkadot, and Cosmos as key “blockchain enablers” helping to build interoperable scaling solutions. These solutions could become especially important when trying to implement a central bank digital currency to work seamlessly with older blockchains at some point in the future.
PGIM also pointed to companies that are focusing on fraud prevention as potentially good investments. Companies like Fireblocks, Chainalysis, Coinfirm, and Elliptic that analyze the blockchain could be used by regulators to fight money laundering via cryptocurrencies.
PGIM believes that the tokenization of real assets could soon become a reality. As the world continues to grow more digitally oriented, assets like real estate will become increasingly tokenized. This means greater opportunities for retail investors to better diversify and have a voice in real world assets.
An example of a company that is tokenizing the “real world” is Royal, which sells music NFTs. Through Royal, a fan can purchase tokens from artists like Nas or the Chainsmokers and receive a percentage of the future royalty rights from the song.
Finally, PGIM stated that while investors still have to wait to see if the metaverse will be limited to a gaming experience, or if it will have more consequential societal impacts, its growth will bolster cryptocurrencies.
In metaverses, digital tokens act as currency, and smart investors will continue to monitor payment systems used in metaverses, keeping an eye out for those that gain popularity or work particularly well. Many metaverse games like Decentraland or The Sandbox utilize in-game cryptocurrencies whose values have skyrocketed due to metaverse real estate sales.