Is Blockchain Too ‘Bleeding Edge’ for ETFs?

Oli Weiss

Earlier in September both traditional and alternative investors reacted positively to the news that Nasdaq will launch a new index tracking a select group of DeFi crypto innovators.

Not only did this represent another milestone passed in terms of blockchain tech gaining mainstream acceptance as a potent and potentially widely applicable form of disruptive tech, but also stands for a huge leap forward in terms of the access to live, minute-by-minute data traders need to tap into if they are to put their capital at risk behind a new idea.

As such, the question emerges as to precisely how traders, investors and the markets in general are going to gain exposure to blockchain stocks in the future.

In general, how will the ‘active’ and the ‘passive’ approach to investing play out in this field? More specifically, what type of funds and/or ETFs will thrive and succeed in what could still be categorizfed as a ‘bleeding edge technology’?

Active vs Passive

Until now, it would be fair to say the market has been dominated by the so-called active approach to investing, where either fund managers or investors themselves allocate their capital towards individual stocks based on qualitative and quantitative research, thus placing a premium on experience and market knowledge.

A current high-profile example of this approach would be Tyler Winklevoss.  Once known only for his abortive attempt to claim authorship and seize control of Facebook, today in his role as co-founder and CEO of Gemini, a next-generation digital asset exchange, Winklevoss is now a major player in the stable coin market, as well as having been the world's first bitcoin billionaire.

However, passive investing, especially in the firm of ETFs have soared over the past decade, with the US-based ETF industry alone now counting over $4 trillion of assets under management.  Whilst reaching the $1 trillion mark took nearly 8 years, the final push upwards from $3 to $4 trillion took just two.

Whilst the crash of 2008, and resulting loss of faith in some aspects of traditional finance as part of the explanation for this, the simple fact is that ETFs have more than proved their worth by now in comparison to actively managed investment portfolios.

This is the context in which the launch of the Nasdaq DeFi index, which will track and provide live data on a small group of hotly-tipped crypto financial services firms, needs to be seen.  This raises the question: will the seemly unstoppable rise of passive investment vehicles also prove to be popular with crypto/blockchain investors?

Blockchain ETFs: The Financial World’s Best Kept Secret

The paradoxical answer to this question is that ETFs focused exclusively on blockchain tech, or occasionally on broad baskets of cryptocurrencies, have arrived, and have generated excellent returns, but still languish a long way down the ranking of most desired ETFs.

Currently the biggest blockchain-focused ETF is Amplify Transformational Data Sharing ETF (BLOK).  As can be seen in the chart below, reproduced from stockcharts.com, the Amplify fund is trading up 24% this year up to September, running slightly ahead of the S&P 500 as tracked by the SPDR S&P 500 ETF Trust (SPY), which has returned around 18% to date.

chart of BLOK ETFSource: Stockcharts.com

Included above are two other prominent blockchain ETFs, tickered as KOIN and BLCN, which have also slightly outperformed the benchmark index.

However, despite both the popularity of ETFs, and the credible returns generated by the flagship blockchain funds, net capital outflows have been an issue throughout 2019.

Risk-On Risk-Off

It is hard to fully account for this puzzling pattern – above average returns coupled with capital outflows and limited investor appetite – but some analysts simply see this as the latest piece of evidence for a ground-swell of risk-aversion amongst global investors.

The basic tenants of the risk-on/risk-off view is that investors either see risk as manageable (or effectively already priced in to investments), and therefore accept higher risk in search of higher returns, or see risk as undervalued, and therefore seek only to tie their capital up in low risk assets on which they accept a lower rate of return.

The main driver of this Yes/No binary approach to risk is the global economy and general economic sentiment at the time, and anyone looking to find examples of extreme risk-aversion doesn’t have to look any further than government and increasingly corporate bond markets where unfathomably large amounts of debt are now trading at negative yields. 

Government bonds alone are thought to account for nearly $15 trillion of negative yielding debt according to a report by Deutsche Bank published in August.

Closer to home, from a crypto/blockchain investors point of view, the recent news that VanEck and SolidX have now withdrawn their application to the US Securities and Exchange Commission for a Bitcoin ETF has similar risk-averse overtones.

The Very Long Run

Despite these facts, there are reasons to believe that the new Nasdaq index signals something of a rallying point for the relationship between blockchain tech, indexes, and ETFs.

The ‘Very Long Run’, a phrase used by economists to conceptualize the time period in which structures of production become almost totally fluid due to rapid albeit irregular waves of technological disruption, seems to provide an appropriate point to conclude on.

Firstly, there is by now a consensus within both the purely tech and the purely financial world that blockchain is a big, disruptive tech with great potential.  The large-scale and extremely well-resourced projects exploring blockchain applications by the likes of Microsoft, Allianz, JP Morgan Chase, and Apple are ample testimony to this.

Secondly, the existence of a small but growing number of highly innovative fintech firms who straddle the border between tech and finance who are also having success utilizing blockchain suggest further disruption of normal ways of operating in these markets is highly likely. 

The companies included in the Nasdaq index would provide some of the best examples of these.  Not only do these firms represent strong value/accumulation investment opportunities, but they also suggest the pressure on larger market incumbents to keep up with developments in this technology should be sufficient to avoid any kind of technological ‘slowdown’ affecting the pace of innovation.

Furthermore, by providing exposure to a wide array of stocks grouped within a particular sector, many argue ETFs provide the ideal mix between risk and reward for investors wanting to gain some exposure to a new technology whilst maintaining a level of diversification at the same time.

However, an investor can wholeheartedly agree with both the points raised above but still feel a deep insecurity about the growth path of the global economy.  Ultimately until this general mood starts to dissipate, ETF tracking firms developing and employment blockchain applications will always struggle to attract the same level of inflows as funds tracking more traditional indexes.

 

Photo by Austin Distel on Unsplash.