The Case for Asset Backed Cryptocurrencies
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One of the drawbacks investors in crypto assets face is their volatility. This is to be expected as all markets are volatile in their early years. It’s also unlikely that the crypto asset market will reach maturity anytime soon. On the other hand, crypto assets offer asymmetrical risk reward profiles. They can only fall 100%, but can quite feasibly generate returns of over 1,000% — as many already have.
There’s a strong case to be made for crypto assets backed by real assets, both as a mechanism to reduce portfolio volatility and as a safe haven during periods of volatility.
The entire crypto currency market is highly correlated. Investors may like to think they can ‘move value’ from one crypto to the next to avoid drawdowns. That’s easier said than done. The correlation between cryptocurrencies is high. As volatility increases, the correlation between assets also increases.
In September, the correlation between Bitcoin and Ethereum reached its three-month high during the same week that Bitcoin fell 40%. The correlation between Bitcoin and Litecoin peaked the same week, and the correlation with Ripple peaked the previous week. The same is true of most markets — as asset prices fall, correlations move toward one.
This will only be true for crypto assets that are entirely digital. A token backed by real assets will track the price of the underlying asset rather than other digital assets. Adding tokens backed by real currencies to a portfolio of digital assets will lower the volatility of the overall portfolio. Asset backed tokens can also be used as a place to ‘park’ value when volatility increases.
So, which assets can be used for asset backed cryptocurrencies? The assets that have proven to hold value over time are gold, silver and real estate.
At least three real estate backed tokens are currently being launched. Bitproperty’s ICO was launched in October and closes on 15 November. These may well generate returns over time, but are not effective as a volatility hedge. The underlying market has high transactions costs, liquidity is low and property is not fungible.
This leaves gold and silver as the most suitable assets to back a cryptocurrency. Both metals have a long history as a store of value and as a ‘safe haven’. Goldmint and OneGram are both gold backed tokens. OneGram closed its ICO in September, while Goldmint’s ICO is still open. Silvertoken is a silver backed token which is currently offering silver at a discounted rate.
Gold should provide investors with a reasonable hedge against volatility. After all, it is the original ‘anti-money’. However, silver does offer two significant advantages over gold, and may, for now at least, be a slightly better store of value.
Firstly, several industries actually use silver. That means the world’s supply is falling and silver will become scarcer over time.
Secondly, the rise of cryptocurrencies has meant that gold appears to be losing its position as the ultimate safe haven — a position it has held for centuries. The world’s gold is worth around $7 trillion, while cryptocurrencies have a combined market cap of around $165 billion. While wealth moves from gold to cryptocurrencies, the gold price may under-perform other real assets.
Volatility will be a feature of the crypto asset market for many years to come. Asset backed tokens like Silvertoken, Goldmint and OneGram will provide investors with a smart way to hedge that volatility.