We’re living in an age of transition.
Some businesses are accepting cryptocurrencies in their transactions. Others are stockpiling crypto as a hedge against inflation. These might be welcomed moves in society, but as investors, these will affect our valuations and our portfolio performance.
In my opinion, cryptocurrencies and equities are two distinct asset classes and should remain as such. They are different for a reason and when the lines between these two asset classes blur, alarm bells start ringing.
As much as I’m bullish on both asset classes in the long term, I feel that there is a need to keep these two asset classes separate in order to maintain a well-diversified portfolio.
If you’re holding on to any stocks which have exposure to cryptocurrencies then this is a MUST read. As a fellow investor, I try to answer:
- Why stocks with cryptocurrency exposure might be bad for investors?
- How can you find out if the stocks that you hold have exposure to cryptocurrencies?
- More importantly, what is the extent of the exposure?
Let’s read on to find out more.
Understanding Asset Classes
An asset class is:
a grouping of investments that exhibit similar characteristics and are subject to the same laws and regulations. Asset classes are made up of instruments that often behave similarly to one another in the marketplace.
What is an Asset Class – Investopedia
Think of it this way, when we go to a hawker center to buy food, everything there is food but within that, we have the following,
- Rice Dishes – Cai Fan, Chicken Rice, Duck Rice
- Noodle Dishes- Fish Ball Noodle, Hokkien Mee, Fried Noodles
- Snacks / Desserts / Drinks etc.
Sometimes we have the drink stall selling desserts too, but rarely do we ever come across a chicken rice shop selling drinks.
If we link this back to the world of finance, it is important for us to understand the types of asset classes, as well as the strengths and weaknesses of each class.
For example, Tesla is a stock and ARKK is an ETF. Some may think that they are two different asset classes but truth is that they are both considered equities. One reason they belong to this asset class is because they are both subjected to the same laws and regulations by the U.S. Securities and Exchange Commission (SEC).
When we look at the various types of asset classes in the world, by and large we have the following:
How does a company’s exposure to cryptocurrency affects me?
There are asset managers who encourage companies to take up positions in cryptocurrencies. However, I personally think that when companies are exposed to cryptocurrencies, they put their stock at risk of experiencing the same level of volatility that we see in the cryptocurrency market.
I believe that the more cryptocurrency a company holds (or the more a company’s main business activity is centred around cryptocurrency), the more their share price will experience the same volatility of cryptocurrency.
As an illustration, I analysed the percentage change in the price of 4 stocks between January 2021 to the day of writing (27 May 2021).
Here is the legend and a short background of the stocks which we are covering,
We’ll be focusing on:
- Riot Blockchain (NASDAQ: RIOT) whose primary business activity involves the mining of bitcoin itself.
- Microstrategy (NASDAQ: MSTR) which is currently the largest holder of bitcoin amongst all listed companies in the world – approx 92,079 BTC.
- Square Inc (NASDAQ: SQ) following behind with about 8,027 BTC in their possession.
- Bitcoin tracker (XBT) a tracker which mirrors Bitcoin’s price. We will be using XBT as the main point of reference in the chart below. (Blue Line – Thicker than others)
Hypothetically, RIOT should have the largest level of exposure to cryptocurrencies as its entire business revolves around it. Hence, it should experience the most volatility.
Subsequently, as MSTR has more BTC than SQ, we should see greater volatility in its share price than that of SQ.
With this in mind, let’s take a look at the chart below:
Using the XBT as the “moving average”, it is clear that the percentage change in price for RIOT was the highest followed by MSTR and SQ.
This comes as no surprise, given that the profitability of RIOT depends directly on the price of bitcoin.
Comparatively, while MSTR has experienced lower price fluctuations than RIOT, there is a strong suggestion that the share price of MSTR does respect that of XBT. When the price of XBT rises, so does MSTR and likewise when it falls. SQ behaves similarly as well.
This graph provides us with a clear indication of how equities can be influenced by the price of cryptocurrencies despite them being two distinct asset classes.
How do I know if my stocks are exposured to cryptocurrencies?
If you are an investor who wants to buy stocks that are exposed to cryptocurrencies, you’ll probably know what stocks to buy by now.
However, if you are an investor who do not want your stocks to be influenced by cryptocurrencies, how can you find out if your stocks have any position in cryptocurrencies?
One way is to use Bitcoin Treasuries where you can find out which companies hold bitcoin, as well as which companies pay their staff in bitcoin.
Here’s a quick screenshot:
We can see the top 5 listed companies which hold the most bitcoin.
If you’re someone who wants to buy companies with exposure, this list above would be able to show you just that. Likewise, if you’re looking to avoid such exposure, now you know which companies to stay clear from.
What about companies that accept cryptocurrencies as a method of payment?
At the point of writing, Bitcoin Treasuries does not have information on companies that accept bitcoin as payment. You should do your own due diligence if you are concerned about the exposure.
Early this month, a company that I invested in since its IPO has decided to accept bitcoin as a method of payment. This comes as no surprise, since one of their co-founders is also the co-founder of Paypal (which also recently started accepting cryptocurrency as a method of payment).
However, as an investor, I can’t help but worry that my equity portfolio has now been over-exposed to cryptocurrencies. First, it was Tesla and now it’s Palantir.
Concluding Thoughts
The reason why I’ve decided to write this article today is that we’ve seen in the media that more companies are moving towards accepting cryptocurrencies as a method of payment.
It is too early to determine the impact of such moves but needless to say, when a company decides to associate itself to cryptocurrencies, it immediately puts itself at risk of additional volatility.
As a retail investor, I will have to make a decision on this at some point in the future but before that happens, I believe that will come a time where COMPANIES will have to make this very same decision.
The speed and extent of cryptocurrency adoption by companies will be crucial in determining its future.
