Digital asset investment management holds significant potential, benefiting from techniques and lessons learned in traditional finance, such as portfolio construction methodologies and regulatory frameworks. By utilizing best practices from decades of research in traditional asset management, crypto’s broader adoption can be accelerated. However, blockchain assets may warrant a closer look beyond familiar concepts, including using market capitalization as a weighting methodology for passive portfolios.
Portfolios across traditional and digital asset classes often use market cap to determine investment amounts in underlying assets, providing investors with passive exposure to the overall market. For digital assets, complementing market cap with a measurement of a blockchain’s usage may enhance portfolio construction. One way to achieve this is using total value locked (TVL), which represents the value of assets deposited on a blockchain. Higher TVL suggests greater economic activity, potentially better prospects for future activity, and a larger active user base, while a lower TVL implies the opposite.
Taking the ratio of market cap-to-TVL (MC-TVL) can provide a more fundamental sense of an asset’s utility, similar to how equity investors use price-to-book (P/B) ratios to discern a stock’s value. A higher MC-TVL suggests a bloated capitalization, with a valuation that disproportionately exceeds its usage. Conversely, a lower MC-TVL may imply undervalued blockchain assets for which markets have yet to price in their activity.
Analysis of a top-10 index weighted by market cap versus one weighted by MC-TVL presents an interesting contrast, with the MC-TVL approach producing better full-period returns in a 2021 hypothetical scenario. Though the correlation between the two weighting methodologies reaches 0.85, meaningful differentiation still exists between them, making integrating blockchain usage into passive products potentially promising for improved overall market exposure and alignment with crypto fundamentals.
While this simplistic experiment intends to stimulate more nuanced analyses of the crypto-specific properties and potential integration into portfolio construction, the limited backtest duration may mask long-term dynamics. Over time, lower MC-TVL could prove to be a useful indication of assets with greater network usage versus higher MC-TV, where size alone may not totally reflect value.
As cryptocurrency track records develop in real-time and new, richer on-chain data emerge, investors should explore the possibility of using fundamentals-based portfolio construction adjustments to assist digital asset investment management. It is vital to maintain objectivity and an eye on the future of digital assets as their influence on markets continues to grow. While the traditional financial sector has much to teach, blockchain technology and cryptocurrency hold a unique potential to transform our understanding of investing and market dynamics.