Do Crypto Assets and Tokenized Real Assets Protect Against Inflation?
Blockchain technology creates new asset classes for investors to protect their values and themselves against inflation. In this article, tokenized real assets are presented: scarce assets such as real estate, classic cars, watches or diamonds can be brought on blockchain systems to allow investors to easily invest in them. Tokenization allows an investor to build an optimized portfolio with many small pieces whilst keeping a solid risk distribution. On the other hand, Bitcoin and Ethereum are also interesting asset classes. Many countries have created or are in the process of creating regulation frameworks. Their goal is not to prohibit crypto assets but rather to build a solid fundament for legal certainty and investors’ protection. This could potentially result in interesting upside potential.
Can we expect inflation? With real estate and stock prices, is inflation already here?
One of the key tasks of a central bank is to keep prices stable. If a book costs USD 20 today, the same book ideally costs USD 20 in the future. Inflation is the price increase of a specific set of goods. Recently, the Fed changed the way a price increase over time is measured. This could also be interpreted as if the Fed would be ready to accept temporarily higher price increases. The European Central Bank (ECB) subsequently did similar measures. Are central bank’s getting ready for inflation? This question is difficult to answer and only time will tell us.
If we look at asset prices such as real estate, commodities (e.g. gold, silver) or stock prices, we can see a long upwards trend only temporarily interrupted by the crash in March when the pandemic unfolded. Now that multiple countries can expect a declining economy and companies expect decreasing revenues and profits, it feels surprising that stock prices are close to all-time highs. It is therefore reasonable to argue that we are already in a phase of inflation but so far asset prices are affected. Citizens can experience this by ever increasing housing prices and rents. Maybe soon, will this asset price inflation spill over to normal goods and services? Of course these developments can be disputed but it is reasonable to expect a period of multiple years with significant inflation rates - even though it is not unclear when this period begins: In 2021, or 2022? In any way, with asset prices, it might have already begun.
Investments in scarce assets
If prices of all kinds of goods, services and assets raise significantly over time, it can be a wise tactic to invest in scarce assets. In general, real estate, commodities such as gold or silver, or specific stocks belong to such scarce assets. But what should an investor do if he feels that these assets are becoming overvalued?
Investors could seek to explore asset classes of scarce assets that might still be relatively undervalued or inappropriately explored. The reason for this could be that specific asset classes might exhibit hurdles for investors or that such asset classes are not yet fully understood. Therefore, in the remainder of this article, real assets tokenized on blockchain systems will be presented as an example where technology should lower the hurdles for investors to invest. Also, crypto assets such as Bitcoin as an asset class which is not yet fully understood are presented.
Tokenized real assets: an asset class difficult to access but dramatically changing
At this point in time, tokenized real assets are a very tiny asset class. Tokenized real assets are assets that are brought to a blockchain to ease investors’ access and to allow for a fractionalization. A good example are classic cars. Often, classic cars have a price of USD 250,000 and above. So, an investor needs to bring this sum to the table to invest in one single classic car. To distribute the risk among multiple classic cars, more than USD 1 million is needed. Also, the cars need to be cared for and they need to be safely stored so that they keep their value. If this is done, it can become interesting: The value of classic cars developed nicely over the last years. As a scarce asset - recall that classic cars have been manufactured in former times and therefore, by definition, they remain scarce - they could keep their value even in a world of inflation.
Tokenization brings classic cars on a blockchain: A classic car is segmented for example in 1000 pieces. One share of a classic car then costs USD 250. So, an investor seeking to distribute his or her investments can invest smaller amounts of money in multiple cars at the same time thus building a classic car portfolio. Including risk distribution. Companies offering such investment possibilities to investors are in the making. So far, only very few service providers exist at this point in time. But within the next 12 months multiple such offers will launch to the market.
Classic cars are just one example. There are other such scarce assets that could be tokenized exactly in the same way: watches, diamonds, etc. - again, multiple companies work on such offers and will in 2021 allow investors to invest in these scarce assets. Of course, gold, silver and real estate can also be tokenized. While the same rationale applies, the underlying has already increased strongly in value over the last months and years. In any way, tokenization will be a large trend in 2021 for making large chunks of assets “digestible” for investors such that they can soon invest many smaller portions in a broad array of such tokenized assets - building a solid risk-distributed portfolio.
Crypto assets: a small asset class on an upwards trends
There are thousands of crypto assets. But two crypto assets alone - Bitcoin and Ethereum - make up approximately 75% of the total market capitalization of all crypto assets taken together. To get started, it is exactly these two crypto assets that are worth exploring. Once, acquainted with the appropriate knowledge it of course also makes sense to explore further smaller crypto assets.
Bitcoin is the oldest crypto asset. The mechanics of how Bitcoins are generated and how scarcity is emerging have - believe it or not - extremely large similarities with gold. With gold, excavators and equipment is required to dig gold nuggets out of a gold mine. With Bitcoin, mining hardware and electricity is needed to generate new Bitcoins. As other experts have put it, Bitcoin has the potential to become a store of value. This means Bitcoin is not yet a store of value but has the potential to become one.
The key difference between gold and Bitcoin is that billions of people on our planet know for thousands of years that gold is something valuable. In other words, the knowledge about gold being valuable has been fully diffused. The result is a market capitalization fluctuating around USD 9 trillions. With Bitcoin, it is different: Bitcoin has an age of little more than 10 years and we can expect that only a small fraction of a population knows the conceptual underpinnings.
Once the knowledge about Bitcoin diffuses - which is a lengthy process - it is reasonable to argue that there is quite some upside potential. Gold has found its target bandwidth of having a market capitalization of about USD 9 trillion. Over the course of months it fluctuates around this value. Bitcoin shows a large volatility and currently has a market capitalization of USD 210 billion. The key question therefore is - with increasing diffusion - what will be the target bandwidth for its market capitalization in the next years?
Luckily, regulation in many countries is positive. Quite recently, the European Commission presented their new crypto regulation which will create a pan-EU wide regulation scheme for crypto assets. Switzerland also has a progressive regulation for crypto assets. The same is true for Germany since the beginning of 2020 and more and more also for the US. Governments around the world allow their citizens and companies to work with Bitcoin. The regulations put in place are not made such that Bitcoin and other crypto assets should be prohibited with it. Rather, they provide a solid legal foundation based on which individuals, companies and financial organizations such as asset managers and professional investors can see both legal certainty and investor protection arising. With this, the days are over when fears were justified that Bitcoin could entirely be forbidden. Rather, the legal foundation of positive regulation in many countries could be the basis for investors to invest once knowledge about crypto assets diffuses further.
Blockchain is on the raise in many domains. Blockchain technology creates new asset classes for investors to protect their values and themselves against inflation. Tokenized real assets such as classic cars, watches or diamonds are soon-to-come asset classes that are unknown to many investors so far. Real estate is also ready for tokenization. Here, tokenization allows an investor to build an optimized portfolio with many small pieces whilst keeping a solid risk distribution. On the other hand, Bitcoin and Ethereum are the most important crypto assets these days. If the knowledge about crypto assets diffuses in a wider way - in combination with positive regulation in many countries - an interesting upside potential results.