MEGATRENDS

Executive Summary

CRYPTOCURRENCYINVESTING
Powerful Diversifier or Portfolio Kryptonite?

With a market cap well over $1 trillion, cryptocurrencies have grown too big to ignore. For institutional investors, they offer
the allure of extraordinary and diversified returns in a market that is now of sufficient size and liquidity for meaningful
institutional positions.
To understand the investment implications of the evolving
cryptocurrency space, PGIM’s latest paper draws on theinsights of over 30 PGIM investment professionals across fixedincome, equity, real estate and private alternatives – as well as
leading economists, venture capitalists and crypto investors.
Despite the hype, we find little evidence thatcryptocurrencies offer any meaningful opportunities for
institutional investors. Instead, we argue that enduring value
will be found not in direct ownership of cryptocurrencies,
but in the real-world applications of blockchains themselves.

Understanding the
Cryptocurrency Ecosystem
Bitcoin and other cryptocurrencies are digital assets
maintained and recorded on a blockchain without a trusted
intermediary like a custodian or bank. Whatever bitcoin’s
ultimate destiny, the ingenuity displayed in bringing together
distributed ledgers and cryptography represents a legitimate
technological breakthrough.
Since its launch in 2008, bitcoin has spawned thousandsof other cryptocurrencies and digital tokens. Each ofthese make design decisions along four dimensions:decentralization, security, scalability and stability. Taken
together these four dimensions allow one to neatly classify
the crowded cryptocurrency space. Every cryptocurrency is aunique and different trade-off between these four elements.
However, cryptocurrencies are just one part of the broader
crypto ecosystem.

Shortcomings as a Currency
While a few cryptocurrencies will endure on the fringesof the monetary system, the broad replacement of fiat
currencies globally is unlikely to materialize. Additional,
powerful headwinds come from both increasing regulatory
scrutiny and the growing likelihood of central bank digitalcurrencies, which provide the functional benefits of fiatlinked cryptocurrencies without liquidity or currency risk.
Bitcoin, the first and still the most prominent cryptocurrency,
does not meet the basic functions of a currency:• Store of value: providing a stable store of value, atleast over short periods of time, is an essential functionof a currency. The dramatic price gyrations of many
cryptocurrencies make them highly unattractive as a storeof value – even in the short term.
• Medium of exchange: It is indeed telling that even aftera dozen years, few commercial enterprises accept bitcoin– or other cryptocurrencies - in exchange for goods andservices. This situation is not likely to change soon as
bitcoin’s maximum transaction speed and cost-efficiency
pales in comparison to conventional payment networks.

Exhibit 1: The Cryptocurrency Ecosystem

CRYPTOCURRENCIES
Decentralized, unregulated
digital money

Tether

DIGITAL ASSETS
NFTs, tokenized assets andother decentralized apps and solutions

BitcoinOpen Sea

Maker

EXCHANGES AND WALLETS

INFRASTRUCTURE

Custody, trade, hold andaccess digital assets

To scale, institutionalize and enhance compliance(e.g., KYC, identity, security)

Anchorage

Chainalysis

Coinbase

Fireblocks

Metamask

Lightning Network

BLOCKCHAINS
Decentralized digital ledgers used to record transactions

Bitcoin

Ethereum

SolanaSource: PGIM Thematic Research.

• Unit of account: While some businesses may accept bitcoin
as a payment option, very few businesses fix the priceof their product in it. Outside of the deep digital realm,
bitcoin and other cryptocurrencies are only rarely used toprices goods or services.

Considering Bitcoin for an
Institutional Portfolio
Beyond hedge funds exploiting inefficiencies to generate alphaon the other side of retail- and momentum-driven flows, there
is currently not a compelling case and little evidence for directownership of cryptocurrencies as a meaningful share of an
institutional portfolio.
1. Is bitcoin an effective portfolio diversifier?
Its detachment from broad macro factors suggests that
bitcoin may be uncorrelated with other asset classes. This
was true early in its history. However, it has shown increased
correlation with other assets since 2020.
2. Is bitcoin an inflation hedge?
The scarcity of bitcoin’s supply and its detachment fromgovernments and institutions suggests its value may be resistantto price inflation. Yet, in the lone episode of elevated U.S.
inflation since bitcoin’s inception, it has not held its value well.

3. Does bitcoin offer extraordinary risk-adjusted returns?
While bitcoin exhibited some remarkable risk-adjusted
returns early in its history, since 2018 its Sharpe ratio has
been similar to equities and bonds. Given the frequency
and severity of drawdowns and its diminished risk-adjusted
returns, it is not clear there is a compelling case for direct
investment in bitcoin.
4. Is bitcoin a safe-haven asset or “digital gold”?
Bitcoin’s deliberate detachment from financial institutions,central banks and monetary debasement leads some tobelieve it may be “digital gold” – that is, it retains its value
during turbulent times. But during the COVID-related
market drawdown in early 2020, for example, many markets
collapsed, and bitcoin did not exhibit safe haven characteristics
at that critical time while gold held its value throughout.
5. Is bitcoin supportive of ESG objectives?
For sustainability-minded investors, cryptocurrencies areproblematic along multiple dimensions of ESG. Bitcoin’s
carbon footprint is substantially higher than other payment
networks. While cryptocurrencies are developing protocols
to be more energy efficient, they raise concerns from agovernance perspective, e.g., the anonymity of transacting
makes it a preferred instrument in illicit activity – such as
skirting sanctions.
PGIM | CRYPTOCURRENCY INVESTING 2

Exhibit 2: Bitcoin Correlation with Various Assets(Rolling 1-year)
Correlation Coefficient
0.5
0.4

S&P 500

U.S. Bond Index

Commodities

Nasdaq

0.3
0.2
0.1
0
-0.1
-0.2
2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

Source: PGIM analysis; Refinitiv and Bloomberg.
Note: The Bloomberg Commodity Index and Bloomberg Aggregate Bond Index were used for Commodity and Bonds respectively.

Exhibit 3: COVID Market Drawdown
20%

BTC

Global Equities

Gold

USD

Treasury

10%
0%
-10%
-20%
-30%
-40%
-50%
Feb-20Mar-20

Apr-20May-20Jun-20Source: Refinitiv and Bloomberg.
Note: The MSCI World Index, London Bullion Market Association Gold Price, and Bloomberg Treasury Index were used for Global Equities, Gold and Treasuries respectively.

Investment Opportunities in the Ecosystem
In contrast to direct cryptocurrency ownership, the broader
blockchain ecosystem provides long-term investors withseveral attractive opportunities to evaluate. These include:• Private blockchains and smart contracts
Blockchains are a highly secure and robust system forverifying and recording transactions. Private applications of
distributed ledger technology and smart contracts
are being used in financial services, logistics and supplychain management.
• The infrastructure and broader ecosystem
The landscape for innovation in infrastructure is wide

open, with tremendous potential to reduce current
challenges and barriers. Companies solving issues aroundinteroperability, due diligence, and fraud prevention might
have a first mover advancement as the world of digitalassets and central bank digital currencies matures.
• Tokenization
Tokenization of real assets opens a simpler, morecost-efficient ways to manage and transact assets andinvestments. Once legal, governance and regulatory
frameworks become settled this application will
substantially reduce frictional costs across financial services
and has the impact to reshape the current markets of
illiquid assets.
PGIM | CRYPTOCURRENCY INVESTING 3

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