Looking Beyond Bitcoin into Crypto Equities

As Bitcoin has become a widely discussed investment topic, investors are looking for more opportunities to incorporate Bitcoin into their portfolios. As many investors are comfortable with using ETFs and other index-linked products due to their relative ease and diversification benefits, they may notice that U.S. ETFs are not yet eligible to have spot Bitcoin exposure. Instead, most of the index and ETF world uses crypto-related equities as a method of providing exposure to Bitcoin, while also exploring thematic trends related to the digital transformation. But not all crypto equities are built equally—some have a direct relationship between their profitability and the price of Bitcoin, while some may just share broader themes or underlying blockchain technology. This note provides a high-level overview of crypto-related equities—a relatively new area that many investors may not be as familiar with—and how different subsectors are exposed to Bitcoin.

In general, crypto equities can provide exposure to high growth, emerging technology companies within the digital transformation megatrend.

Most crypto-related equities are generally small-cap technology companies with high growth characteristics. While correlations to Bitcoin prices vary, most crypto-related equities have earnings that are ultimately driven by Bitcoin prices and/or volumes. Investors who are interested in crypto equities are generally bullish on Bitcoin and other crypto assets but may be looking for additional equity exposure to complement their Bitcoin allocation or a high risk/return investment in emerging technologies that support long-term digital disruption trends. The Alerian Galaxy Global Cryptocurrency-Focused Blockchain Equity, Trusts and ETPs Index (CRYPTO), which tracks exposure to a basket of crypto miners, crypto enabling technologies, and crypto buyers, currently has a 45.4% weighting toward technology stocks and a 62.3% weighting to small-cap stocks.(1) The Alerian Galaxy Global Blockchain Equity, Trusts and ETPs Index (BCHAIN), which tracks exposure to the above sectors in addition to companies that use blockchain for non-crypto related purposes, has less weight to small-cap and/or technology stocks since blockchain users are often large, diversified companies that utilize blockchain to modernize their operations—currently, all blockchain user constituents within BCHAIN have market caps above $100 billion. In total, BCHAIN has a 38.7% weighting to technology stocks and a 35.7% weighting to small-cap stocks

Crypto Miners: Mining for Digital Gold

Crypto mining companies run a network of machines to verify crypto transactions and are rewarded with a share of crypto. Like typical commodity miners (e.g., gold miners, coal miners), crypto miners are directly levered to the prices of the underlying commodity, and profitability is dependent on the price of Bitcoin mined less costs from electricity, equipment, and other factors. While industry profitability has been hurt during the recent Bitcoin selloff, larger crypto miners may be better positioned in the long-term to withstand Bitcoin volatility by using their size and capital to invest in efficient facilities, machines, and energy sources to reduce costs. Crypto miners include companies like Marathon Digital Holdings (MARA) and Riot Blockchain (RIOT). Crypto miners are currently 39.2% of index weight in CRYPTO and 22.6% of index weight in BCHAIN.

Crypto Enabling Technologies: Supporting the Crypto Ecosystem

Crypto enabling technologies include companies like crypto exchanges, crypto payment processors, and crypto hardware manufacturers which support the crypto ecosystem. Profitability varies greatly depending on the company. Crypto exchange platforms like Coinbase (COIN) generate substantially all of their revenue from transaction fees, which are based on both quantity and price—so volumes can help drive revenue even if there is short-term price volatility. Silvergate Capital (SI), a digital assets bank, was able to double its net income y/y in its latest 1Q22 earnings report despite the crypto selloff. Net income was driven by interest earnings, while long-term support of Bitcoin helped drive increases in both customers and deposits in the quarter. Crypto enabling technologies are 37.1% of index weight in CRYPTO and 26.9% of index weight in BCHAIN.

Crypto Buyers: Investing in Crypto

Crypto buyers own crypto assets on their balance sheets in order to profit from rising prices. Many of these companies, like Tesla (TSLA) are diversified and earn the majority of revenues from other business segments. In comparison, companies like MicroStrategy (MC) hold Bitcoin long-term as one of its primary revenue sources. The company’s earnings have a strong exposure to the volatility of crypto prices—even with unrealized losses, the company has to account for impairment losses in its statements when Bitcoin prices fall below carrying value, which means that the long-term value of the company could be misaligned from quarterly earnings results. Cryptocurrency buyers are 8.1% of index weight in both CRYPTO and BCHAIN.