“There are more cryptocurrencies than stocks in the US right now,” says Matthew Sigel, Head of Digital Assets Research, at VanEck. “But investors don’t have a comprehensive framework for understanding the drivers of the returns within that cryptocurrency market.”
Sigel sat down with Action Alerts Plus Portfolio co-manager, Bob Lang, as part of our FREE webinar, Beyond Bitcoin and Metaverse: Crypto Categories Investors Should Know. Topics discussed included crypto’s Back to the Future moment, key crypto categories explained, how DeFi compares to traditional finance, monetizing the Metaverse, and so much more.
Watch the video above, or read the transcript below.
- 00:00:45 Digital Asset Categorization: How Crypto Classification Benefits Investors
- 00:07:15 DeFi: What It Is, How It Works, Subcategories Investors Should Know
- 00:11:00 Cryptocurrency Exchanges Explained, Risks, and Opportunities
- 00:13:35 Store of Value: How Should Investors Think About Bitcoin Vs. Other Altcoins
- 00:19:50 What’s Driving Activity Between Credit Card Companies and Cryptocurrency Giants?
- 00:23:20 The Metaverse’s Open and Closed Ecosystems Explained
- 00:25:35 Crypto Is Having Its ‘Back to the Future’ Moment
[00:00:05.16] Bob Lang: The cryptocurrency world is evolving fast. There are now over 12,000 coins in the crypto ecosystem. And with so many coins and even more data points, a rigorous classification system is becoming increasingly essential for investors to structure sound investment decisions. So what are they, and which digital asset categories offer the biggest opportunities and risks short term and long term?
[00:00:28.86] Hello, and welcome to Beyond Bitcoin and Metaverse– Crypto Categories Investors Should Know. I’m Bob Lang. Joining us today is a leading expert who spends his day in the crypto universe– Matthew Sigel, head of digital assets research at VanEck. Thanks for joining us today. So let’s get right to it.
[00:00:46.99] First, Matthew, what is digital asset categorization, and why is it so important to sort out the crypto world in this way?
[00:00:54.27] Matthew Sigel: Traditional investors have been trying to measure performance versus benchmarks for a long time. And one of the tools that help them achieve that is by breaking down the equity markets into sectors like technology, financials, consumer staples, telecom, et cetera. And that not only gives individual investors a chance to express a particular view on the sector, but it also gives diversified portfolio managers better information sources so that they can understand the drivers of their performance and make adjustments to reflect their views on sectors or to understand what stocks are driving the performance of an individual sector.
[00:01:40.53] So it’s much the same in the case of cryptocurrencies. There are more cryptocurrencies than stocks in the US right now. But investors don’t have a comprehensive framework for understanding the drivers of the returns within that cryptocurrency market without this type of categorization framework that we’ve developed. So we’ve tried to introduce eight different categories that can be used by traditional investors or crypto investors, much the same way that folks use the GICS Level 1 Index from S&P. And those sectors are now trackable on Bloomberg. And we think they give a lot of information to investors to understand the performance drivers within this vast crypto ecosystem.
[00:02:28.71] Bob Lang: Well, these are distinct non-overlapping categories that form the building blocks for new a crypto classification scheme at VanEck. Can you tell us more about how these benefit investors?
[00:02:39.18] Matthew Sigel: These eight cryptocurrency categories that we’ve developed at VanEck are distinct, non-overlapping sectors that will give investors a better window into what’s working and what’s not in the broader cryptocurrency market. So we think that investors are going to use these categories to express their views on a specific sector within cryptocurrencies and also to better understand how their diversified portfolio is acting by understanding the differences between how these end markets are acting.
[00:03:16.59] Bob Lang: Are there competing views on the categorization of crypto, and do you see, Matthew, these categories continuing to evolve?
[00:03:24.48] Matthew Sigel: One of the challenges that we faced when deciding on the methodology for this type of taxonomy was whether to make the categories mutually exclusive. That is, many of our competitors have introduced more of a basket-type approach, so collections of cryptocurrencies form an investable basket. But oftentimes, one cryptocurrency will fit into more than one basket. And that makes it a little more challenging to understand the broader performance dynamics within the space. You might not get a full view of what’s happening in a category if the coins that comprise it are also part of another category.
[00:04:09.55] So I’d say that was one of the big decisions that we had to make, which was making these categories mutually exclusive. Another challenge has to do with just how fast-moving and flexible this space is. Many of these coins are open-source software projects whose final destination is still unknown. And it’s possible that the category that they’re in now may not be the one that they’re in tomorrow.
[00:04:37.09] So this exercise is a recurring one, requires a lot of maintenance, continual upkeep. And we should expect the categories to change over time and the constituents also to change. And investors can understand those changes by going to the website, the MVIS website, or the VanEck website, where the index categories are released monthly.
[00:05:01.02] Bob Lang: Would you say, in effect, that these indices with common characteristics and value in measuring their performance as a group, and are all indices investable?
[00:05:10.84] Matthew Sigel:: On top of this crypto classification system that we’ve unveiled, we’ve released eight separate indices. So we’ve chosen the four most investable categories. And then for those categories, we’ve launched two indices for each of them, so a broad index that captures all the coins in that category, over $250 million market cap, and then a leaders index, which is the same category coins but a larger market cap requirement, $1 billion and up. And then we’ve introduced an invest-ability component. So a coin cannot make it into the leaders’ category unless it is traded on one of the top-tier cryptocurrency exchanges and custodied by one of the top cryptocurrency custodians.
[00:05:55.34] And so in that way, the leaders’ indices represent a true investable benchmark that investors can use to measure their own performance and also to measure the performance of the categories versus each other. That’s a very helpful tool for investors in this space who have not had such a taxonomy in the past.
[00:06:13.75] These categories comprise coins that have common characteristics and share common values. So we see value in measuring them as a group and then measuring the groups versus each other to give investors an idea of how these baskets of coins with common characteristics are performing in the marketplace.
[00:06:32.96] Bob Lang: So do you see any potential for new categories and classifications as the crypto universe expands?
[00:06:38.23] Matthew Sigel: We started with these eight categories that represent something akin to a GICS Level 1, so the broadest cut of the ecosystem. We’re in the process of working on it and will soon release a level 2 categorization. So each of the eight categories has between three to five subcategories, a further refinement of that system of common use, common values, creating groups of coins that investors can measure against each other.
[00:07:13.49] Bob Lang: Well, let’s break down some of these categories for investors. The Street’s crypto editor calls DeFi the next big thing and a real game-changer. Do you agree with that, and how so?
[00:07:23.83] Matthew Sigel:: Decentralized finance protocols, DeFi, are essentially software programs that run on top of another cryptocurrency. And they use a combination of that protocol’s assets as a means to automate a financial service. So DeFi protocols connect lenders and borrowers, buyers and sellers without requiring a centralized institution.
[00:07:48.76] DeFi protocols comprise an overlapping ecosystem of decentralized applications and smart contracts. Most operate on Ethereum, which is the largest open-source blockchain smart contract platform. But many other blockchains now support decentralized finance applications.
[00:08:06.88] Bob Lang: Matthew, which tokens top the MVIS DeFi Leaders Index? And with such complicated earnings models, how are the leaders determined?
[00:08:17.02] Matthew Sigel: The MVIS Decentralized Finance Index comprises coins such as Uniswap, Aave, and Maker. These are the largest decentralized exchanges. And they create value by hosting a marketplace where buyers and sellers can meet to exchange cryptocurrencies and by taking a small commission of every trade. The complicating factor is that those commissions are denominated in the native token. So you pay Uniswap in Uniswap coins. And that represents a stream of earnings that can be valued by market participants using a discounted cash flow analysis or price to sales.
[00:09:00.07] Bob Lang:: Let’s talk about DeFi protocols, which can be divided into several subcategories. What are they, and can you give us some examples of those?
[00:09:09.28] MATTHEW SIGEL: DeFi protocols include subcategories such as decentralized exchanges like Uniswap, lending and borrowing platforms like Compound and Aave, derivatives exchanges like Synthetix, asset managers like Mirror or Numeraire, insurance protocols like Nexus, and then protocols that aggregate all of those services together like Yearn Finance. It’s really a fast-moving sector with a lot of changes. And we hope that this classification and subcategory model will give investors a better idea of what types of coins are working and what types of coins are underperforming. And that’ll help capital get allocated more efficiently in the marketplace.
[00:09:53.80] Bob Lang:: What are some of the unresolved challenges that are facing DeFi? Some say this is a chance to rebuild finance from the ground up. Would you agree with that?
[00:10:02.86] Matthew Sigel: DeFi platforms enable buyers and sellers to find each other online without a centralized exchange or intermediary taking a large commission. And because it’s a cheaper and faster and less censored way to transact, decentralized finance has been taking a lot of market share from both centralized crypto exchanges and the broader financial system at large.
[00:10:29.64] Now, there are a lot of uncertainties about the space still– regulatory uncertainty, technological uncertainty. But the underlying innovation– faster, cheaper, more frictionless value transfer across the world, 365, 24/7– that’s an innovation, a technological innovation that we don’t think is going to slow down anytime soon.
[00:10:51.51] Bob Lang: Huge advantage to the currency. Many digital currency investors, Matthew, are familiar with exchanges. We use them, of course, for our digital currency transactions. Can you walk us through this category for the viewers?
[00:11:06.89] MATTHEW SIGEL: The exchange category includes the tokens of centralized cryptocurrency exchanges such as FTX and Binance, who, in many cases, have chosen to list their entities as cryptocurrencies that trade on a cryptocurrency exchange rather than going public in an IPO on a traditional securities exchange. Many times, the underlying model is similar. The exchange will collect profits that it derives from charging its users commissions.
[00:11:40.26] And those profits will be denominated in the native token. In the case of FTX, that’s the FTT token. So the exchange category includes those centralized cryptocurrency exchanges like Coinbase who, instead of listing in an IPO or raising capital in the traditional private markets, instead fund their equity via these crypto tokens which trade on crypto exchanges.
[00:12:08.19] Bob Lang: Hackers, Matthew, just hit the crypto exchange Crypto.com, siphoning some $35 million. What would you say are the biggest vulnerabilities? And should investors brace for more theft of this size if not greater?
[00:12:20.82] Matthew Sigel: As activity grows in cryptocurrency, and indeed in any industry, there are always opportunities and risks for technological mistakes and hacking. We’ve seen that in many industries. In fact, the proportion of cryptocurrency illicit activity fell in 2021 versus 2020. So we’re optimistic that increased analytics and tools in the industry are helping regulators and exchanges better monitor the flow of funds in the industry and more quickly apprehend the wrongdoers.
[00:12:56.37] So many of the largest hacks that we saw last year, the funds were actually returned voluntarily after the perpetrators have doxed online thanks to the transparency that the blockchain provides. So it’s true that in crypto, there are bad actors, as there are in every industry. But we’re pretty optimistic that because of these analytics and tools that are available to anyone who’s observing the blockchain– anyone’s crypto wallet can be tracked and monitored– that the opportunities for wrongdoing are actually falling over time, not rising.
[00:13:30.24] Bob Lang: That’s good news for future investors. Let’s talk about the store of value, Matthew. What is that, and what falls under it, store of value?
[00:13:39.27] Matthew Sigel: The store of value category includes bitcoin and bitcoin derivatives. So we believe that bitcoin’s proof of work consensus model is unique among cryptocurrencies. It provides the most robust security. And it guarantees that every bitcoin that’s created contains the same amount of thermodynamic energy. And that is a point of attraction for investors who compare bitcoin to a hard asset such as gold, which also requires a lot of physical investment in order to mine.
[00:14:17.13] So bitcoin’s high energy use is more of a feature than a bug, but it does merit its own category as a store of value thanks to the simplicity of its code, its energy intensity, and importantly, its fixed supply, making Bitcoin really the only fungible asset in the world that doesn’t respond to higher demand with higher supply. That cannot happen with bitcoin.
[00:14:43.11] Bob Lang: Very unique, the qualities there. So investors often equate, Matthew, bitcoin to the whole crypto sphere, but there’s so much more. How should investors think about Bitcoin as it compares to other altcoins?
[00:14:56.16] Matthew Sigel: The cryptocurrency industry is now $1.6 trillion roughly. Of that, bitcoin is about $700 billion. So we think investors are starting to differentiate between the various categories in crypto. Bitcoin stands alone as a store of value thanks to its unique proof-of-work consensus. We believe that it deserves a weighting in a portfolio that is commensurate with one’s views on stored value. So maybe for gold and bitcoin, that may be 0% to 5% of an investor’s portfolio.
[00:15:32.58] A large proportion of the ex-bitcoin cryptocurrency universe is more closely related to the growth equity component of your investment portfolio. These are bets on software protocols that are gaining market share thanks to their innovative ability to send value across the world in a more frictionless nature. So perhaps that allocation in an investor’s portfolio, the ex-bitcoin smart contract allocation, might also be a 0% to 5% allocation.
[00:16:06.18] And perhaps it might be compared to one’s investment in FAANG stocks, which represent 20% of the S&P 500 but whose profits may be at risk if indeed cryptocurrencies form a competitive threat thanks to the lower cost and lower take rates that they charge. So that’s how we think about it over here.
[00:16:28.35] Bob Lang:: Well, The Street’s crypto editor says governance tokens are as important as DeFi, as it tackles one of the core issues with crypto. For those new to this concept, can you explain governance tokens?
[00:16:39.69] Matthew Sigel: Governance tokens are an important part of cryptocurrencies. So governance tokens represent the right to own the decision-making of an entity. So if you owned 10% of the Uniswap DAO, the Uniswap Decentralized Autonomous Organization, then you would have a 10% vote in the corporate actions of that entity. So a decentralized autonomous organization is essentially a corporation that lives online where all stakeholders have the right to vote on corporate actions.
[00:17:16.50] Many times, the entity cannot spend even a dollar without the approval of the DAO members. So this governance right can be very valuable if the underlying entity owns a valuable asset, such as a decentralized exchange which might be earning hundreds of millions of a year in the case of Uniswap in trading profits. The Uniswap DAO’s treasury is now $2 billion.
[00:17:43.35] And to spend even a dollar of it, the community has to vote. The community gets to vote. And that’s why the token value of many of these governance tokens ballooned well beyond the size of the actual treasury. It’s because these entities are earning profits, and the community gets to decide the destination of those profits, the use of those profits.
[00:18:07.11] So it’s a new wrinkle on the corporation, which restores autonomy to the everyday player and really flips the script on capital formation. So we think we’re going to see a lot of very interesting DAOs in 2022 that raise a significant amount of capital. One of the most interesting was, late last year, the Constitution DAO that raised $43 million, tried to bid on a hard copy of the US Constitution. They were outbid by Ken Griffin. But we have a hunch that the next DAO may not be so unlucky.
[00:18:41.71]Bob Lang: Well, it was a heck of a try. That’s for sure. Let’s talk about the regulatory environment here for a moment. Is the regulatory environment around these still uncertain? What do you think?
[00:18:52.83] Matthew Sigel:: The US regulatory environment is particularly uncertain. It’s quite unique to have a new technology that the US is not leading on. And that is in large part due to the current administration’s view on cryptocurrencies. The current STC is, we think, holding the bitcoin ETF hostage. We’re trying to get Congress to act.
[00:19:21.66] Every day that we move closer to a midterm, there is less chance of Congress acting. That’s just the history of legislation. So we think this year, there’s likely to be very little that happens in terms of meaningful regulation. And in the absence of meaningful regulation, the innovation will keep moving forward. So it should be a good year for crypto because of that.
[00:19:48.03] Bob Lang: We’ve seen a flurry of partnerships between companies like Mastercard, Visa, American Express with cryptocurrency giants. What’s driving all this activity?
[00:19:56.44] Matthew Sigel: What’s driving the activity among the credit card companies to release bitcoin credit cards and other crypto credit cards is consumer demand. So consumers are sick and tired of unaccountable, unelected officials taking a large proportion of their savings, whether that’s the banking sector or whether that’s Web 2. So they’re asking for these products.
[00:20:19.47] And in return, the market is providing them. And we think that’s a big reason why crypto volatility, specifically bitcoin, is probably set to fall over the coming years. The early adopters of this technology were retail investors who were more volatile in their trading strategies. As the more sticky institutional buyers come in– sovereign entities like El Salvador, which declared bitcoin legal tender, corporations who now own more than 1% of bitcoin outstanding, and the next leg will be these micro-payments, credit card rewards, gaming– that will form the base of the pyramid– a consistent source of demand, tiny pieces of bitcoin being bought by everyday people who are asking their financial institutions to provide products like these bitcoin credit card rewards.
[00:21:09.03] So we’re hugely excited about that. We’re trying to do some work on tracking the wallets associated with these credit cards so that we can begin to size and scope how big the demand will be. But it’s a key linchpin in the thesis that bitcoin volatility should fall over time.
[00:21:25.62] Bob Lang: Yeah, good– it’s a good move for consumers, I think. Mastercard recently partnered with Coinbase for the crypto exchange’s upcoming NFT marketplace. What could this mean for all the players as well as users, and could we see more partnerships like this down the road?
[00:21:41.08] Matthew Sigel: NFTs really just prove the ability to make digital items scarce. The original, killer app to demonstrate that utility for the marketplace was art– profile pictures, files of digital art. This year, we think that utility will broaden out to include sports ticketing and concert ticketing along with gaming applications. So in the case of ticketing, what if the courtside NBA ticket that you bought also came with a 10% chance of dinner with one of the players after the game?
[00:22:25.60] That’s the type of additional goods and services that can be bundled into an NFT– connecting the digital world with the real world on top of it, proving digital scarcity, unlocking a series of benefits for ecosystem participants. It’s the same type of model that these cities like Miami are trying to exercise with their city coins. If you own enough of the coin, you might get access early to, let’s say, a museum opening or a park. And in that way, these cryptocurrencies really reward early participants, large participants who have conviction, and incentivizes them to do good and avoid wrong. And NFTs will enable that type of permission technology solution and bring a lot of value to consumers over the next year.
[00:23:21.60] Bob Lang: Matthew, media, and entertainment is pretty exciting area. NFTs are offering the early steps of monetizing the metaverse, of course. Can you walk us through that category?
[00:23:30.48] Matthew Sigel: Consumers already play in the metaverse when they use platforms like Roblox or Fortnite. These are real-time rendered 3D virtual worlds which can be experienced persistently by an effectively unlimited number of users with an individual sense of presence, with continuity of identity and history, and even some payments ability. The difference between the closed metaverse– the Roblox and Fortnite ecosystems– and the open metaverse is that in the open metaverse, all of these platforms can talk to each other. And they all can operate on a common unit of account, whether that’s a stablecoin like US dollar coin or whether that’s a more traditional cryptocurrency like bitcoin.
[00:24:19.23] And in the open metaverse, all these platforms being interoperable with each other will make a much more vibrant marketplace where consumers are going to have a lot more choice. And as we’ve seen in technology generally, open-source systems tend to beat closed systems. And we think that the same thing is going to happen with the metaverse. So think of it as Roblox or Fortnite but on the blockchain and interoperable because of the global nature of cryptocurrencies.
[00:24:50.65] So each of these metaverse platforms may have its own token and may use that token to incentivize certain behaviors, whether that’s building interesting architecture, displaying NFTs, lingering for a certain amount of time, making certain goods or services available to customers. All of that will happen within each ecosystem’s token, but those tokens will be interchangeable via bitcoin or Ethereum or US dollar, coins, or other stablecoins. So it really makes for a very scalable ecosystem in which users will share currencies in common. And we think that’s a more attractive business proposition than walled garden ecosystems which tend to charge higher take rates and which are smaller.
[00:25:39.24] Bob Lang: Matthew, millennial investors are receiving one of the largest wealth transfers in history, $24 trillion. Why is it so important to understand this group of investors along with the investing process?
[00:25:50.31] Matthew Sigel:: In that scene in Back to the Future when he’s playing “Johnny B. Goode” in front of all the high schoolers, and they’re all staring at him glassy-eyed, and he says, I guess you guys aren’t ready for that, but your kids are going to love it– that’s what’s going on with cryptocurrencies. I can see it in my own family.
[00:26:06.69] The kids just understand this intuitively because they’re digital natives. And the old fogies don’t get it. And every day, more old fogies are dying, and more kids are turning 18 and getting access to their own money. So the math is inevitable here, just like the math was inevitable when it came to gaming– World of Warcraft, Fortnite. The same thing will happen with digital currencies.
[00:26:30.64] And that’s why we think it’s important to get an early start, to dollar cost average in, because many of these assets are expensive, and to keep conviction that over the long run, because of this enormous wealth transfer that’s about to happen, trillions of dollars headed from baby boomers to the younger generation who are increasingly digital native, they will adopt cryptocurrencies. There will not be young people who have zero weighting. And that will be a big change in how assets are allocated over time.
[00:27:00.12] Bob Lang: Huge change from one generation to the next. It happens through history, right? What are the key takeaways that investors should walk away with after this talk?
[00:27:08.93] Matthew Sigel: The key takeaways here are that up until now, investors have not had a transparent, comprehensive taxonomy that they can use to measure these mutually exclusive cryptocurrency categories against each other. And we think that the eight indices that we’ve released, these category indices, are going to do a great job of educating investors what are the common characteristics of these coins, how are they performing, as well as providing investable benchmarks that professional investors can use to measure themselves against the market. So we plan to use them for both purposes here.
[00:27:47.31] Bob Lang: That’s fantastic. So with that, we’re going to wrap it up. Thank you, Matthew Sigel. You’ve been watching The Street’s special presentation– Beyond Bitcoin and Metaverse– Crypto Categories Investors Should Know. I’m Bob Lang. And for more information, head over to thestreet.com or our partners at vaneck.com.
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Editor’s Note: TheStreet’s Zach Faulds produced this video.