Galen Stops takes a look at the new launch from Elwood Asset Management that is targeting institutional investors wanting exposure to digital assets – without holding cryptocurrencies.
London-based Elwood Asset Management, which is backed by Brevan Howard co-founder, Alan Howard, has partnered with Invesco to launch its first product aimed at investors looking for exposure to digital assets, the Invesco Elwood Global Blockchain UCITS ETF.
The central problem identified by staff at Elwood prior to this launch is that currently there is a distinct lack of ways for institutional investors to gain exposure to digital assets. Right now, these firms can either buy cryptocurrencies – such as bitcoin – or invest in a venture capital fund, both of which can be problematic for institutional investors given the liquidity and regulatory issues surrounding cryptocurrencies and the limitations dictated by firms’ investment mandates.
To solve this problem, Elwood is building out products that enable these investors to gain exposure to different parts of the digital asset ecosystem via regulated vehicles.
“We see the world in three layers,” explains Kevin Beardsley, a partner and head of business development at Elwood. “We call it the digital asset stack: at the bottom layer is blockchain technologies, the consensus protocols and security; the middle layer is capital markets, which facilitate the transfer, trading and consumption of digital assets; and the top layer is the assets themselves, today there’s only really cryptocurrencies, but over time we expect there to be more assets that come online. So we work with partners like Invesco to give institutional investors exposure to different layers of the digital asset stack through innovative and regulated products.”
This is why, in partnership with Invesco, Elwood launched this new ETF, which aims to deliver the performance of the Elwood Blockchain Global Equity Index by physically investing in the index constituents. The index itself offers exposure to global companies in developed and emerging markets whose have potential earnings growth driven by the adoption of blockchain technologies.
In terms of the largest sector allocations, the index currently has 46% in information technology, 23% in financials, 9% in communication services and 8% in both the materials and consumer discretionary sectors. The three largest geographical allocations are to the US, Japan and Taiwan, with 39%, 29% and 12%, respectively. The index is calculated for Elwood Asset Management by Solactive AG and is reviewed and rebalanced quarterly.
“You can be a large institution and believe that that there’s potential in the blockchain space and that companies will profit from this technology but not necessarily believe in cryptocurrency. This ETF is in many ways designed for people who hold that view,” explains Beardsley.
The ETF, he adds, is both highly transparent and highly regulated, given that it tracks large, publicly listed companies whose shares are traded on major stock exchanges around the world. Crucially for these large investors, it is highly liquid, having capacity in the billions of dollars. By contrast, trying to buy $1 billion of bitcoin would, to say the least, prove problematic given the size of the market and the level of liquidity generally available.
Different blockchain models
Discussing the challenges associated with the institutional adoption of digital assets, Beardsley says that many investors still have the tendency to conflate blockchain technologies with bitcoin, the asset. The response to this from the staff at Elwood has been to spend time detailing the two types of blockchain that exist to investors – open or permissionless blockchains – like the ones underpinning cryptocurrencies such as bitcoin and ethereum, and closed or persmissioned blockchains, whereby only certain participants can interact with the network.
“What we aim to do with the ETF is to give investors exposure to both open and closed blockchains, because it isn’t yet necessarily obvious which model will prove most profitable and they’re likely to exist in parallel,” says Beardsley.
He sees the development of blockchain technologies as being analogous to the development of the Internet, commenting: “If you look at the Internet, it transformed how we interact with information and if you look at blockchain, it has the ability to transform how we interact with assets.”
In much the same way that cryptocurrencies represented the first practical application of permissionless blockchains, email was the first widely adopted application of the Internet and, given that anyone could email anyone, it was likewise an open system. While there was a mass adoption of email as a form of communication – and it remains an important offering for providers that offer email as a service – in the long term, it did not generate the majority of shareholder value for these providers.
By contrast, online companies operating in closed systems have generated a vast amount of shareholder value, with companies like Facebook, YouTube and Netflix generating significant revenues by offering the creation and dissemination of information within closed networks. Thus, the comparison to the Internet suggests that it is possible that cryptocurrencies are here to stay and could gain mainstream adoption, and yet still there could be more value in companies building businesses based on private, permissioned blockchains.
Targeting capital markets
However, Beardsley also cautions against thinking in purely binary terms about blockchain technology.
“People tend to think about it in terms of extremes,” he says. “So they either think of fully open blockchains designed to replace existing market structures or authorities, or they think about something like the JP Morgan Coin in which one firm is going it alone. But I think that what you might see over time is something in between these extremes, where a consortium of participants create and manage a private blockchain together. For example, you might have five banks on a network and while they might not trust each other individually, they might still trust that the other four banks aren’t going to conspire in order to take advantage of them. So I think we’ll see this type of group approach develop using private blockchains.”
He continues: “The other interesting thing about private blockchains is that they allow you to add a lot of distributed participants to the network very quickly, as opposed to having to deploy a lot of hardware and software and applications. So it can be a much more scalable way to deploy a system for a market with a very dynamic membership, which could have a number of real-world benefits for things like supply chain shipping.”
Looking ahead, Beardsley says that the focus for Elwood will be on supporting the ETF, whilst also developing new products focused on different parts of the digital asset stack that he identified earlier, with a specific focus on creating regulated, breakthrough products for investors. Within this stack, he highlights capital markets as a particular area of interest right now.
“We think the capital markets segment is really interesting because what you have, particularly with open blockchain assets like cryptocurrencies, is very inefficient markets that are lacking market infrastructure. There are huge inefficiencies within the existing capital structure in the ecosystem and so we think it will be interesting to explore opportunities to improve this.”
Alexi Esmail-Yakas, a partner and the head of trading at Elwood Asset Management will be speaking at Forex Network London, on the panel session “Does the Price Action of Crypto Tell the Whole Story? “. Click here to see the full agenda for the event.