Feb 7, 2023

Decoding Institutional Investors' Crypto Portfolios: Key Metrics and Evaluation Factors

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Institutional investors are increasingly looking at cryptocurrency as a new asset class to invest in. However, the cryptocurrency market is still a relatively new and highly volatile space. This means that institutional investors need to use a variety of different metrics to help them evaluate the potential returns and risks associated with different digital assets. In this blog post, we will explore some of the key metrics that institutional investors use when building their portfolios.

Valuation metrics for digital assets 

Institutional investors need to know whether a particular digital asset is overvalued or undervalued. One way to do this is to compare the current market capitalization of a digital asset to its historical prices. For example, if the current market capitalization of Bitcoin is much higher than its historical prices, it may be considered overvalued.

Flow of capital 

Institutional investors need to know whether money is flowing into centralized or decentralized crypto exchanges. Centralized exchanges are more regulated, offer more liquidity, and provide on-off-ramps for fiat to crypto. Decentralized exchanges offer more privacy and lower fees but they lack the on-off-ramps for fiat. The flow of funds to centralized exchanges can signify that users are looking to exit their crypto into fiat indicating market weakness. 

The flow of funds into different digital assets can also provide an indicator of which projects are gaining traction. CoinShares posts Digital Asset Fund Flows Weekly which is a brief synopsis covering investment inflows and outflows in popular ETPs, mutual funds, and OTC trusts referencing bitcoin, ether, and other digital assets. It covers flows by the provider and by asset, helping investors understand the drivers of recent price moves and investor sentiment in the digital asset world. 

Image as of Jan 23rd 2023

One thing to keep in mind while analyzing fund flows is to “normalize” the data by looking at relative flows. For example, recently Binance outflows were numerically huge. But compared to their reserves, this proportion of outflows has happened many times before. So taking a normalized view of data helps frame the perspective. Another way to do this is to not look at the outflows in USD denomination but to measure them in terms of # of Bitcoins or Ethereum. This way we eliminate fluctuations due to price variations. Yet another way is to look at the % change monthly, annually, etc.

Spending behavior vs Holding behavior of digital assets 

Institutional investors need to know whether digital assets are being held for long-term investment or traded in the short term. For example, HODL Waves present a macro view of the age distribution of the coin supply and provides insight into changes to this age distribution arising from holding and spending behavior. The metric bundles the coin supply into categories depending on age and presents it in color bands with a thickness proportional to the total coin supply.

State of the Bitcoin Miners

More recently, Institutional investors have started looking at whether Bitcoin miners are sending coins to exchanges, and what the current hash rate is. If the miners are sending coins to exchanges, it can suggest a weakness in their balance sheet or anticipation of lower prices. Glassnode calculates a metric called The Puell Multiple which is a cyclical oscillator that captures the aggregate profitability of the bitcoin mining industry. 

Mining hashrate is another key security metric. The more hashing (computing) power in the network, the greater its security and its overall resistance to attack. With increasing difficulty, however, old hardware becomes unprofitable. Websites such as Hashrate Index do a great job at compiling such metrics in one dashboard. 

Blockchain Network Activity

Institutional investors look at the level of activity on different blockchain networks and the specific Decentralized Apps (dApps) built on them. For example, the blockchain explorer page of a specific smart contract can give us insights into the number of contract calls made to the protocol’s smart contract indicating the activity on the protocol. Another way could be to look at the fees generated and revenue metrics using platforms such as Token Terminal

Derivatives and On-chain Data for Sentiment Gathering

Institutional investors study how perpetuals are trading compared to spot. Futures contracts, a type of derivatives instrument, postpone payment and delivery until predetermined future dates, whereas spot contracts are for immediate buying and selling. In contrast, a perpetual contract (which is a type of futures contract) lacks a fixed settlement time and an expiration date. The price of perpetual contracts in relation to the underlying asset’s spot price can tell investors about the market sentiment. NYDIG wrote an article on how the current bitcoin rally can be interpreted based on this metric. 

Another metric to look at could be the amount of activity on derivatives exchanges. Thus metrics such as GMX long/short ratio, and deposits in derivatives exchanges vs spot exchanges also help institutional investors gauge the retail market sentiment. This is because derivatives exchanges such as GMX are typically used by retail investors looking for more leverage. But if they want to take less risk then they will move to spot exchanges as they might want to exit. 

Closing Thoughts

Thus, there are several key metrics that institutional investors use while building their portfolios and generating alpha. Although these metrics are useful, by no means are they sufficient. There are currently many unknowns in the cryptosphere such as: What happens to the proof of reserves for centralized exchanges? How can investors see the proof-of-liabilities on-chain? Which other tokens (such as FTT) are propping up other exchanges’ balance sheets? Which exchanges are generating yield through centralized lending? Who might be the next SEC chair?

Institutions have done their homework on blockchain technology and DeFi. They have been building, testing, and training their models. Many big institutional players sat on the sidelines so far. This year there will be more institutional participation once the SEC and the CFTC figure out how they want to regulate digital assets. Coinchange Head of Research, Jerome, and Research Analyst, Pratik talk about all this and a lot more in our next Guest AMA with Paul McCaffrey from KBW, which will be aired on the 30th of January. Head to our YouTube channel and subscribe to it, so that you don’t miss out on this important conversation.

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