New equity vehicle promises exposure to crypto, but liquidity, cashflow issues may signal risk
Cryptocurrencies, like grass breaking through a sidewalk crack, always find a way onto equity markets. That began with ETFs, spot bitcoin funds tracking that cryptocurrency, and that investable universe has exploded in Canada and the United States, covering a huge array of different cryptocurrencies, underlying blockchains, and overlaid strategies. Now, a new equity vehicle is offering investors access to certain cryptocurrencies that they can’t yet reach via ETFs or other means: Digital Asset Treasuries (DATs).
DATs are publicly listed companies that hold cryptocurrencies or digital assets as a primary strategic function. These companies seek to actively acquire and hold cryptocurrencies in order to grow their holdings and offer beta to a particular digital asset in their stock price. According to research by Galaxy released in July of this year, DATs now hold over $100 billion (USD) in cryptocurrencies, with the vast majority of that capital in DATs holding bitcoin. It’s a class of equities that one advisor believes demands the Canadian industry’s attention.
“There are multiple revenue streams to consider with these types of holdings, but the challenge that most DATs face are the lack of experienced executives and marketing dollars that are required to catch the attention of investors or developers who build applications on the blockchain.” says Michael Zagari, Investment Advisor & Associate Portfolio Manager at Wellington-Altus Private Wealth. “If you simply speculate, hoping that you’re buying into the next 100x opportunity and you have yet to quantify the use case of the token, you could lose a considerable amount of money.”
Underpinning his own assessment of DATs is the same approach Zagari takes with any crypto asset: gauging whether the underlying blockchain has utility beyond price speculation. He cites the example of a company called Spetz which trades on the Canadian Securities Exchange. Spetz holds $S which is native token of the sonic network with the goal to try and bridge traditional finance with decentralized, blockchain technology. Today, the sonic token is not currently available via an ETF, but investors can gain exposure through its DAT in Canada. The sonic network is constructed around a staking mechanism whereby the holder of existing tokens can stake them to secure the blockchain and generate yield. The validators can also generate fees from validating transactions on the network. That yield and fees, Zagari says, is used by Spetz to purchase more of its native token.
While some investors may see opportunity in using these vehicles to access cryptocurrencies they can’t get elsewhere, Zagari argues that advisors need to be cognizant of both risks and opportunities in the space. Many DATs, he says, trade at high premiums to the underlying NAV of the digital asset they hold. When that occurs, Zagari believes advisors and investors need to be wary about why investors are taking this approach to the product.
Because DATs are publicly listed companies, disclosure requirements and transparency standards are high, which offers advisors a better opportunity to assess quality. Because they operate in the murkier digital asset space, though, Zagari suggests focusing on three core metrics: operating costs of the DAT vs. revenue, the price discovery potential of the underlying digital asset, and fee generation. This can allow advisors to track earnings from DATs easily by calculating the volume of an asset held by its current price, provided the inventory doesn’t change. He also says that advisors should look for the means of generating cash flow, through mechanisms like staking, which can offer the DAT a way to offset operating costs without just grinding their digital asset holdings into cash. Despite the availability of options like Staking to generate cash, Zagari says that the primary way these companies make money is through asset appreciation or the use case of a particular network. The more adopted that network is, the larger the network effect possibility. That means even though these are equities, what’s being measured is not the traditional earnings of a company like Wal-Mart or Amazon.
Liquidity is also a crucial quality when assessing DATs. Zagari explains that without an appropriately liquid market for these shares, an investment can be subject to widening bid-ask spreads and eventual price dislocation. Zagari argues that when assessing the liquidity of a particular DAT, advisors and investors need to ask themselves what the trade-off is for any liquidity challenges and to size their trades accordingly.
For most advisors, this latest edge of the evolving cryptocurrency and digital asset space may seem marginal. Bitcoin ETFs might be more normalized now, but a sonic-tracking digital asset treasury compared to bitcoin, is a little further out. Zagari, however, argues that advisors need to be aware of this space both to appropriately protect clients from risk and to appropriately present areas of opportunity that come with advances in technology.
"Historically, groundbreaking innovations like electricity, telephone, airplanes, computers, or mobile apps were often out of reach for those without wealth or specialized knowledge," says Zagari. Digital assets are no exception today, understanding them is key to seizing their potential."
