The similarity between cryptocurrencies and the Pepsi Challenge. The analysis of the bitcoin phenomenon
Remember the Pepsi Challenge? This is a marketing stunt organized by Pepsi and carried out mainly between the 70s and 80s. Pepsi representatives would set up a stand inside shopping centers or public places and offer two white glasses to passers-by. One contained Pepsi-Cola and the other Coca-Cola. People were then encouraged to taste both the colas and others choose the one they preferred, without knowing which it was. Although many participants instinctively thought they preferred Coca-Cola during the challenge the majority chose Pepsi. Despite the notoriety conferred by the initiative on the Pepsi brand, the victory still left a bad taste in the mouth.
The challenge did not result in a significant increase in Pepsi-Cola sales. In fact, it seemed that people were not willing to “betray” the Coca-Cola brand to switch to what the challenge seemed to indicate was a cola better suited to their tastes. Cryptocurrency investor behavior has a lot in common with the Pepsi Challenge.
The “Crypto Challenge”
Let’s imagine a challenge between cryptocurrenciesin which we describe the quantitative characteristics of the bitcoin to multi-asset managers without naming the asset we are talking about. Armed with data collected over the last 11 years or so, we could say that: This asset has beaten large-cap and small-cap stocks, government bonds, investment-grade and high-yield bonds, as well as gold, REITs or infrastructure, in nine of the last 12 years.
The correlation of this asset class calculated over the last 11 or 12 years to all of the above asset classes has been less than 25%. The volatility of the asset is 69% but, thanks to its low correlation, adding 1% of this asset to a 60/40 portfolio (60% MSCI All Country World, 40% Bloomberg Multiverse) increased the volatility by just 0.07% and the maximum drawdown of 0.5%1. This 1% addition improved returns over the past 11 years by 0.67% per year, equal to an exceptional information ratio of 0.961. We therefore ask investors if they think it is worth it add this asset to their current portfolio and whether it is appropriate delve deeper into the topic.
There is no doubt that, considering the purely quantitative data listed above and comparing them with those of the diversification elements currently used by investors in their portfoliosthis asset would receive many positive and enthusiastic responses. The correlation with stocks and fixed income is lower than that of assets commonly used by investors such as commodities, gold or REITs. The return potential is significantly higher to that of all other often used asset classes and the information ratio is in line with or higher than most active strategies or hedge funds.
Cognitive biases and erroneous beliefs
Yet, contrary to what happens with cryptocurrencies among retail investors, the attention of institutional investors remains very limited, although it has recently grown thanks to the “recall” which followed the approval and launch of spot bitcoin ETFs in the United States. Just like consumers who, faced with the tangible proof of their preference for Pepsihave remained loyal to Coca-Colainstitutional investors continue to ignore the new asset class represented by cryptocurrencies, dismissing all the accumulating research on their strong potential as a source of growth and portfolio diversification.
Cryptocurrencies and, in particular, the bitcoin they continue to carry with them the stigma of many erroneous and often contradictory beliefs, such as they are usable only for criminal activities and, at the same time, that they have no use case in real life. Such erroneous beliefs are the basis of a psychological prejudice which prevents many investors from recognizing facts that are now difficult to refute: bitcoin is no longer new. It has been around for over 15 years. It is older than Instagram, WhatsApp or Uber and has survived several “cryptocurrency winters” that critics said were the beginning of the end; with a market capitalization of almost 2 trillion dollarscryptocurrencies represent approximately 1.5% of the capitalisation of total market of liquid assets.
They have now reached it similar dimensions to consolidated institutional investments, such as high-yield bonds, inflation-linked bonds or emerging market small caps; for a multi-asset manager, taking a neutral position means investing 1.5% of your portfolio in bitcoin and cryptocurrencies (since this is the weighting in the market portfolio). Not investing in cryptocurrencies means take a negative asymmetric risk against space and actively bet against the asset class. It is certainly not a choice that can be made lightly and without careful reflection. Warren Buffett he said: “The thing that human beings do best is interpret all new information so that his previous conclusions remain intact“. On the contrary, investing means trying to eliminate emotions and prejudices and stick to the facts. The time has come for the world of investments to apply this principle to cryptocurrencies.
*Head of Quantitative Research & Multi Asset Solutions, WisdomTree
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