The techniques and lessons of traditional finance can be applied to digital asset management. Leveraging best practices in traditional asset management, from portfolio construction methods to regulatory frameworks will accelerate crypto’s adoption.

Blockchain assets are different from traditional asset classes in certain respects. This includes using market cap as a method of weighting for passive portfolios.

Market cap is often used to determine the amount to invest in each asset, both for traditional and digital asset classes. This gives investors a simple way to gain passive exposure to the market. In the case of digital assets, however, adding a measure of blockchain usage to market cap may improve portfolio construction.

Subscribe to our weekly newsletter Crypto Long & Short for insights, news, and analysis for professional investors.

Total value locked (TVL) is one way to achieve this. TVL represents the value of assets that are deposited onto a blockchain. A higher TVL indicates greater economic activity, better future prospects or a more active user base. A lower TVL suggests the opposite.

By comparing the market cap to the TVL, we can get a deeper understanding of the asset’s value than the market cap alone. This is similar to the way equity investors determine the stock’s worth by comparing the price to the book (P/B). A high MC-TVL indicates that an asset’s valuation may be inflated, with a valuation disproportionately exceeding its usage. A lower MCTVL could indicate that the blockchain is undervalued, as markets haven’t priced in its usage.

We ran a simulation of a top-10 Index weighted based on market capital versus MC-TVL. Below are the results:

(Truvius)

In this hypothetical scenario, the MC-TVL method produced higher full-period return due to a large positive performance in 2021. The daily returns of the two approaches had a correlation coefficient of 0.85 over the period. This suggests that, while their weighting methods are similar (by intention), there is still a significant difference between them. In the long term, integrating blockchain into passive products could improve overall exposure to the market and help investors align better with crypto fundamentals.

The conclusion of the article is:

This experiment is a simplified simulation that is primarily intended for illustration. Its goal, however, was to encourage a more nuanced analysis of crypto-specific characteristics and how they could be integrated into constructing a portfolio. Despite the limited duration of the backtest, lower MCTVL could be a good indicator for assets that have a higher network usage compared to assets with MCTVLs greater than MCTVLs, whose only size may not reflect their true value in the digital asset universe.

Investors should be aware of how portfolio adjustments based on fundamentals could help digital asset management.

Description of simulation: The data is for the period January 1, 2021 to March 31, 2023. These indexes are hypothetical backtests that are rebalanced every month. They do not take into account transaction costs, or whether assets can be invested. Indexes do not include stablecoins or wrapped/pegged tokens. They also exclude centralized exchange tokens as well as assets that did not receive a price within the past 365 days. The indexes include only assets that are proof-of stake and for which TVL information is easily available. The circulating market capital of an asset is referred to as “market cap”. TVL encompasses all the ways assets are “locked” onto a chain. This includes staked deposits, unstaked funds in wallets or smart contracts, as well as assets in DeFi protocols or dapps. TVL is described in this article, but it can be quantified or defined more fully. Truvius prepared this hypothetical backtest solely as an example. Truvius does not make any warranty or representation as to the accuracy of or completeness or construction of this information and will not be liable for any implied or expressed representations regarding information contained within, or omissions in, this information. Past returns do not guarantee future performance.

Nick Baker is the editor.