The definition of potential energy is “the energy possessed by an object by virtue of its position relative to other objects.” While this notion is often examined in high school physics classes, it is also appropriate when considering your digital asset portfolio. All assets are a store of value, and how investors manage that store of energy (or value) is fundamental to managing portfolio risk.
The easiest way an investor can access the inherent value of an asset, of course, is through a sale. This allows the investor to acquire the market value of the asset, turning potential into realized value. But it also results in the investor relinquishing control or ownership of that asset in order to receive an asset he or she determines has greater utility or relative value.
Of course, selling is not the only way to access value. Assets can also produce yield for the investor while retaining ownership and control. Whether it is an apartment building or dividend-paying stock, merely owning these assets can provide the investor with income while also maintaining ownership in the asset.
Regardless of whether an investor’s holdings are passive (a bar of gold) or active (rental property), most assets can also be leveraged. Leverage can be a useful tool to access the potential value of an investment while also broadening an investor’s choices. Levering a long-term holding by using it as collateral for a loan allows investors to purchase other assets, and if such assets are less or non-correlated to the original assets, creates a more diversified portfolio.
Digital assets are by nature passive investments. They do not automatically produce yield, and for the vast majority of holders, the only way to realize the full value is by selling them. This is not the desired outcome for many, particularly digital asset and blockchain believers, but leaving them sitting in a wallet provides no utility whatsoever. At the start of 2020, research by Digit Asset Data indicated that over 11 million Bitcoin had not moved in over a year. This staggering sum represented over 60% of all Bitcoin ever minted. This is an enormous amount of wealth sitting idle.
Now consider the plethora of investment opportunities available in the current market. With proper advice, the potential value in dormant digital assets can be unlocked without the holder relinquishing control. But as with any loan product, valuation and due diligence are paramount when approaching these alternative investments.
For the leverage to make sense, it must be prudent, thoughtful, and executed reliably. Many of the lending solutions in the digital space employ margin calls and involve recourse to the borrower. This flies in the face of maximizing the value of the holdings for the investor. In a margin call scenario, the borrower is forced to re-balance the economics of the loan for the sake of the creditor, either having to pledge more collateral or see some of his or her holdings liquidated. Selling the lows is hardly a prudent approach to portfolio management. Moreover, the pledged coin is often rehypothecated, creating another layer of risk.
The most judicious approach is the use of structured loan products that do not require a margin call and allow the investor to sell the high. This provides an intelligent mechanism to unleash the “potential energy” of a digital asset portfolio while maximizing value. Additionally, it provides the necessary investment capital for digital asset holders to diversify their portfolios.
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