Kodak’s announcement in January that it was embracing blockchain may have been greeted with skepticism in some quarters, but judging by the immediate quadrupling of its share price, not every investor was a cynic.
The news also received a mixed reception from the promoters of blockchain ETFs, the first few of which launched earlier this year. On the one hand, Kodak demonstrated the incredible returns available within this nascent part of the market. But on the other, the firm’s change of direction has done nothing to assuage fears about an unsustainable bubble in the crypto space.
Eric Ervin, chief executive of Reality Shares – which offers the Reality Shares Nasdaq NexGen Economy ETF – was enthusiastic. ‘I’m glad Kodak did what it did,’ he said.
‘A lot of the recent pivots have been bogus in our opinion, but this Kodak one is really intriguing,’ he added. ‘It is a last-ditch effort to survive, but they picked the right solution. This is one of the solutions I have used when I explain blockchain and it turned on the light bulb for me when I first started learning about blockchain.’
One element of Kodak’s new venture will apply blockchain to digital rights management: By embedding a smart contract into digital files, a micropayment can be made to the publisher any time that the file – such as a photograph or an MP3 of a song – is downloaded. This is just one of the genuinely commercial possibilities for blockchain. It is more than simply the technology that underpins cryptocurrencies.
However, innovation is no guarantee of success. ‘I don’t know whether Kodak can pull it off, but that is one of the reasons why you need an index that evolves and that contains more than 10 or 20 companies, because then you would get some companies that fail miserably,’ Ervin said.
Links in the (block)chain
Reality Shares and Nasdaq’s process draws on multiple qualitative and quantitative factors to populate its index, ranging from a detailed analysis of the nature of the business and whether it is a member of a mainstream blockchain community, to the company’s patent filings and its expenditure on research. The ETF will also draw upon an advisory board made up of crypto pioneers and academics, who will assess the fund’s potential holdings. The resulting portfolio spans blockchain developers and users, as well as firms that supply the industry, such as semiconductor manufacturers.
Indxx, which is working with First Trust on a separate blockchain ETF, also undertakes extensive research on each company’s exposure to blockchain as it builds its own index. Stocks are then divided into three tiers: the first consisting of the ‘active enablers’ that stand to benefit from the development of blockchain through multiple avenues, the second made up of ‘active users’ of blockchain, and the third representing ‘active explorers’ that have confirmed plans to deploy blockchain but that have not yet implemented it.
In both cases, this research – as well as a minimum market cap requirement – should screen out penny stocks trying to exploit blockchain mania. But these methodologies also nudge such indices away from being purely passive; Reality Shares and Indxx instead characterize them as quantitative and rules-based, but maintain that they are still essentially passive approaches.
‘If you could objectify all the rules so that someone could walk in tomorrow and fire all of us, it is likely that the portfolio would not be too much different,’ Ervin said. ‘I want humans involved where needed, but as limited as possible.’
Meanwhile, the Amplify Transformational Data Sharing ETF is actively managed. Christian Magoon, chief executive of Amplify ETFs, described its style as ‘responsive and responsible’, seeking upside participation when blockchain names surge and downside protection when sentiment sours.
Although his ETF will also apply a minimum market cap threshold, Magoon expected to have more flexibility than passive competitors to invest in smaller firms and to buy in at IPOs. He also highlighted the disadvantages of infrequent index rebalances, with both Nasdaq and Indxx doing so only semi-annually.
‘With the speed of this market, the newness of its technology and the seemingly daily announcements that have material effects on stock valuations, it is hard for me to think that you can’t be looking at this area every single day,’ Magoon said.
Ervin noted that his ETF did have risk-management mechanisms to minimize the impact of day-to-day spikes and troughs, but defended the passive mandate. ‘We’re trying to get exposure to the sector, not necessarily to the best of the best because we don’t know yet which companies those will be,’ he said.