This article was originally published as part of the exame.com “Future of Money” series.

 

There is little controversy about the importance of a company’s size in explaining differences between returns in a given time window. This has been demonstrated in academic literature, including cross-section analyses such as Fama and French (1993) and Carhart (1997). Where there is controversy is the question around the existence of the so-called "size premium," an expected return in excess of the shares of small companies in relation to those of large companies. In the specialized literature, there are several pieces of evidence corroborating and refuting the existence of a size premium. And there are even cases in which a negative size premium was reported.

Crypto assets make up an emerging class of assets, with just over a decade of existence. According to data from Google Scholar, the number of academic papers on crypto multiplied more than 18 times between 2016 and 2022, but it is still relatively small compared to traditional asset classes. Naturally, part of the crypto literature aims to investigate to what extent digital assets reproduce phenomena observed in traditional ones.  For example: in crypto assets, does size matter?

Using the Nasdaq Crypto Index (NCI) and its constituents, we look for some clues about this question. The NCI replicates the performance of the largest crypto assets by using a robust methodology that includes liquidity requirements and other factors. A key factor is market capitalization weighting, which makes Bitcoin and Ethereum more than 90% of the total weight.

For comparison purposes, we have created an alternative version of the index, which we call NCI - Equal Weighted (NCI-EW), which has the same assets, but weighted equally. As a result, we give greater weight to lower capitalization assets.

Having in hand the original (blue) and this alternative (red) series from the launch of the NCI, in March 2021, to June 1, 2023 (nine quarters), we can unravel the results, represented in the graph below.

 

The first result that draws attention is the difference in returns over that period. NCI's substantial drop of 35.6% seems small compared to NCI-EW's 76.8%. Part of this performance discrepancy could be explained by the difference in risk, given that it is known that, in general, smaller crypto assets are riskier.

In fact, when we compare the annualized volatilities, we observe a difference of 15%: 69% for the portfolio weighted by market capitalization and 84% for the equally weighted portfolio. However, this difference is small for the observed disparity in returns. A period that also draws attention is the year 2023. The NCI had a strong appreciation of 59.7%, while the version with equal weights rose only 8.6%.

The crypto market has certain peculiarities, including that Bitcoin and Ethereum are much larger in market capitalization, liquidity, and accessibility for institutional investors. Therefore, we repeated the previous experiment excluding them. In the chart above we have both market cap weighted (ALT, yellow) and equally (ALT-EW, green) weighted versions.

The series show the same results, but with a smaller disparity. The market capitalization-weighted version showed higher returns (-80.1% versus -85.4%) and lower volatility (88.7% versus 90.3%).

Despite these indications, it is still early for a verdict on whether or not a size premium exists among crypto assets. To make reaching a conclusion even more difficult, the period of analysis is short and marked by a strong crisis.

Furthermore, any size premium in crypto does not have to be stable over time. This year, a phenomenon similar to what has been observed in the crypto market was also seen in the stock market: the vast majority of the strong appreciation in the S&P 500 was due to a small number of giant companies.

 

So does size matter in crypto?

What we can confirm is that, in recent years, the two giants of crypto assets have had a measurable advantage over the smaller ones. However, it’s important to keep in mind that the crypto market remains incredibly dynamic and a turnaround in this advantage within a short period of time would not be surprising. 

 

Thanks to my Hashdex colleagues Pedro Nacif and Lucas Afonso for their collaboration with this analysis.

 

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