Why XRP may complement bitcoin in achieving portfolio diversification

Key Takeaways

• XRP is a digital asset native to the XRP Ledger, and it was designed to be a faster and more sustainable alternative to bitcoin.
• It was built in 2012, specifically for payments, and relies on the Proof-of-Association (PoA) consensus mechanism, which consumes less energy than the Proof-of-Work (PoW) consensus mechanism.
• As an altcoin to bitcoin, XRP could sit alongside it in a multi-asset portfolio and reduce investors’ exposure to a single cryptocurrency.
• While bitcoin and ether are strongly correlated, XRP has a low correlation with both.

As investors start to recognise the potential benefits of adding crypto to their multi-asset portfolios, they are also looking for ways to diversify their crypto exposures. That is, some investors no longer want to be overexposed to a single mega cap cryptocurrency and are actively looking for a suitable altcoin to sit alongside it.

The WisdomTree Digital Asset Taxonomy categorises cryptocurrencies into:

• Layer-1 payments
• Centralised finance
• Layer-1 smart contracts network
• Stablecoin
• Layer-2 scaling
• Decentralised finance
• Non-fungible token
• Miscellaneous

This taxonomy helped us identify XRP as an altcoin that could sit alongside bitcoin, given that both are classified as Layer-1 payments. There are parallels between Ethereum and Solana, which are classified as Layer-1 smart contracts networks, with Solana being an altcoin to Ethereum.

Figure 1: WisdomTree’s Digital Asset Taxonomy

What is XRP?

XRP is a digital asset native to the XRP Ledger (XRPL), an open-source, permissionless, and decentralised blockchain. Built in 2012, specifically for payments, XRP can settle transactions on the ledger in 3-5 seconds and was designed to be a faster and more sustainable alternative to Bitcoin. This is possible because XRPL and Bitcoin use two different consensus mechanisms:

• XRPL uses Proof-of-Association (PoA)
• Bitcoin uses Proof-of-Work (PoW)

PoA is operated by universities, exchanges, businesses, and individuals to validate transactions. It is more efficient to run than PoW as it requires fewer hardware resources and consumes less energy.

XRP can be sent directly without a central intermediary, making it a convenient instrument for bridging two different currencies quickly and efficiently. It is freely exchanged on the open market and used in the real world to enable cross-border payments and microtransactions.

Why invest in XRP?

As of now, cryptocurrencies have a significant track record of 15+ years. Per Figure 2 (below), they also represent a portion of investable market portfolio.

Figure 2: The market portfolio

Figure 2 (above) shows the market portfolio of all listed, investable assets accessible to investors. With a market cap of over $2 trillion¹, cryptocurrencies represent approximately 1% of the market portfolio that has a total market cap of just over $200 trillion². XRP itself has a market cap of $31 billion³ which places it as number 5⁴ by market cap among all cryptocurrencies.

Since cryptocurrencies have a low correlation to traditional asset classes, they can help enhance the diversification of multi-asset portfolios and potentially improve the risk/return profiles of those portfolios. As an altcoin to bitcoin, XRP could sit alongside it in a multi-asset portfolio and reduce investors’ exposure to and reliance on a single cryptocurrency.

Figure 3: Crypto to crypto correlations

Interesting to note, and as seen in Figure 3 (above), bitcoin and ether are strongly correlated with each other, while XRP has low correlation with both of them.

XRP supply dynamics

Transaction fees on the XRPL are systematically burned, applying deflationary pressure to XRP’s total supply of 100 billion units. Since its inception, approximately 12 million XRP units have been burned. While this burn rate may seem relatively low, it is directly linked to most transactions only costing fractions of a cent. Low transaction costs are important for real world adoption of XRP.

In addition, 1 billion XRP units are released from escrow to Ripple each month. This is due to Ripple originally locking 55 billion XRP units (i.e. 55% of the total possible supply) into a series of escrows in order to ensure predictability to the XRP supply⁵. Any XRP not spent or distributed by Ripple in that month is put into new escrow contracts. This will continue until the remaining ~45 billion XRP units become liquid. Afterwards, the burned fees will be the only supply variable.⁶

For investors, both bitcoin and XRP are scarce cryptocurrencies with different issuance schedules. Bitcoin should reach its max supply of 21 million units in approximately 2140, and XRP should reach its max supply in the next few years. Afterwards, the number of XRP units will only shrink due to the burning of transaction fees. As long as XRP demand grows or even remains the same, XRP scarcity should be positive for XRP price.

Conclusion

XRP offers a strong complement to bitcoin in a portfolio. With its focus on fast, low-cost transactions, XRP balances bitcoin’s strengths as a digital asset. By holding both, investors can spread out risk and enjoy the unique benefits each brings making the combination a versatile choice in today’s evolving market.

¹ Source: Bloomberg, WisdomTree. 30 September 2024.
² Source: Bloomberg, WisdomTree. 30 September 2024.
³ Source: Messari. 22 October 2024.
⁴ Source: Messari. Excluding stablecoins. 22 October 2024.
⁵ Please see further detail here: https://ripple.com/insights/explanation-ripples-xrp-escrow/
⁶ Sources: Messari’s State of XRP Ledger Q1 2024; Q2 2024 XRP Markets Report

Important Risks Related to this Article

Crypto assets, such as bitcoin and ether, are complex, generally exhibit extreme price volatility and unpredictability, and should be viewed as highly speculative assets. Crypto assets are frequently referred to as crypto “currencies,” but they typically operate without central authority or banks, are not backed by any government or issuing entity (i.e., no right of recourse), have no government or insurance protections, are not legal tender and have limited or no usability as compared to fiat currencies. Federal, state or foreign governments may restrict the use, transfer, exchange and value of crypto assets, and regulation in the U.S. and worldwide is still developing. Crypto asset exchanges and/or settlement facilities may stop operating, permanently shut down or experience issues due to security breaches, fraud, insolvency, market manipulation, market surveillance, KYC/AML (know your customer/anti-money laundering) procedures, non-compliance with applicable rules and regulations, technical glitches, hackers, malware or other reasons, which could negatively impact the price of any cryptocurrency traded on such exchanges or reliant on a settlement facility or otherwise may prevent access or use of the crypto asset. Crypto assets can experience unique events, such as forks or airdrops, which can impact the value and functionality of the crypto asset. Crypto asset transactions are generally irreversible, which means that a crypto asset may be unrecoverable in instances where: (i) it is sent to an incorrect address, (ii) the incorrect amount is sent, or (iii) transactions are made fraudulently from an account. A crypto asset may decline in popularity, acceptance or use, thereby impairing its price, and the price of a crypto asset may also be impacted by the transactions of a small number of holders of such crypto asset. Crypto assets may be difficult to value and valuations, even for the same crypto asset, may differ significantly by pricing source or otherwise be suspect due to market fragmentation, illiquidity, volatility and the potential for manipulation. Crypto assets generally rely on blockchain technology and blockchain technology is a relatively new and untested technology which operates as a distributed ledger. Blockchain systems could be subject to internet connectivity disruptions, consensus failures or cybersecurity attacks, and the date or time that you initiate a transaction may be different then when it is recorded on the blockchain. Access to a given blockchain requires an individualized key, which, if compromised, could result in loss due to theft, destruction or inaccessibility. In addition, different crypto assets exhibit different characteristics, use cases and risk profiles. Information provided by WisdomTree regarding digital assets, crypto assets or blockchain networks should not be considered or relied upon as investment or other advice, as a recommendation from WisdomTree, including regarding the use or suitability of any particular digital asset, crypto asset, blockchain network or any particular strategy.