In our last segment, we outlined how finance [the study of money and how it is used around the world] plays a huge role in our everyday lives and ultimately is the driver for larger economic cycles and global markets. These global financial markets provide access for buyers and sellers to invest in different instruments sorted by how they are regulated and how they behave in marketplaces -- or by asset class. Companies, professional traders, and individuals can build investment portfolios -- buying and selling various asset classes -- to build a more well-balanced exposure to these global markets.
What are asset classes and why do they matter?
Asset classes refer to the different types of investment opportunities available on the market.
Dividing our holdings among different asset classes enables us to mitigate the risk associated with a particular investment by diversifying our holdings into multiple investments.
When diversifying our holdings, it’s important to include different asset classes because different asset classes offer different levels of risk. Optimizing a portfolio based on the amount of risk we’re comfortable taking on is how we get the most value out of the portfolio.
One of the first steps to take when building a diversified portfolio is to learn about the different types of asset classes so we can begin to evaluate the different investment opportunities available to us.
Traditional Asset Classes
Different people divide asset classes in different ways so for the sake of simplicity, we’ll focus on the broadest classification of asset classes and explain where and why some people choose to divide things more specifically.
The four asset classes generally recognized by investors include:
Money market and cash equivalents
Fixed income and debt (bonds)
Real estate and tangible assets
Money Market and Cash Equivalents
Let’s start by talking about the asset likely to be the most familiar to us: cash.
As they say, “cash is king,” and we say this because cash can generally be considered the most liquid asset a person can have. The closest alternative to cash would be to open a credit or debit account with a bank or merchant.
Cash and accounting are two of the most basic ways we account for value and the reason that money market and cash equivalents are defined as an asset class because they tend to be the most liquid.
In other words, they can easily be exchanged for goods, services, and other assets without much trouble at almost any time.
What are money market and cash equivalents?
The money market refers to low-risk, short-term investments in debt.
At the institutional level, this includes overnight reserves issued by banks and commercial papers issued by corporations, while at the retail level the money market includes investments like treasury bills and money market accounts.
“Cash equivalents” is simply another way to refer to highly liquid investments like treasury bills, certificates of deposit (CDs), and commercial papers.
Fixed-income and Debt (Bonds)
Like money market and cash equivalents, fixed-income and debt refer to debt-based investments in things like government or corporate bonds that offer the expectation of a return in the form of interest.
Unlike money market and cash equivalents, however, investments in fixed-income and bonds tend to be held over a longer timeframe.
As the name suggests, investments in fixed-income provide investors with regular payments until the maturity date of the investment. Bonds, on the other hand, accrue value over time and can either be redeemed or held until their maturity date.
Equities, commonly referred to as “stocks,” refer to investments in businesses.
Unlike debt-based investments that provide investors with interest in exchange for their deposit, the returns on equities depend on fluctuations in the price of the stock or the dividends paid to stockholders by the company that issued the stock.
Or, as investors like to say, “Buy Low and Sell High.”
The price of a stock depends on a variety of factors, including where the stock is listed, the performance of the company behind the stock, and the state of global markets in general. Kids these days even use the word "stonks" to refer to stocks affectionately. ;)
Real estate and tangible assets
Here’s where the traditional division of asset classes tends to break down. Real estate and tangible assets may both be considered “property,” but as investments, they can diverge wildly in terms of the associated risks and rewards.
Real estate, as you can probably guess, includes investments in things like land, housing, and corporate property but it has also grown to include investments like Real Estate Investment Trusts (REITs).
Similarly, tangible assets include common commodities like agricultural products, precious metals, and foreign currency but the class has also expanded to include digital assets like cell phone minutes and Internet bandwidth.
New Generation of Financial Assets
You’ll see in a lot of crypto commentary the term “traditional asset classes” to describe the markets mentioned above. This does not mean they are no longer “cool” it simply means they have been around longer and most of the world is familiar with them as investment tools. The new wave that started when Bitcoin arrived is the birth of digital assets as a new asset class.
How Old is Traditional?
Well, the New York Stock Exchange (NYSE) was founded on May 17th, 1792, when 24 stockbrokers signed the Buttonwood Agreement on Wall Street in New York City. They famously met beneath a Buttonwood tree and formed a centralized exchange for the up-and-coming securities market in the United States. This wasn’t even the oldest one - that would be the Philadelphia Stock Exchange of 1790.
For perspective, Binance.US was founded in September 2019 in San Francisco.
This is why distributed ledger technologies or digital assets like Bitcoin, which showed up in 2009, have been dubbed a “new asset class” or the next generation of financial instruments. They have different regulations covering them (regulations that are being written as we speak!) and they behave and trade similarly across marketplaces like Binance.US. Digital Assets are also available to trade in centralized marketplaces as well as decentralized marketplaces. Decentralized Finance (DeFi) is an emerging area of application for blockchain and distributed ledger technologies that aim to develop censorship-resistant financial products and services.
Other ways to trade different asset classes
In addition to the primary asset classes we’ve outlined, folks can trade variations of the current asset -- trading a derivative of the underlying asset class, in short, “trading derivatives.”
Derivatives include financial instruments that consist of an underlying asset or group of assets and a contract between two or more parties defining what the participants can do with the financial instrument.
Rather than making an investment in the current or “spot” price of a stock or commodity, investors may trade on things like futures or options that enable investors to trade on the future price of something or the option to buy or sell something before a given date, respectively.
Follow along as we add to our Binance.US Education 101 Series: Your Guide to Crypto Literacy
#1 Demystifying Digital Dollars
#2 Evolution of the Internet
#3 Finance, Rhymes with …
#4 Back that Asset Class Up
#5 What are Cryptocurrencies?
#6 Defining Decentralized Finance
#7 Cryptoeconomics Explained
#8 Intro to Consensus Algorithms
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