Cryptocurrencies like Bitcoin have established themselves as an emerging new asset class, distinct from bonds, equities, and fiat currencies. This recognition took considerable time, but today investors, large and small, are keen on adding more cryptocurrencies to their portfolios.
Bitcoin and cryptocurrencies, in general, remain very risky propositions for the uninitiated, and we often find prudent investors asking ‘how much of your portfolio should be in Bitcoin and crypto?’ In this article, we intend to answer this question and address similar concerns surrounding cryptocurrency investments.
Why invest in Bitcoin and crypto at all?
In order to assess how much crypto to have in your portfolio, we first need to understand why investment in Bitcoin and crypto is warranted at all.
Disruptive technology: At a fundamental level, Bitcoin and other leading cryptocurrencies have the potential to disrupt the existing financial system across the world. This is the reason for the comments and concerns raised by governments, central banks, the International Monetary Fund and more recently, US Secretary of Treasury Steven Mnuchin.
Potential for and history of high payoff: This disruptive quality of Bitcoin (and cryptocurrencies) presents a unique investment opportunity in the future of the global economy, meriting consideration. Bitcoin’s average return since inception has been 993%. You can see additional BitBull research on crypto returns here and here.
A small investment can mean outsized gains: Because of crypto’s historically high payoff, even a 1% allocation would have almost doubled returns of a portfolio invested in the S&P 500 in 2017, from 22% to 42%. On the other hand, if the value of crypto were to go to 0, or face a down year such as 2018, the maximum loss would only be 1%.
Potential for high returns of diversified, actively managed strategies: Prudent investors pay attention to the correlation between their portfolio investments. Whether it is stocks, bonds, gold or real estate, it is important to have diversification so that an adverse economic event does not impact the entire portfolio in the same way.
Bitcoin and the crypto space has shown, time and again, that it does not necessarily follow traditional assets in market action. This lack of correlation makes Bitcoin a very attractive alternative investment.
Bitcoin vs traditional alternative investments
Where most portfolios are heavy on stocks and bonds, the need for diversification is fulfilled by alternative investments, which have traditionally consisted of commodities like gold or foreign currencies; private equity and venture capital; real estate, and others. Bitcoin, in our view, is a very strong contender for a spot in the ‘alternative investments’ allocation in any portfolio and has numerous benefits over traditional candidates.
While many blockchain and crypto investors choose to make angel investments in blockchain companies, crypto can be seen as a type of “liquid venture capital” where investors get a part of a disruptive technology, while investing in an area that has up to the second pricing, and immediate liquidity (over $10B of Bitcoin trades per day per www.coinmarketcap.com). Emerging technology investments have historically been a high-performing asset, so the liquidity of crypto while enabling exposure to emerging tech has been very attractive to investors.
Even private equity is now evolving to make room for crypto investments, where equity projects raise funds via cryptocurrencies, including Bitcoin and Ethereum, and the crypto gives ownership of equity, and dividend distribution process is handled over the blockchain.
Bitcoin vs Gold:
Bitcoin and gold are often discussed together, where the former is likened to the latter’s digital iteration. While some of their characteristics do overlap (mining, limited supply, store of value), gold is less liquid (due to physical storage and movement constraints) and does not present the same opportunity for growth and return as Bitcoin. Within the crypto industry, many believe that Bitcoin is superior to gold for many reasons and has the potential to be used alongside gold, and yet has about 50x to grow in value to be on par with gold.
Ray Dalio, the head of Bridgewater Capital, recently spoke in July 2019 regarding alternative assets. He said:
“Those that will most likely do best are those that do well when the value of money is being depreciated and domestic and international conflicts are significant, such as gold. Additionally, for reasons I will explain in the near future, most investors are underweight in such assets, meaning that if they just wanted to have a better-balanced portfolio to reduce risk, they would have more of this sort of asset. For this reason, I believe it would be both risk-reducing and return-enhancing to consider adding gold to one’s portfolio.”
While not naming Bitcoin by name, he further hinted at the future of crypto by adding: “Central banks doing more of this printing…will lead investors to increasingly prefer alternative forms of money (e.g. gold) or other storeholds of wealth”.
Similarly, real estate, though a very stable avenue for alternative investments, is significantly less liquid, and the market price is considerably less reliable. Bitcoin, on the other hand, is traded 24 hours, 7 days a week and its spot price is readily accessible through various channels and exchanges.
Like with equity, emerging crypto assets have not only replicated equity ownership but also tokenized real estate ownership, so many real estate ventures are now emerging within crypto assets.
Moreover, fiat currencies, which provide security and liquidity, also prove to be poor investments in comparison to Bitcoin due to their inflationary nature (whereas Bitcoin is technically a deflationary currency). While the value of one US Dollar has gone down 97% over time, Bitcoin has a finite amount that will ever be created, and its value has gone up over time.
However, these arguments do not endorse a complete substitution of all alternative investment assets with Bitcoin, they merely establish that the leading digital currency, with its unique value proposition and high-risk-high-reward nature, merits a spot in any well-managed portfolio.
Portfolio allocation for Bitcoin and Cryptos
Having established the purpose of having Bitcoin and cryptocurrencies in an investment portfolio, we can discuss actual allocation, which comes down to an individual’s appetite for risk and consideration of both short and long-term goals. Saving for retirement, for instance, is a long-term investment, and we would say anywhere between 0% – 5% is a good start. For short-term objectives, a 5% – 10% allocation with active balancing every 6 months would be a prudent strategy.
Given the inherent volatility of crypto markets, rebalancing regularly is critical to generating maximum returns. This necessitates active management which takes the market’s up and downsides into consideration. For some investors, it may also make sense to opt for an actively managed crypto fund (versus a passive investment such as an index). Again, this is due to the volatility in crypto and the benefits of a fund which actively works to profit off of that volatility.
To learn more, please refer to our guide on investing in Bitcoin and cryptocurrencies, which discusses the various options available to investors seeking increased exposure in cryptocurrencies. You can also schedule a call with one of our representatives to discuss the strategies and results from our funds, and read much more research, at www.bitbullcapital.com.