Bitcoin investment has been a roller coaster ride lately. After dropping over 74% in 2018, the currency nearly doubled in price in 2019, only to quadruple during 2020. Investment volumes have also increased as individual investors embraced cryptocurrencies through commission-free trading platforms such as Robinhood.
Bitcoin was originally created as a digital, encrypted alternative to traditional currencies controlled by central banks. The cryptocurrency has also become increasingly attractive to mainstream investors. For example, BlackRock recently added prospectus language giving three of its mutual funds the flexibility to invest in bitcoin futures. In late 2020, MassMutual purchased $100 million in bitcoin for its investment portfolio.
Bitcoin’s Potential for High Returns
A study from Yale University shows that cryptocurrencies can show a greater potential return than other asset types but also are extremely volatile. The study only examined the three major cryptocurrencies (bitcoin, ethereum, and ripple) so it is not intended to provide a comprehensive view of the industry.
Dragan Boscovic, a researcher at Arizona State University, agrees. “Institutional investors are recognizing this new asset as a valued investment opportunity,” he says. “This will encourage individual investors. It will also encourage consumers and small shops to start trading in cryptocurrency.” Meanwhile, Nobel laureate Robert Shiller has come out against bitcoin. In May of 2017, he noted that the asset is a failed experiment and somewhat of an anomaly.
Optimal Portfolio to Include Bitcoin
According to a Yale University economist, owners of passive investment assets should own at least 5% of their assets in the form of Bitcoin. The survey suggests that even those who are wary of the cryptocurrency industry are best off investing 0.1% of their assets in this space, not only to diversify but also because it can generate positive returns.
Bitcoin’s Role in Portfolio
Bitcoin can play a role in diversifying a portfolio, but like other digital currencies, its price varies wildly on any given day. Investors should note that long-term, bitcoin appears to be undervalued, according to some digital currency experts. This is based on the fact that the number of bitcoins being mined is rapidly slowing and there are no more than 21 million bitcoins that will ever be mined.
Over the past three years, bitcoin has shown a rapid evolution, as evidenced by its meteoric rise. During that time, it has shown an impressive increase in volatility as measured by standard deviation. But due to the low correlation with other financial instruments, adding bitcoin to an existing portfolio did little to increase volatility.
