Are Cryptocurrencies The Holy Grail of Asset Allocation?


A few days ago I wrote about Managed Futures noting some terrific, uncorrelated results from decades past as well as noting that the last ten years or so the strategy has struggled possibly because the cash held to collateralize the futures contracts used has been earning just a handful of basis points as opposed to several hundred basis points back when interest rates were higher. From before the last ten years, the results from Managed Futures appeared to be a holy grail of sorts.

The folks at Grayscale, the company that offers exchanged traded investment vehicles targeting Bitcoin and Ethereum Classic, published a white paper that seeks to position digital assets like Bitcoin as a holy grail similar to what Managed Futures appeared to previously be (holy grail and the comparison to Managed Futures are my observations not Grayscale's).

At a high level a robust portfolio will be a blend of different asset classes (or maybe merely just different holdings) that are influenced by different factors such that they react differently to different events be they market events or external events. For example, gold has had the long term tendency to have a low to negative correlation to equities. Many times it has gone up when equities have faltered. This is not absolute but works often enough that I believe in it.

Grayscale is trying to position Bitcoin and the others in a similar manner, noting that "digital currencies, like Bitcoin, seek to fulfill the role of a decentralized global currency and store-of-value, a necessary alternative to government-monopolized fiat monetary regimes in the post-financial crisis world." In setting the table for its research it refers to "a new market paradigm" which is a phrase that might make anyone who was around during the tech wreck cringe.

Capital markets and effective portfolio construction are always evolving, the ride from greatness to underperformance for Managed Futures supports that notion. In that light, a forward looking investor should want to take the time to understand whether something new, like Bitcoin, could actually do what its proponents say it can do. That is not saying go buy it, it is saying go learn about it. This will sound harsh but if you're unwilling to learn about new things, you are decreasing your odds of long term financial success.

Now to some data;

I would note that this seems very similar to data Matt Hougan used in a report he published for his new gig at Bitwise but I am not sure. Look at the table. Looks good to me, it looks great actually. Grayscale looks at the data in several different ways to support the notion. They also address expectations for future positive returns and volatility.

At a minimum this is of course interesting. However look at the period covered by the chart above. It is only 17 months. Granted a lot happened in that 17 months but it is very difficult for me to draw any confident conclusions based on such a small window of time. The short window is complicated even further by the possibility raised by the New York Times that price has been manipulated, read it and draw your own conclusion. I have always been open to the possibility that Bitcoin could be everything they say it is and more but it is just as true that all of the positive attributes and expectations could ultimately accrue to a cryptocurrency that does not yet exist and for that matter the whole concept could go poof. I am also not sure how forward looking expectations for something that has been so volatile can be effectively modeled.

Despite Bitcoin having been around since 2009 it is still a very new thing and I am very skeptical that the data that exists is enough to draw any serious conclusions from yet and again. it may be some other crypto that does all of what Grayscale is theorizing. I do think that where Grayscale is talking about 1% or 3% in Bitcoin, they are thinking correctly in terms of sizing for anyone who is interested in this but 5% does seem like a lot.

My framing of this is less reliant on the work done by Grayscale and more about a variation of asymmetric risk where if you allocate 1% of your assets to Bitcoin or one of the others you have low exposure in terms of value at risk but could have a monstrous return if the price goes to $400,000 as some believe. The trade off in that scenario is between a bad, non-consequential trade to a life changing piece of money. Whatever you do, keep any allocation small to something you can afford to lose and if it does grow into a life changing piece of money, sell it and let it change your life.