Should Asset Allocation Now Include Cryptocurrencies?

Is there a case for a Bitcoin allocation?

As you may know, Matt Hougan recently moved on from ETF.com to become head of research at Bitwise Asset Management which as the name implies, works in the cryptocurrency realm. He recently published a report that explored the effect that adding Bitcoin in various weightings with different rebalance plans would have on a diversified, 60/40 portfolio comprised of Vanguard Total World Stock ETF (VT) and Vanguard Total Bond Market ETF (BND).

A 10% weighting to Bitcoin, looking back would have increased returns in a a staggering manner, at times, with equally staggering drawdowns during the two Bitcoin bear markets in the period Matt studied. Allocations of 1% or 5% still offered favorable return attributes to a portfolio with panic-inducing volatility.

I've looked at Bitcoin in quite a few posts. A quick recap on my take is that a technology/network (tokenization) that offers faster and more secure transactions will certainly happen but we are not there yet. And while Bitcoin is clearly the early leader (not sure if it was the first cryptocurrency or not), I have not seen anything that tells me why Bitcoin must be the ultimate solution as opposed to another crypto (the ultimate solution may very well not exist yet). I've asked that question a couple of times on Twitter including once, directly to one of the biggest proponents of Bitcoin but did not get a reply. I don't doubt the tech or where it is (probably) headed but it quite simply does not need to be Bitcoin (at least I personally have not seen anything that says why it must be Bitcoin, please leave a comment if you can shed some light).

In one of the early episodes of ETFiq on Bloomberg an executive from Grayscale referred to Bitcoin as uncorrelated alpha, I quipped in a post that for now it is more like unanalyzable beta. Matt cites fundamental factors that he believes should drive the price for Bitcoin and by his reckoning they are much different than factors that drive equities or fixed income. With something so new, it is difficult to truly know what the fundamental factors will be. Arguably the price is still being driven far more by various emotions than anything fundamental. If that is correct, then whose to say when the fundamentals will matter or if the fundamentals Matt cites will actually be the fundamentals that matter. Hence unanalyzable at least for now, at least in a portfolio sense. If your work involves blockchain or tokenization or anything else related then you probably can analyze it in different contexts than its potential merits as part of a diversified portfolio.

Matt explains the period he chose to study (2014 to March 31, 2018) because it had two huge declines but it also had an up year that would be very tough to duplicate in the future as it matures; it was up 1331% in 2017. Who knows maybe that can be repeated, it was up 1473% in 2011 and 5507% in 2013 but either way, drawing conclusions based on that kind of number in a 51 month period is difficult.

I've said all along, there's nothing wrong with taking a very small flyer on Bitcoin one way or another, realizing that it going to zero is certainly possible. If you put one or 2% into Bitcoin or one of the others and it goes to zero, you merely made a bad trade. Sizing with something like this is crucial, and if you're lucky enough that a tiny little trade turns into a life changing piece of money, sell it and let it change your life.

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