As digital assets continue to shape the investment landscape, many in the financial industry are grappling with how to categorize and allocate them effectively. In a recent report, the CoinShares Research Team delves into the unique nature of the digital asset class and how Bitcoin’s investment characteristics could impact modern multi-asset portfolios.
Bitcoin’s Growth Trajectory
During its growth phase, Bitcoin behaves much like a tech stock. It began its journey from a price of zero, mirroring the trajectory of successful startups. As a potentially disruptive technology, Bitcoin’s risk profile resembles a technology stock with immense potential gains and a non-zero chance of failure.
This risk profile attracts a certain type of investor who views BTC as a liquid tech startup stock, treating it as a high-reward, yet liquid, risk-on asset. However, as interest rates rose at the start of 2022, Bitcoin’s correlation with equities increased for differing reasons. BTC’s rate sensitivity is linked to its fixed supply and pricing in US dollars, which positions it as an emerging store of value. On the other hand, equities’ rate sensitivity is associated with squeezed margins when rates rise.
As the US Federal Reserve steps back from historic rate increases, the correlation between BTC and equities is expected to decline. Equities are likely to underperform in times of economic weakness prompted by the Fed’s actions, while Bitcoin’s transparent and sound monetary policy may find support.
In its mature phase, BTC resembles a store of value more closely, evidenced by its increasing correlation with gold and its sensitivity to interest rates. It’s also evolving into a financialized asset, with $37 billion in Bitcoin investment products and growing acceptance as collateral for debt financing in fiat currencies.
Bitcoin’s growth and financialization are reinforcing each other. More value transferred into the BTC ecosystem will likely reduce its volatility, making it behave more like a stable haven and store of value, akin to gold’s trajectory after the 1970s.
Bitcoin’s Unique Features: Beyond a Store of Value
However, Bitcoin remains a unique asset class, offering digital ownership, security, immutable and traceable records, and programmable money. Its future potential market capitalization ceiling seems to approach that of traditional safe havens like gold or US treasuries.
One challenge is that BTC’s changing identity and financialization may lead to increased correlation with other asset classes in times of crisis, as observed during the COVID-19 panic in March 2020.
Backward-looking analysis can’t predict future behavior, but historical data suggests that BTC has been a better diversifier than gold or commodities. Regular rebalancing has helped mitigate the impact of Bitcoin’s volatility in portfolios.
The question of how much BTC to add to a portfolio depends on various factors. One method is volatility targeting, which suggests a Bitcoin weight of just under 4% in a traditional 60/40 equity/bond portfolio.
The most significant improvements in the Sharpe ratio occur with an allocation of up to 10% BTC in the portfolio. Even a small addition of BTC has a substantial impact on portfolio performance. BTC’s effectiveness as a diversifier is also evident, with minimal weights having a far greater impact on reducing correlation in multi-asset portfolios than other alternatives.
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