Diversifying Your Portfolio with Blockchain Assets: Is the Return Worth the Risk?
This is the second blog in our series on Diversifying Your Portfolio with Blockchain Assets: A Guide for Investors.
Return vs. Risk
Traditional asset classes have often followed a familiar pattern: an increase in risk often equates to an increase in return, particularly over long investment periods. In the last 10 Years, Bitcoin obtained a 80.03% compound annual return, with a 172.70% standard deviation. In financial terms, standard deviation is a statistical measure that indicates the degree to which an asset's price or investment returns deviate from their expected value over a specific period of time. It is commonly used to quantify the level of volatility or risk associated with an investment. A higher standard deviation indicates that an asset's price or returns are more dispersed, indicating a higher level of risk. Conversely, a lower standard deviation indicates that an asset's price or returns are more consistent and less volatile, indicating a lower level of risk.
Measuring Returns
In the last 10 years, Bitcoin (BTC) obtained a 73.32% compound annual return!
Over the last decade, Bitcoin's annualized return has been nothing short of extraordinary. Returns like this highlight that bitcoin and cryptocurrencies in general are unique from traditional asset classes. The below graph compares the gains of BTC and top-performing crypto tokens of late, and shows how well they performed against other asset classes. The closest competition was US Equities at about a 12% annualized return in the same period.
Risk and Time Horizon
Examining the risk profile of Bitcoin, the following chart leads us to a conclusion that Bitcoin's risk profile is just as remarkable as it gains. Since volatility readings measure standard deviations or variance between returns, it highlights the variations in price action for over the last decade.
Credit: Liu, Siyuan. (2023). Bitcoin: A Blessing or a Curse. Highlights in Business, Economics and Management. 6. 363-370.
What is most notable about the BTC volatility time series chart is that we see a general trend of decreased volatility. Examining the time from the early 2010s to the early 2020s, we see that volatility jumped to about 150%! With an approximate reading of less than 50% in 2022, we can now see signs of a maturing asset class taking shape and volatility is compressing.
Even with a more stabilized volatility index, BTC and cryptocurrencies in general maintain a higher risk profile than that of most other asset classes. On the flip side, examining the Sharpe ratio provides a more balanced measure of risk as it is an assessment of cumulative risk. Simply put, the Sharpe indicates how well the return of an asset compensates assumed risk, or the ROI divided by the Risk (Delta of ROI). The Sharpe is one of the more important metrics when evaluating risk in an investment. As investors we would like to see a sharpe ratio over 1, and we can see from the chart below that BTC is out-pacing all of the higher risk assets charted against it.
Credit: http://charts.woobull.com/bitcoin-risk-adjusted-return/
Keep in mind that the chart above is measuring a 4-year holding period for all assets. The time period is important to note because of the associated volatility that holding any cryptocurrency for a short period of time would have. Simply trying to time the market would not be a best practice for investing. Attempting to time any investment rarely works out, and most likely will only increase the risk profile of the asset you are investing in.
As we examine more metrics and what BTC and other cryptocurrencies have to offer in your portfolio, the discussion shouldn’t be around whether there is room for crypto in a traditional assets portfolio. Instead, the conversation should be about how best to allocate to this asset class. As always, we will dive further into blockchain wealth management next by examining correlation.
This is the second blog in our Diversifying Your Crypto Portfolio with Blockchain Assets series. If you missed the first blog, head over to Diversifying Your Portfolio: Is There Room for Crypto in Your Wealth Management Plan?
