Understanding the Role of Cryptocurrency in a Traditional Portfolio
CoVenture Research demonstrates below that a portfolio with just a 1% allocation to cryptocurrency substantially outperforms a traditional 60% Stocks, 40% Bonds asset allocation over the last 2 years. In this hypothetical scenario, each portfolio begins on January 1, 2016 and ends on November 20, 2018. The portfolio has $US 100K initial capital, and is rebalanced annually to maintain original asset allocation targets.
In the chart above, it is clear that over a time period of 2 years, the portfolio with Bitcoin exposure generated greater returns while also limiting downside risk by re-balancing annually. For example, the re-balancing period from 2017 to 2018 meant Bitcoin exposure decreased from 1 Bitcoin to 0.08 Bitcoins, minimizing its effect on overall 2018 portfolio draw-down.
From January 1, 2016 to November 20, 2018, a 1% allocation into Bitcoin increased total returns by over 50%, but also increased average annualized volatility by 4%.
Separately, Cryptocurrencies historically exhibit low correlation to other asset classes
Bitcoin has historically exhibited low levels of correlation to other asset classes, making it a unique portfolio diversification tool. As the cryptocurrency markets continue to mature, Bitcoin appears to retain a low level of correlation to other assets over a long time horizon. In the correlation chart below, 2017 Bitcoin returns are compared to other asset classes. Bitcoin returns over the past five years have exhibited extremely low levels of correlation.
In the chart above, Bitcoin’s correlation to SPX & QQQ appears to constantly fluctuate. We found that Bitcoin returns in the short term (< 3 months) exhibited either extremely positive or negative correlation to both the QQQ and the S&P. However, a longer time frame suggests extremely low levels of correlation.
Infrastructure Development
Better trading infrastructure leads to higher liquidity
In the chart above, the introduction of GLD, the first US ETF backed by physical gold, in November 2004, allowed investors to gain exposure to the asset class. In the three years since GLD launched, gold prices have increased by 17%, 23%, and 31% respectively.
In January 2019, ICE, the parent company of NYSE, is set to launch Bakkt, a fully regulated digital asset platform to trade, store, and spend digital assets such as Bitcoin. In addition to introducing physically settled Bitcoin futures, Bakkt has partnered with companies like Starbucks and Microsoft to make digital assets efficiently spendable.
In October 2018, Fidelity announced Fidelity Digital Asset Services, a trade execution and custody service designed for institutions.
Who is already using Bitcoin?
ICOs and Early Investors have sold Bitcoin to New Investors
Key Takeaways
▪ “ICOs“ and “Early Investor“ categories above sold approximately $30 billion worth of Bitcoins to “New Investors” between December 2017 and April 2018. Half of this unprecedented transfer occurred during the month of December 2017.
▪ An increase in “New Investor” wallet holdings has diluted the Bitcoin supply concentration. Half of all new investor wallets own more than 200 Bitcoins, while half of ICOs and “Early Investor“ wallets hold less than 700 Bitcoins.
Why use a blockchain at all?
Blockchain databases are far less efficient than current database technology, so why use blockchain at all?
In 2018, the Institute of Electrical and Electronics Engineers (IEEE) ranked Python the most popular programming language among developers and job
recruiters. Yet when Python was first released, it had faced heavy criticism
regarding its speed. Python’s code execution is 100x slower than traditional
programming languages like C or Java. Over time, however, many developers
switched from traditional languages like C or Python because Python’s design
philosophy (of code readability) became something developers valued more over raw speed. As with any technology, there are often tradeoffs that people value other than speed. In the case of blockchain, the tradeoffs for speed and
computing costs are decentralization, transparency and security. As the world
becomes increasingly digital, online trust is evermore critical; a World Economic Forum survey suggested that 10% of global GDP will be stored on the blockchain by 2027.
Cryptocurrencies aim to achieve certain characteristics …
1)Censorship Resistance: Transactions on the blockchain cannot be removed
Chinese activists are recording their #MeToo movement experiences on the Ethereum Blockchain after being censored by the Chinese government
2) Robustness: The network has no single point of failure
The Bitcoin network has been running for 10 years without any instance of network hacks or network failure
3)Transparency: Counterparties can transact without “trusting” each other
The Ripple Blockchain empowers Thai nationals living in Japan to send money home instantly previously done with cash and third party agents
4) Interoperability: Anyone can build or interact with a blockchain
Over 2,200 independent projects built on top of open-source blockchain platforms
Sentiment around Cryptocurrency
A June 2018 international survey by ING Group showed these results:
▪ Across 13 countries, one in four (25%) European citizens expect to own cryptocurrencies in the future
▪ People in Europe who use mobile banking are more likely to say they expect to own cryptocurrency in the future (31%) than those who don’t use mobile banking (13%)
▪ Cryptocurrencies may viewed more favorably in countries where the traditional financial system is less efficient and more expensive to use
Store of Value?
In a few markets Bitcoin acts as a store of value
Cryptocurrency evangelists tout Bitcoin as a store of value, a “digital gold”. Critics claim that Bitcoin’s wild price swings make Bitcoin unfit as a store of value, and therefore won’t gain massive adoption. Our research demonstrates that in certain markets, Bitcoin acts as a store of value. In others, like the US, a store of value is not likely the case.
LocalBitcoins, the most popular person-to-person exchange and escrow service allows users to trade local currency for Bitcoin. Users agree to meet each other in person or pay via online banking.
In Figure 1 below, data shows that in developed countries with low inflation rates, weekly volume of Bitcoin transactions spiked during the speculation frenzy of late 2017, and crashed alongside price decreases indicating that a store of value narrative is likely not the case.
(Due to hyperinflated local currencies, prices were adjusted to Bitcoin value and divided by global Bitcoin volume. Russia currently consists of 27% of global LocalBitcoins trading)
In Figure 2 below, data shows that in less developed countries with high inflation rates, weekly volume of Bitcoin transactions spike higher and higher even as Bitcoin prices plunge 62% from all time highs suggesting that a last resort store of value narrative is most likely the case.
DISCLAIMER
This document is provided for informational and/or educational purposes. The opinions expressed are as of November 2018 and may change as subsequent conditions vary. The information herein is not to be considered investment advice and is not intended to substitute for the exercise of professional judgment. Recipients are responsible for determining whether any investment, security or strategy is appropriate or suitable and acknowledge by receipt hereof that neither CoVenture Management nor its affiliates (collectively, “CoVenture”) has made any determination that any recommendation, investment, or strategy is suitable or appropriate for the Recipient’s investment objectives and financial situation. A reference to a particular investment or security by CoVenture is not a recommendation to buy, sell or hold such investment or security, nor is it an offer to sell or a solicitation of an offer to buy such investment or security. Certain information and opinions herein have been provided by a number of sources that CoVenture considers to be reliable, but CoVenture has not separately verified such information. Nothing contained herein shall constitute any representation or warranty and no responsibility or liability is accepted by CoVenture as to the accuracy or completeness of any information supplied herein. Before relying on this information, CoVenture advises the Recipient to perform independent verification of the data and conduct his own analysis hereto with appropriate advisors. Analyses contained herein are based on assumptions which if altered can change the conclusions reached herein. CoVenture reserves the right to change its opinions or assumptions without notice. This document has been prepared and issued by CoVenture and/or one of its affiliates. Redistribution or reproduction of this document is prohibited without written permission.
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