7 min readIn recent years, cryptocurrencies have transitioned from a niche interest to a mainstream financial asset, offering new opportunities for portfolio diversification. As traditional investment strategies, such as the 60/40 portfolio, face increasing challenges, investors are turning to alternative assets like cryptocurrencies to enhance their portfolios. This article explores the historical context of crypto as an asset class, its role as a diversifier, and its impact on real-world portfolios.
A Brief History of Crypto as an Asset Class
The story of cryptocurrencies begins with Bitcoin, which was launched in 2009 as the first decentralised digital currency. Initially, Bitcoin was seen as an experimental technology, embraced mainly by early adopters and tech enthusiasts. However, over the past decade, Bitcoin and other cryptocurrencies have gained broader acceptance, evolving into a legitimate asset class.
Today, cryptocurrencies are considered a mainstream financial asset, with institutions and retail investors alike recognizing their potential to transform traditional finance. The emergence of decentralised finance (DeFi), non-fungible tokens (NFTs), and other blockchain-based innovations has further solidified the role of crypto in the global economy.
Why Investors Are Turning to Alternative Investments
The traditional 60/40 portfolio, which allocates 60% to equities and 40% to bonds, has long been a cornerstone of investment strategy. Historically, this balanced approach provided a good mix of growth and income while mitigating risk. However, recent challenges have led many investors to reconsider this strategy.
High Correlations Between Equities and Bonds: In today’s markets, equities and bonds have become more correlated than in the past, reducing the effectiveness of the 60/40 portfolio in providing diversification.
Low Interest Rates: With interest rates at historic lows, bond returns have diminished, making it harder for the 40% bond allocation to contribute meaningfully to overall portfolio performance.
Increased Market Volatility: Market uncertainty and volatility have heightened the need for diversification beyond traditional assets.
Given these challenges, investors are increasingly looking for alternative investments to improve their portfolios' risk-adjusted returns. Cryptocurrencies, with their unique attributes and potential for high returns, have emerged as a popular option.
Enter Crypto: A Potential Powerful Diversifier
Cryptocurrencies, particularly Bitcoin, have been recognised for their historical low correlation with traditional asset classes such as stocks and bonds. This makes them a valuable addition to an investment portfolio, as they have provided diversification benefits that helped mitigate risk during past periods of market volatility.
Unique Attributes of Crypto
Low Correlation with Traditional Assets
Historical data shows that cryptocurrencies, especially Bitcoin, exhibit low correlation with equities and bonds. This means that when traditional markets are down, crypto may still perform well, providing a hedge against market downturns.High Potential Returns
Cryptocurrencies have demonstrated the potential for outsized returns compared to traditional assets. While they are highly volatile and therefore risky, their growth potential could significantly enhance a portfolio’s overall returns.Superior Risk-Adjusted Returns
Based on historical data, even a small allocation to cryptocurrencies can improve a portfolio’s risk-adjusted returns. This means that the potential reward relative to the risk taken is higher when crypto is included in the mix.
Crypto’s Impact on Real-World Portfolios
Adding even a modest allocation of Bitcoin or other cryptocurrencies to a traditional portfolio could significantly improve its performance based on past performance. The CoinShares Research report, “The Bitcoin Advantage: Enhancing Real-World Portfolios,” provides data-driven insights into how Bitcoin can enhance different portfolio strategies.
Let’s take a closer look at some examples of how small allocations to Bitcoin have affected portfolio performance:
60/40 Benchmark Portfolio
A classic 60/40 portfolio typically consists of 60% equities and 40% bonds. By adding just a 4% allocation to Bitcoin, the portfolio’s annualised returns increased from 9.1% to 16.2%, while the Sharpe ratio (a measure of risk-adjusted returns) improved from 0.48 to 1.05. This demonstrates how even a small allocation to crypto could have significantly enhanced a traditional portfolio’s returns.
All Weather Portfolio
The All Weather Portfolio, designed to perform well in various market conditions, benefits from adding 7.5% Bitcoin. In this scenario, annualised returns rise from 19.1% to 20.4%, while the Sharpe ratio improved from 0.33 to 1.38.
Cockroach Portfolio
For the Cockroach Portfolio, which focuses on capital preservation and risk management, adding a 7% Bitcoin allocation increased annualised returns from 19.1% to 20.4% and boosted the Sharpe ratio from 0.48 to 1.68. This shows that Bitcoin could have enhanced portfolio performance across a variety of investment strategies.
These examples illustrate the power of diversification and how crypto can help investors achieve superior risk-adjusted returns. While Bitcoin is often the first choice for crypto allocation, other cryptocurrencies can also contribute to portfolio diversification but are riskier.
Practical Steps for Diversifying with Crypto
For investors interested in adding crypto to their portfolios, the process is straightforward. Here’s a practical guide to getting started:
Open a Brokerage Account
Many brokerage platforms now offer access to cryptocurrency Exchange-Traded Products (ETPs), making it easy to buy and sell digital assets without directly holding them.Fund the Account
Once your account is set up, fund it with the amount you plan to allocate to cryptocurrencies.Select the Right Crypto Products
Consider whether you want to invest in a single asset, such as Bitcoin, or gain diversified exposure through an index product like the CoinShares Finanzen.net Top 10 Crypto ETP. This ETP provides broad exposure to the top 10 cryptocurrencies by market capitalization, making it a practical option for investors looking to diversify their crypto investments.Execute the Trade
After selecting your crypto investment, simply place the order through your brokerage platform.
Conclusion
Cryptocurrencies offer a potential powerful diversification tool for investors looking to improve their portfolios' risk-adjusted returns. By adding a small allocation to crypto, investors could reduce their reliance on traditional asset classes and benefit from the unique attributes of digital assets, such as historical low correlation with equities and bonds and the potential for high returns, at the cost of a slight increase in volatility.
With the availability of regulated crypto ETPs, it has never been easier for investors to incorporate digital assets into their portfolios. Products like the CoinShares Finanzen.net Top 10 Crypto ETP provide an accessible and diversified way to gain exposure to the cryptocurrency market.
As the investment landscape continues to evolve, diversifying with crypto is becoming an increasingly important strategy for investors seeking to navigate the challenges of modern markets.
