Since its inception, investors and market participants alike have noted the elevated levels of historical volatility observed in the digital asset space. While large swings in asset prices can be unsettling even for the most seasoned investors, rigorous quantitative and qualitative analysis can provide valuable insights that serve as the cornerstone of the investment process.
A core tenet of the investment process is risk management. Portfolio diversification is a prudent and practical system to manage overall portfolio risk. Incorporating digital assets as a potential source of alpha can produce superior risk-adjusted returns.
Digital Assets Defined
Digital assets, such as Bitcoin and Ethereum, leverage blockchain technology, which verifies and stores transactions on a distributed ledger. Blockchain technology is decentralized in nature and does not rely on a centralized intermediary, thereby reducing the influence of powerful actors or monetary policy on the native asset.
Generally, a digital asset launch is accompanied by a white paper formalizing its use case, token economics, governance structure, and issuance schedule. While token holders maintain the right to vote on proposals that may alter existing policy, such as issuance, formal changes are well-documented and communicated to stakeholders and the broader community.
Origins of Digital Currency
One notable precursor was eCash, developed by David Chaum. It aimed to facilitate safe, private, and anonymous online transactions and money exchanges. Chaum's encryption formulas and tools paved the way for subsequent digital assets, such as Bitcoin and Ethereum, which captured widespread attention and users. Technological advancements and surging consumer demand resulted in exponential user growth and adoption.
User interest and adoption can be corroborated by recent price trends in Bitcoin and Ethereum. The two largest digital currencies by market capitalization realized returns of 377%9 and 347%7 during the past five years, respectively.
During the same period, the S&P 500 and gold returned 62%10 and 58%8, respectively. The Dow Jones Internet Index Fund, exhibiting a 0.26 correlation to Bitcoin due to its tech-centric constituents, reported a 27%11 gain over the same time period (figure 1). 2,3,4,6,12
On balance, the digital currency market outperformed the U.S. equity and gold markets over a five-year period.
Bitcoin, the oldest surviving and largest digital currency, has demonstrated its exceptionalism and leadership in the market. As per a NYDIG survey, over 22% of individuals in the US owned Bitcoin as of January 2021. An astounding 81% of respondents expressed interest in crypto if their banks supported it. Thus, convenience remains a determining factor in Bitcoin ownership.
In 2016, there were roughly nine million Bitcoin wallets with non-zero balances.1 By the end of 2022, the number of wallets rose to 43 million—a staggering 400% increase.5
Unlike fiat currencies, which do not have supply caps, Bitcoin has a limited supply of 21 million units. Its slowing rate of issuance, which is disinflationary, provides an artificial price floor, which in turn encourages user growth and adoption.
Diversifying Your Investment Portfolio with Digital Currency: Getting Started
As an asset class, cryptocurrencies have outperformed on a five-year basis. However, this outperformance is accompanied by significant volatility. Despite elevated volatility levels, cryptocurrencies can serve as a risk-on element of a well-diversified investment portfolio through prudent position sizing.
Digital assets have proven to be a source of outsized returns, especially in the context of traditional assets. Incorporating cryptocurrencies in an investment strategy will provide exposure to an asset class that has outperformed numerous risk-on assets over a long horizon. Moreover, digital assets’ relatively low correlation with equities and gold suggests that it can be an useful and uncorrelated source of alpha in the portfolio construction process.
Investing in a relatively nascent asset class can be unnerving. It is crucial to have a trusted and experienced partner to navigate market peaks and troughs together. Path simplifies the process of diversifying and driving value with digital assets.
Contact our team today to embark on your crypto investment journey.
References and Visuals
Figure 1. Five-year Correlation Matrix for Bitcoin (BTC), Ethereum (ETH), S&P500, Gold, Dow Jones Internet Index Fund, and Bloomberg Galaxy Crypto Index (BGCI).
1.“Bitcoin Bullish Signal: Number Of Wallets With Non-Zero Balance Exceeds 40M.” Bitcoinist, https://bitcoinist.com/bitcoin-bullish-signal-number-wallets-exceeds-40m/. Accessed 17 August 2023.
2.“Bloomberg.” Bloomberg Galaxy Crypto Index, https://www.bloomberg.com/quote/BGCI:IND?in_source=embedded-checkout-banner.
3.“CoinMetrics.” CoinMetrics, 2 October 2022, https://coinmetrics.io/?utm_term=coinmetrics&utm_campaign=Branded%20Search&utm_source=adwords&utm_medium=ppc&hsa_acc=4768490894&hsa_cam=17570591213&hsa_grp=143684893608&hsa_ad=608735388840&hsa_src=g&hsa_tgt=kwd-612759843538&hsa_kw=coinmetrics&hsa_mt=b&hsa_. Accessed 18 August 2023.
4.“First Trust Dow Jones Internet Index Fund (FDN) Stock Price, News, Quote & History.” Yahoo Finance, https://finance.yahoo.com/quote/FDN/. Accessed 18 August 2023.
5.“How Many People Own, Hold & Use Bitcoins? (2023).” Buy Bitcoin Worldwide, https://buybitcoinworldwide.com/how-many-bitcoin-users/. Accessed 17 August 2023.
6.“S&P 500 (^GSPC) Charts, Data & News.” Yahoo Finance, https://finance.yahoo.com/quote/%5EGSPC?p=%5EGSPC. Accessed 18 August 2023.
7.“Trading View.” https://www.tradingview.com/chart/iC7sHJZ0/?symbol=BITSTAMP%3AETHUSD. Accessed 16 August 2023.
8.“Trading View.” https://www.tradingview.com/chart/iC7sHJZ0/?symbol=TVC%3AGOLD. Accessed 16 August 2023.
9.“Trading View.” https://www.tradingview.com/chart/iC7sHJZ0/?symbol=BITSTAMP%3ABTCUSD. Accessed 16 August 2023.
10.“Trading View.” https://www.tradingview.com/chart/iC7sHJZ0/?symbol=CBOE%3ASPX. Accessed 16 August 2023.
11.“Trading View.” https://www.tradingview.com/chart/iC7sHJZ0/?symbol=AMEX%3AFDN. Accessed 16 August 2023.
12.“Yahoo Finance.” Gold DEC 23, 2 October 2022, https://finance.yahoo.com/quote/GC=F?guccounter=1. Accessed 18 August 2023.