With Bitcoin’s recent surge, the questions surrounding whether to invest have followed suit. It has been on an impressive run, doubling in value in 2024. Momentum has been strong recently with almost half of the jump coming after November’s presidential election.
Several factors have driven the current rally. In early 2024, the SEC’s approval of spot Bitcoin exchange-traded funds (ETFs) sparked momentum, enabling investors to gain Bitcoin exposure without owning or storing it directly. This marked a significant step toward the industry’s institutionalization.
Optimism about more favorable policies toward cryptocurrencies drove the recent post-election surge. The current SEC Chair, a long-time critic of crypto, announced plans to step down when President-elect Trump takes office, opening the door for what many believe will be a more accepting stance towards crypto. Analysts also predict that Congress will establish a legal framework for crypto and enhance the industry’s legitimacy.
With Bitcoin and other cryptocurrencies becoming increasingly mainstream, many investors are now wondering if crypto deserves a place in their portfolio. While the impressive returns are hard to overlook, determining how or where crypto fits into a strategic asset allocation is complicated.
Crypto is usually presented as either a currency or an asset, or both. Some promoters consider it “digital gold.” Whatever category you want to put it in, the main appeal in the investment world has been its potential for growth and generating alpha, or risk-adjusted returns, in portfolios.
But a quick dive into the numbers doesn’t paint a clear picture. Most crypto assets, including Bitcoin, generate no income, and Bitcoin has been a poor diversifier. Its three-year rolling correlations with stocks and bonds are both positive. In fact, most cryptocurrencies behave as risk assets that have been highly sensitive to interest rates since 2020. In layman’s terms, Bitcoin has been behaving like stocks and bonds, but to an exaggerated extent. Not exactly what we want when looking to diversify.
While Bitcoin’s returns have been impressive, they come with extreme volatility – four times that of the S&P 500. Yes, four times the magnitude of volatility of public stocks. In contrast, stocks are driven by more predictable fundamentals, such as revenue and earnings growth, which analysts can use to estimate future performance. Based on historical information, this makes stocks a more reliable choice for long-term investment goals.
Given these factors, the role of crypto in portfolio construction largely depends on an investor’s risk tolerance. Cryptocurrencies are inherently volatile, with little predictability regarding future price movements. While Crypto’s underlying blockchain technology holds potential, it also faces low barriers to entry, meaning tokens may become obsolete as newer, more efficient ones emerge. Also, some of the long-term outlook about the cryptocurrency industry’s regulations are still unclear. Consequently, any crypto allocation in a portfolio should be kept small enough to avoid jeopardizing overall personal financial planning and investing objectives in the event of a significant downturn.
While each day that passes grants us more clarity on the long-term characteristics and uses for cryptocurrency, there are still lots of unknowns that make this type of investment highly risky. Everyone’s situation is different. Talk with your advisor about these risks before adding crypto to your holdings. Meanwhile, remain true to your personal risk tolerance amidst the crypto frenzy, and remember that long-term investing success is largely a matter of staying patient with a thoughtful strategy.