I questioned myself about bitcoin again last week. I know it is a volatile, speculative asset, but it’s hard not to feel like you’re missing out when the gains are so rapid and shocking. I started seriously analyzing it as a financial instrument in March of 2021 when Morgan Stanley endorsed it as an option for its clients for the first time. The bank allowed an allocation of up to 2.5% of a portfolio, citing its non-correlation with traditional assets as a justification.
Fast forward three years, and I still don’t have a position in Bitcoin. Digital currency seems to be the future, but it’s not clear what role Bitcoin or any other existing cryptocurrencies will have in that. From a statistical perspective, Bitcoin is not as attractive as it was in the past. At the time of Morgan Stanley’s announcement, Bitcoin had a low 0.15 correlation with equities. That is now up to 0.52. Worse, its volatility changes so much from year to year that it is hard to get reliable signals for a risk-managed portfolio.
Even so, I don’t think a small allocation is unjustified. The market cap of Bitcoin amounts to 1% of the value of publicly traded companies globally, and it is reasonable to use that to guide a 1% portfolio allocation. On the statistical side, a 0.52 correlation isn’t terrible and its volatility appears to be converging to a predictable value. My wild guess is that Bitcoin, Ethereum, and other decentralized blockchains will play a secondary role to future Central Bank Digital Currencies, and will eventually settle into some boring pattern a bit below their current value. If you’re okay with that, or with the very imaginable chance of it falling to zero, then consider adding a 1% or 2% allocation.