Original authors: Jack Manley, Sahil Gauba
Translation: Luke, Mars Finance
The core attraction of cryptocurrency lies in its potential for excess returns (Alpha Generation), yet challenges still exist. Despite the remarkable returns of Bitcoin, it comes with extremely high volatility—its fluctuations are four times that of the S&P 500 index.
The astonishing rise of Bitcoin and its driving factors
This year, Bitcoin has experienced remarkable market activity, with its price doubling to nearly $100,000 and approaching all-time highs. In 2024, the drivers of Bitcoin's rise have changed over time: at the beginning of the year, the U.S. Securities and Exchange Commission (SEC) approved a spot Bitcoin ETF, allowing investors to gain exposure without the need to directly buy or store Bitcoin, marking an important milestone in the institutionalization of the cryptocurrency industry. By the end of the year, the aftermath of the U.S. elections propelled Bitcoin to rise 40% in just one month. Market optimism stemmed from expectations of cryptocurrency-friendly policies—the current SEC chair (a long-time critic of cryptocurrency) announced plans to resign after the election, paving the way for Congress to establish a legal framework for cryptocurrency and adding legitimacy to the industry.
Is cryptocurrency suitable for inclusion in a portfolio?
Bitcoin and other cryptocurrencies are now closer than ever to 'mainstream,' yet many investors still question: Is cryptocurrency worth including in a portfolio? Despite this year's significant returns being eye-catching, determining its position in strategic asset allocation is not straightforward.
To assess the potential of cryptocurrency, one must first examine its performance as a currency. In this regard, cryptocurrency falls short: it cannot serve as an effective store of value (as evidenced by its significant price fluctuations), nor can it become a medium of exchange (acceptance in retail transactions is extremely low; even if the legal framework improves, the high volatility of most cryptocurrencies still deters merchants). Therefore, a more reasonable approach is to view cryptocurrency as an asset.
Cryptocurrency in alternative investments
As an asset, cryptocurrency resembles 'alternative investments.' Generally, the role of alternative investments in a portfolio includes: providing yields (such as infrastructure), achieving diversification (like hedge funds), or generating excess returns (such as private equity). However, based on the first two criteria, cryptocurrency performs poorly. Most crypto assets (including Bitcoin) do not generate any yields; moreover, Bitcoin's performance as a diversification tool is also weak: since 2020, its three-year rolling correlation with stocks and bonds has been positive, with a very high sensitivity to interest rates of risk assets.
Potential for excess returns amidst volatility
The core appeal of cryptocurrency lies in its potential to generate excess returns. However, this potential comes with significant challenges. Despite Bitcoin's impressive returns, its volatility is extremely high. Additionally, unlike Bitcoin, the drivers of stocks are more predictable, such as revenue and earnings growth, which analysts can use to forecast their future performance, making stocks more suitable for long-term investment goals.
The core value of blockchain
Nevertheless, the true value of cryptocurrency may lie in its underlying innovation—blockchain technology. Blockchain is essentially a database, but it represents a significant improvement over traditional 'row and column' information storage methods: it can operate without intermediaries (for example, individuals can transfer assets digitally without the need for banks or other third parties) and boasts high security (the 'crypto' in cryptocurrency refers to the cryptographic techniques used to protect transactions and verify user identities). Therefore, for more promising blockchains, their tokens can be seen as a form of ownership, as using blockchain requires tokens as a medium of exchange.
Investment advice: caution and diversification
In summary, the role of cryptocurrency in a portfolio depends more on the investor's risk tolerance. Cryptocurrency is inherently unpredictable: its future price movements lack transparency, and despite the promising prospects of blockchain technology, the low barriers to entry mean that tokens may become obsolete due to new technologies, potentially losing all value. Therefore, for most investors, the allocation to cryptocurrency should remain moderate to ensure that even significant sell-offs do not severely impact overall investment objectives. At the same time, diversification should be pursued to avoid single asset risk.
Between high returns and high risk, cryptocurrency is an investment area that requires careful exploration.
