Allocating Funds to Bitcoin - A Guide for Investors

Dec 29, 2024

Originally published at Weebly on Dec 12, 2024

It is now possible to invest in Bitcoin through the public markets. Investors should, however, exercise caution when allocating funds to the volatile cryptocurrency.

Bitcoin is a digital currency developed on top of a digital ledger known as a blockchain. It was created in 2009 by an anonymous developer (or developers) named Satoshi Nakamoto. Its existence later inspired the creation of other cryptocurrencies, but Bitcoin remains the largest by market capitalization and is the most popular.

In the 15 years since Bitcoin was created, many people have traded it as an investment, albeit through online exchanges. This motivated investment banks to apply to the Securities and Exchange Commission (SEC) for approval to launch Bitcoin exchange-traded funds (ETFs) so that financial firms could invest in it too.

In January 2024, the SEC began approving Bitcoin ETFs. It started with 10, but has since approved more. According to ETF Database, as of July 2024, over 30 Bitcoin ETFs were listed on US stock exchanges. Some of the biggest Bitcoin ETFs by market capitalization are IShares Bitcoin Trust (IBIT), Grayscale Bitcoin Trust (GBTC), and Fidelity Wise Origin Bitcoin Fund (FBTC).

There are many reasons why investors might consider adding Bitcoin to their portfolios. First, Bitcoin is a store of value like gold. As of July 30, 2024, one bitcoin trades at around $66,000. As Bitcoin adoption grows, demand for Bitcoins will rise while supply remains fixed, opening the door for potential price increases.

Furthermore, Bitcoin is potentially a good diversification option. Bitcoin has a low correlation to traditional asset classes like bonds, meaning its price does not move in alignment with them. A 2023 Fidelity study found that between August 2019 and August 2022, Bitcoin’s correlation with stocks was 0.6 and bonds 0.32. Fidelity measured the correlation on a scale of 1 to -1, with 1 indicating positive and -1 indicating no correlation. The study showed that Bitcoin could diversify a traditional 60/40 portfolio (60 percent stocks, 40 percent bonds).

Finally, Bitcoin can enhance the performance of investment portfolios. Historically, Bitcoin has posted impressive returns. An analysis by VanEck found that, in Bitcoin returned 102.39 percent in its first year, 448.34 percent in its first five years, and 11,399.18 percent in its first ten years. Bitcoin outperformed all asset classes in eight out of eleven years from 2013 to 2023.

VanEck further considered the potential returns investors would have gained if they allocated a small portion of their assets into Bitcoin. From 2012 to June 2024, a traditional 60/40 portfolio would have earned a cumulative return of 200.63 percent. A 59.5 percent equities, 39.5 percent bonds, and 1 percent Bitcoin portfolio would have earned a cumulative return of 251.03 percent. A 58.5 percent equities, 38.5 percent bonds, and 3 percent Bitcoin portfolio would have earned a cumulative return of 374.33 percent. Thus, Bitcoin has the potential to enhance portfolio performance.

Notably, though, Bitcoin is a volatile asset with several drawdowns of over 50 percent in its history, including one of 64 percent as recently as 2022. A 2024 Morningstar study found that Bitcoin significantly raised the overall risk in a portfolio at levels above 5 percent of a portfolio. In fact, in a 55 percent equities, 40 percent bonds, and 5 percent Bitcoin portfolio, Bitcoin contributed over 20 percent of total risk. In a 50 percent equities, 40 percent bonds, and 10 percent Bitcoin portfolio, Bitcoin contributed over 45 percent of the risk.

In portfolios with a Bitcoin allocation of 1 percent and 2 percent (taken out of equities), Bitcoin contributed about 3 percent and 7 percent of risk, respectively.

There are advantages to including Bitcoin to a portfolio. However, given the volatility risk, caution is necessary.