Bitcoin, the original cryptocurrency, and its host of competitors are constantly making their mark on the financial scene. Blockchain technology powering cryptocurrencies is revolutionary; it enables decentralized peer-to-peer transactions without a trusted third party while addressing the risk of the same asset being spent twice. Bitcoin has created fortunes for some investors and attracted the attention of many others – despite its volatility. And its predetermined scarcity gives it the potential to challenge gold in its role as a safe-haven asset.
In our view, despite the recognition, cryptocurrencies like Bitcoin face significant limitations, both as currencies and as assets. It is not clear that they will ever be adopted as traditional currencies, and their role in portfolios is still poorly defined. We believe that central banks are likely to introduce their own digital currencies in the coming years. This may be one of cryptocurrency’s most lasting legacies, whether or not the boom eventually busts.
The role of cryptocurrencies in portfolios
We look at three potential roles for cryptocurrencies in portfolios. In any case, we find (through our Bitcoin analysis) that the potential contribution of cryptocurrencies to portfolio performance has yet to be conclusively demonstrated. Cryptocurrencies appear to be:
Unreliable as diversifiers and safe-haven assets: Bitcoin’s correlation with stocks and bonds has been unstable, and its volatility has been much greater than that of gold.
Limited as an inflation hedge: Bitcoin has not shown a strong correlation with inflation expectations.
Inadequate way to gain exposure to the tech sector: Bitcoin is more volatile than tech stocks and cannot provide ownership and control of shares. Its correlation with tech stocks may be spurious — it simply reflects investors’ interest in finding the “next big thing.”
Perhaps the best way to think about cryptocurrency in a portfolio is as a call option on its underlying blockchain technology. Like options, these assets can be volatile, speculative and offer investors limited ability to shape their future performance.
Our analysis asks what the expected return would have to be for various allocations of Bitcoin to the 60/40 portfolio to maintain the portfolio’s volatility-adjusted return. Answer: extremely high – any allocation should be done with caution.
Central Bank Digital Currencies
Cryptocurrencies are putting pressure on central banks to issue digital currencies, and many are actively pursuing this option (China has already launched its own). But – while some central bank digital currencies may contain elements of blockchain technology, the resulting environment is likely to be something less than the idealized decentralized, authority-free financial systems originally envisioned at the start of the blockchain revolution.
El Salvador had a bitcoin revolution
“Nobody really talks about bitcoin here anymore. It’s been kind of forgotten,” said Carlos Acevedo, former head of El Salvador’s central bank. “I don’t know if you’d call it a failure, but it certainly wasn’t a success.
Salvadoran President Nayib Bukele took to the stage last year with fireworks and AC/DC’s “You Shook Me All Night Long” to announce to a cheering crowd of crypto enthusiasts at a beach conference that Bitcoin would revolutionize his country. It was November, the digital token had just reached new all-time highs, and El Salvador was at the very beginning of its experiment as the first country in the world to use cryptocurrency as legal tender.
Now, after a year of travel, there are far fewer fireworks. Adoption has moved slowly, and steep declines in bitcoin’s price from those lofty levels last fall dampened the early euphoria that swept across the nation. Bitcoin hasn’t replaced Salvador’s hard currency, the US dollar — far from it — but it also hasn’t brought about the financial crash that some have warned it would. Or not yet.
Conclusion: Bitcoin is undoubtedly a Revolution
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Disclaimer:Crypto products are unregulated as of this date in India. They could be highly volatile. At Unocoin, we understand that there is a need to protect consumer interests as this form of trading and investment has risks that consumers may not be aware of. To ensure that consumers who deal in crypto products are not misled, they are advised to DYOR (Do Your Own Research).