The adoption of cryptocurrency is increasing. As a result, many are wondering if they should include crypto in their portfolios. Determine exactly how much is the next challenge.
The increase in adoption by companies like PayPal, the investment from institutions like Rothschild Investments, and the recent Coinbase listing make it harder to deny that cryptocurrencies are becoming a common feature not only around the world but in a world. well balanced portfolio.
There are several that suggest different allocations based on the typical 60/40 stocks / bonds portfolio. However, using the Black-Litterman model, investors can allocate the amount of crypto they hold based on their confidence in its growth potential.
The interest of institutional investors in bitcoin
Just two years ago, famous Shark Tank investor Kevin O’Leary called bitcoin (BTC) “trash”. Last year, he posted a video titled “Why I’m Not Investing in Bitcoin!”
However, as the total crypto market cap recently surpassed $ 2 trillion, it has become nearly impossible for institutional investors to ignore.
Even O’Leary changed his tone. Last month, the famous investor announced that he would allocate 3% of his portfolio to bitcoin. For someone with a net worth of $ 400 million, that allowance amounts to $ 12 million of BTC.
Other companies have given a similar example over the past year. In August 2020, MicroStrategy invested $ 250 million in bitcoin. Since then, they have spent a total of $ 2.226 billion on bitcoin.
Payment service Square Inc. followed suit in October 2020, investing $ 50 million in bitcoin. He recently increased that amount by an additional $ 170 million. Finally, Tesla caused a sensation in February 2021, investing $ 1.5 billion in cryptocurrency.
As with all investments, the increased interest of these large players spills over to smaller-scale investors who want to make smart portfolio moves.
Understanding bitcoin for your wallet
Investors who want to understand how to invest in cryptocurrencies must first understand them.
Investment firms are starting to provide explanations to potential clients. For example, Fidelity Investments released the “Understanding Bitcoin” report.
In the report, Fidelity Global Macro CEO Jurrien Timmer describes the growth potential of bitcoin and compares it to other assets to help investors better understand it.
Potential exponential growth
Timmer says that a growing number of investors and portfolio managers view bitcoin as a legitimate and distinct asset class. Bitcoin, he explains, is a finite asset with a single supply and a single dimension of demand. However, its distributed nature allows for a network effect, which is not the case with other assets.
Specifically, Timmer refers to Metcalfe’s Law. Essentially, Metcalfe’s Law says that as the number of its users increases linearly, the value of a network increases geometrically.
In other words, Bitcoin’s utility, in this case value, is expected to grow much faster than its network of participants. Timmer notes that bitcoin’s growth curve appears to be still in its first exponential phase and could remain so for several years. This indicates a bullish case for bitcoin. As its demand could grow exponentially, its supply remains fixed at a total of 21 million.
Digital gold vs physical gold
Timmer then points out that some see bitcoin as a form of “digital gold”. Indeed, bitcoin could act as a stable store of value, potentially offering protection against inflation.
In this time, when the economic stimulus against the coronavirus has seen governments around the world printing money at an unprecedented rate, bitcoin can steal some of the thunder from gold when it comes to self-protection. against inflation.
As well as being easier to transfer and hold, Timmer notes that bitcoin has a unique advantage over gold: its limited supply. “Gold is scarce but not scarce,” he said in the report.
Timmer concludes with several suggestions. First, he says some investors may want to think of bitcoin as part of the bond side of a 60/40 equity / bond portfolio. Since bond yields are close to zero or negative, he suggests replacing some of them with gold or “assets that behave like gold”.
He points out that bitcoin comes with several risks, including volatility, competitors, and political intervention. However, he also admits that:
“Bitcoin is a legitimate store of value, is rarer than gold, and comes with potentially exponential demand dynamics.”
As the report suggests, the question now changes as to whether you should invest in bitcoin at how much?
Various crypto allocation suggestions
Other financial experts have also made portfolio allocation suggestions based on the 60/40 model.
Ark Invest CEO Cathie Wood said she believes bitcoin and other cryptos could become a standard part of recommended wallets for investors.
She postulated that cryptocurrencies, like bitcoin, will end up looking like bonds. Therefore, she believes that the bond portions of these portfolio allocations could finally give way to cryptocurrencies.
“You think of the traditional 60/40 equity bond portfolio, but look at what’s going on with bonds right now,” she said. “If we put an end to a secular 40-year interest rate cut, this asset class has done its job. And after? We think crypto could be the answer.
Another allocation suggestion comes from a study by Yale economist Aleh Tsyvinski.
According to the study, cryptocurrencies enjoy higher potential returns than other types of assets, despite their higher volatility. A wallet must contain 6% bitcoin to achieve optimal build, according to the study.
Even for bitcoin skeptics, research suggests at least a 4% bitcoin allocation. If only for the sake of diversification, those who are wary of cryptocurrencies should have at least 1% in their portfolio.
This conservative amount is suggested by Ric Edelman, founder of Edelman Financial Engines. Replacing a percentage point of the 60% equity allocation with a cryptocurrency would give investors the advantage of diversification without risking their portfolio.
“We have to recognize that a 1% allocation is not going to materially harm a client,” he said. “It won’t stop them from reaching their financial goals and it won’t hurt their personal finances.
Edelman praises virtual currency for diversification because it has little correlation with other asset classes.
The Black-Litterman model
While experts have varying opinions on how much bitcoin one should have in one’s wallet, how can an average retail investor decide?
Fortunately, there is a model that takes an objective approach while including investor preferences.
The Black-Litterman model begins with a neutral and “balanced” portfolio. It then provides a formula for increasing holdings based on the investor’s worldview. It not only incorporates an investor’s growth estimate, but also confidence in that estimate. These inputs are translated into a specific portfolio allocation.
It starts with the global market portfolio, or all holdings in the world, as a neutral starting point. If bonds occupy 51.98% of the total asset market, stocks 47.03%, and crypto at $ 2 trillion, 0.99%, then the core portfolio should have a similar allocation.
Then, for a given growth rate of the cryptocurrency, the Black-Litterman model returns the amount that an investor should hold in their portfolio. The investor can then specify their level of conviction in this assumed growth rate, and the model adjusts accordingly.
As crypto increasingly overshadows investors’ interests in other assets, it is apparently worth considering the Black-Litterman model among the many tools for determining your optimal crypto investment.