Why do managers have bitcoin?

Is bitcoin a way to diversify your portfolio? How attractive is bitcoin (BTC) compared to other assets? These are all questions that managers ask themselves. In recent years, cryptocurrencies have attracted countless managers, from the biggest (Blackrock), to the smallest. The interest raised by bitcoin is not only to have become an additional diversification, it is also to understand why bitcoin is correlated to traditional markets.

bitcoin, an asset in diversification?

Bitcoin is famous for its performance, but also for its volatility. And this is where the manager’s difficulty lies: exposing himself to a very unstable but potentially very efficient asset. In modern portfolio theorythe investor ” rational “ look for maximize its performance and minimize the instability of its investments. Therefore, it is common for managers to resort to comparing the performance of each asset with its volatility. But as we will see, the case of cryptocurrencies is truly exceptional and deserves treatment as such.

The graph above shows the performance of different assets since 2020. The horizontal axis also shows the volatility of each asset. In our case, we selected three cryptocurrencies (bitcoin, ethereum, and the CMC200 index), and 17 traditional assets (Gold, silver, MSCI World, S&P 500, etc…). Of course, some indices are nested between them but this allows to have a set of representative assets. The red line represents the trend line ” mean “ between all assets. Ideally, assets above the red line show high performance for more moderate volatility. The higher the asset in question is to the top left of the chart, the greater its performance and the lower its volatility.

In addition, we clearly notice the existence of a globally increasing relationship between the desired performance and the risk borne (the volatility involved). An investor who wants great performance must endure great instability in his portfolio.

The special case of altcoins

Therefore, we clearly see that traditional assets behave similarly to each other (bottom left area). Among them, gold seems to act well as a safe haven (adequate performance for limited volatility). For their part, cryptocurrencies really appear ” apart “. Bitcoin and ethereum have, since 2020, considerable performance (x3, x13, etc.) and despite everything high volatility (between 50% and 75%).

In addition, the CMC 200 index shows a performance comparable to bitcoin, but its volatility is significantly higher. It follows that the cryptocurrency market as a whole is extremely volatile, but not exceptionally successful. A sustained outperformance of small and medium cryptocurrencies would result in them emerging as big cryptocurrencies. This would necessarily reduce their volatility. We must therefore bear in mind that the attractiveness of cryptocurrencies is actually only a minority of them. In our previous article, we recalled the existing correlations between cryptocurrencies.

“There is a very strong correlation between major cryptocurrencies. In fact, bitcoin seems to strongly determine the behavior of other major cryptocurrencies. Conversely, stablecoins appear to be very decorrelated from the market as a whole. This means that stablecoins fit properly into a logically independent of that of the global market.

Then, it appears that the smaller cryptocurrencies are less immediately determined by the evolution of the price of bitcoin. Thus, the degree of independence of the secondary sectors seems greater. But by the very fact that the degree of independence from bitcoin is linked to the size of the cryptocurrency in relation to the market, appears an impassable limit and an antagonism with the global evolution of these small cryptocurrencies. »

Correlations between the main cryptocurrencies – Tremplin.io

Sharpe ratio

But if cryptocurrencies present a priori an interesting profile, how to situate them in relation to other assets?

To do this, analysts sometimes use the measure of the Sharpe ratio. The Sharpe ratio compares the actual return of an asset (the return adjusted for the risk-free rate) with its volatility (its instability). A Sharpe ratio value greater than 0 means that for each point of volatility risked by the investor, he reaps a positive gain. If the ratio is close to 1, this means that the investor can expect a gain as large as the risk wagered in terms of volatility. The ideal is to diversify your portfolio on assets with a high Sharpe ratio, and most favorably, with a ratio greater than 1.

Sharpe ratio = (active return – risk-free rate) / volatility

In our case, we take the rate of 3.75% (ECB deposit facility rate) as the risk-free rate. The table below shows the Sharpe ratio between 2020 and 2023 for all of our 20 assets. Bitcoin shows a ratio above 5, against more than 17 for ethereum. These are truly exceptional values ​​that far exceed most stocks. That is to say, for each point of volatility risked since 2020, the expected gain on bitcoin is 5, and 17 for ethereum. In comparison, Gold is the traditional asset with the highest Sharpe ratio (0.85). This is equivalent to asserting that each point of volatility risked by the investor leads to an expected gain of 0.85.

The special case of bitcoin volatility

Necessarily, such values ​​no longer really have any meaning. It is moreover quite paradoxical that a random model and apparently based on the “rationality” encourages the investor to diversify, mechanically so to speak, into cryptocurrencies. Managers can no longer ignore cryptocurrencies because they have very attractive management criteria. But it is obvious that an investor who is not able to assume a higher volatility than that of the traditional markets would turn away from it.

In this case, volatility is not always synonymous with risk. This makes the analysis of the Sharpe ratio relatively irrelevant. Indeed, bitcoin shows a unique behavior in the face of its volatility, that is to say in the face of its instability. The chart below shows the annualized volatility of bitcoin. It is quite remarkable that the level of bitcoin volatility in the summer of 2023 is quite comparable to that of traditional markets. But between 2020 and 2023, bitcoin shows volatility up to 3 times greater than that of stock indices.

Therefore, it is important for us to specify that bull markets are usually accompanied by an increase in bitcoin volatility. This is contrary to traditional stock market indices, for which volatility often accompanies the most severe corrections.

Why relativize the instability of bitcoin?

“Indeed, the rise of bitcoin in the long term generally results in the reduction of its volatility. Bitcoin thrives on decreasing long-term volatility. Then, over a few months, bitcoin, on the contrary, feeds on an increase in volatility to increase its performance. […]

On the other hand, we have shown that a minimum in the volatility of stock market indices often reflects a maximum in the price of bitcoin. Conversely, the rise in bitcoin over the long term will more frequently be positively correlated with the rise in index volatility. But at the same time, increases in index volatility over a few months can be a source of bitcoin declines. Bitcoin therefore does not protect against “shocks” or “panics”. On the other hand, it benefits from the growing instability of the long-term indices, which is not negligible. »

Volatility and Bitcoin (BTC) – Tremplin.io

Thus, it is clear that bitcoin has a disproportionate performance in the face of the volatility actually observed. But volatility above 50% is still very high and sometimes meaningless. An outperformance of bitcoin on the stock market indices is therefore more than enough to make this young asset very attractive.

However, modern portfolio theory is based on random models. Random models are often poorly representative of extreme variations. It is therefore important to remember that this traditional management criterion remains, despite everything, difficult to read in the case of cryptocurrencies. The fact that the volatility of bitcoin generally accompanies its bullish performance can therefore constitute a reassuring criterion in the face of the imperfection of the statistics studied.

In conclusion

In conclusion we have seen that bitcoin has clearly outperformed traditional assets in recent years. The relationship between its performance and its volatility is quite exceptional. In addition, ethereum shows an attractive interest all the more interesting in traditional management. Nevertheless, most medium and small cryptocurrencies show interesting performance but considerable instability. It is therefore proportionally more interesting for a manager to be exposed to major cryptocurrencies.

In all cases, cryptocurrencies present an obvious interest in diversification for the manager, due to the observed return/volatility ratio. Despite everything, volatility does not have the same meaning on cryptocurrencies as on traditional markets.