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Bitcoin divides opinion. Some view it as gambling or inherently worthless because it isn’t a productive asset, others see it as an investment akin to gold, which doesn’t particularly have a tangible use despite what many claim. And, there are still some people that view it as merely a currency, which was its original purpose.
The rise of crypto sports betting and various other industries paint it as a dual-purpose, where it can be a currency but also a speculative asset.
The SEC has yet to fully classify Bitcoin. It’s still so new that many regulating bodies are beginning to regulate it as an investment asset, as seen with the launch of Bitcoin ETFs, but the situation has yet to stabilize. This ambiguity shapes Bitcoin's role in investment portfolios, influencing decisions on allocation percentages amidst differing perceptions of its nature and utility.
Understanding Bitcoin’s Risk Profile
Bitcoin's risk profile is characterized by high volatility, with price swings influenced by market sentiment. In 2021, Bitcoin experienced a dramatic price surge to nearly $65,000 before halving in value over subsequent months. Many buying for the long-term will claim it’s almost back to its ATH, but this doesn’t mean it’s not profoundly risky in terms of volatility.
Such volatility contrasts sharply with traditional assets, but then, so have the historical returns.
Bitcoin’s Role in Enhancing Portfolio Returns
Incorporating Bitcoin into diversified portfolios has historically offered outsized returns compared to traditional assets. A study from 2020 revealed that portfolios with a 5% Bitcoin allocation significantly outperformed those without over multiple time horizons, highlighting Bitcoin's potential to enhance overall returns despite its volatility.
This performance isn’t solely attributed to Bitcoin's high gains in isolation, but its low correlation with traditional financial assets, making it a strong option for diversification. The asset's past performance is not indicative of future results, but adoption and regulatory acceptance appear to show that Bitcoin is being legitimized in the mainstream.
How Much Bitcoin Should Your Portfolio Contain?
Determining the optimal Bitcoin allocation depends on individual risk tolerance, investment horizon, and financial objectives. Financial experts often recommend a cautious approach, with many traditional investors holding allocations of just 1% to 5%.
Some investors have seen tremendous gains by holding 100% in Bitcoin, but this would be a reckless gamble given the currency’s infancy - regardless of their gains in the past. There are too many question marks and risk factors for any given cryptocurrency to be a primary holding, but this doesn’t mean it cannot supplement a portfolio. At some level of risk, investing turns into gambling, and that point is when you can no longer justify your portfolio as being balanced.
Bitcoin as a Hedge
Analysis of Bitcoin's performance in relation to traditional assets reveals mixed evidence regarding its efficacy as a hedge. During the 2020 market downturn, Bitcoin initially fell but then decoupled from the stock market, posting significant gains. This suggests potential as a non-correlated asset, offering diversification benefits.
However, its correlation with traditional markets can fluctuate, limiting its reliability as a consistent hedge against the S&P 500, USD, or gold. We do not know yet if it will be consistently negatively correlated with any asset. Even gold, which has historically been negatively correlated with the USD, strengthened alongside the dollar since interest rates went up.
Conclusion
In conclusion, while Bitcoin presents a unique opportunity for portfolio diversification and potentially high returns. Its allocation should reflect its high risk, and one’s own tolerance to risk, but should only ever be considered as a supplement to a balanced portfolio.
Disclaimer
The views and opinions expressed in this article are solely those of the authors and do not reflect the views of Bitcoin Insider. Every investment and trading move involves risk - this is especially true for cryptocurrencies given their volatility. We strongly advise our readers to conduct their own research when making a decision.