Forbes.com 2nd of June 2016
Bitcoin has been hard for the average investor to wrap their head around.
A new white paper provides the analysis that would help explain these jaw-dropping phenomena and argues persuasively that Bitcoin (and by extension, other similar digital assets) represents the emergence of a new asset class, and one that should seriously be considered as a diversifier for investment portfolios.
“Bitcoin is consistently the lowest correlated asset to other traditional asset classes,” says Chris Burniske, blockchain analyst at ARK Investment Management, the first public fund manager to invest in Bitcoin, and co-author of the paper, Bitcoin: Ringing the Bell for a New Asset Class PDF
“If an investor who holds bonds and equities swapped a percentage of their prior holdings into bitcoin, because of bitcoin’s low correlation and superior absolute performance, they could have decreased the volatility of the portfolio while simultaneously increasing absolute returns,” says Burniske. “That’s the golden bullet of an asset class.”
“It’s time for investors to take a serious look at bitcoin and other digital currencies and see how they may want to include that as a small part of their portfolio,” says Adam White, vice president of business development and strategy at Coinbase. “What stymies a lot of that is that investors don’t understand the technology behind Bitcoin … I use the analogy that I don’t understand how the Internet works, but I see how it provides a net benefit to society and thereby has value. Bitcoin is very similar. There’s a finite amount of bitcoin that will be created and by owning a small piece of that, you own a portion of this technology that allows you to access the benefits,” which he lists as global payments, micro-transactions, data registry and more.
Given that at the end of 2015, U.S. households had more than $34.5 trillion in investable assets according to Cerulli Associates, more mainstream adoption of bitcoin as an investment could boost its price, trading volume and market cap by orders of magnitude.
The analysis examines bitcoin according to four characteristics that define asset classes:
ARK Invest and Coinbase define investability as providing ample liquidity and opportunity to invest.
Based on Bitcoin exchange trading volume averaging around $1 billion a day through the first quarter of 2016.
Bitcoin has roughly the same liquidity of the largest gold ETF (GLD) and three times that of Vanguard’s REIT ETF (VNQ) even though GLD and VNQ store significantly more in assets — $34 billion and $56 billion, respectively.
2. Politico-Economic Profile
The politico-economic profile of an asset class is driven primarily by its basis of value, governance, and use cases.
What gives bitcoin value is the fact that it can facilitate all kinds of transactions, starting with the most basic one of enabling money in the form of bitcoin to be sent across the world near immediately, securely, transparently and at almost no cost.
Compared to bitcoin, no asset has evolved from concept to billions of dollars in stored value so quickly. Moreover, no asset in history has followed such a predictable supply trajectory.
3. Correlation of Returns: Price Independence
Given its unique politico-economic characteristics, bitcoin’s price should behave differently relative to other assets as it is pushed and pulled by distinct market forces.
The strongest argument for bitcoin’s inclusion in a portfolio comes from how uncorrelated its price is to any other asset.
The table below summarizes the correlation coefficient of bitcoins prices performance compared to major asset classes and emerging countries’ forex.
4. Risk-Reward Profiles
While daily percent change is a useful metric, investors most often measure volatility via the standard deviation of those changes. While bitcoin still experiences large price swings, the magnitude of those swings has diminished resulting in decreased volatility.
In a low-rate and slow-growth economy, an allocation to bitcoin is not only a way to mitigate risks of traditional capital markets but also a way to better overall portfolio returns.
For three of the five years examined, with a decreasing volatility and unparalleled Compound Annual Returns, bitcoin had an outstanding Sharpe Ratio, superior to all other asset classes.
Bitcoin exhibits characteristics of a unique asset class—meeting the bar of investability, and differing substantially from other assets in terms of its politico-economic profile, price independence, and risk-reward characteristics.
ARK and Coinbase believe bitcoin is the first of its kind in what is rapidly becoming a distinct asset class. Since cryptocurrencies are subject to the strong network effects of users and developers, they may submit to a “winner takes most” model unlike bonds and equities.
The cryptocurrencies that successfully foster the flywheel of user and developer engagement could grow to formidable market capitalizations.
Read more on Forbes.com