CapitalTime

Articles on investing and capital management, with a quantitative focus.

Time To Invest In Bitcoin?

2021-05-02

No.

I already committed myself to a specific portfolio strategy, based on extensive research and modelling. My portfolio is based on the risk parity framework which diversifies between three asset classes.

What if Bitcoin is a new asset class?

It's possible that Bitcoin might turn out to be a new asset class. So what? Many asset classes already exist, and I don't include all of them in my portfolio. For example, I don't include REITs, junk bonds, commodities, or private equity.

What's the hurry?

We still don't know if Bitcoin is an asset class, as opposed to, say, a pump-and-dump scam or completely speculative mania.

I think it's best to wait and see. If Bitcoin really does turn out to be a legitimate asset class, then it should provide consistent returns over the long term. If Bitcoin is legitimate, then I can add it to my portfolio 10 or 20 years from now. There's no hurry.

Warning signs

There are quite a few things about cryptocurrencies that make me uncomfortable. As a computer engineer who has worked in cryptography and internet security for over 20 years, I really think that cryptocurrencies are too complex and have too many pitfalls. They have some very esoteric challenges (like key management), which is extremely difficult even for technical experts, let alone the general public.

I'm also concerned by the expectations of extremely high returns. A typical expectation with nearly every legitimate asset class is a "real return" (after inflation) of a few % per year, generally single digits.

In contrast, cryptocurrency investors expect to see tremendous increases, and seem to view these vehicles as a way to turn small amounts of money into large, or even life-changing amounts. There is a get rich quick mindset everywhere you look in this ecosystem.

The people promoting cryptocurrencies encourage this view, setting expectations for returns such as 50% to 100% (or more) per year.

These unrealistic expectations and promises are a huge warning sign.

Remember XIV

Back in 2017, there were many investors who believed that XIV, an "inverse volatility" ETF, was a great investment. It was a new, innovative vehicle that let investors profit from a certain characteristic of market volatility. It was very popular with active traders, with returns of 30% to 50% annualized.

And it certainly was a very interesting vehicle. Some people thought it was a new asset class that should be included in portfolios.

XIV blew up and investors lost all their money. Although it was an interesting and novel thing, it turned out that XIV wasn't a new asset class, and wasn't useful for portfolios.

How much history is there?

I will happily reconsider Bitcoin when there's more history available. But so far, Bitcoin has only had a liquid global market for about 8 years.

The assets that I invest in have long histories. Stocks and bonds have existed for roughly 300-400 years, and gold has been valuable to humans for roughly 5,000 years.

— Jem Berkes