However, although disagreements are extremely important in finance, we intend in this article to avoid the fundamental debate about cryptocurrencies. Instead, we will focus on the cold, hard numbers and examine the return, risk and correlations of the two cryptocurrencies with the largest market shares – Bitcoin and Ethereum. We will then use these numbers to determine whether and to what extent they warrant an allocation. And we'll look at this in the context of three industry standard approaches to portfolio construction: the global market portfolio, risk parity, and optimization. Each has its own merits and idiosyncrasies, and each will attack potential allocations to cryptocurrencies from a slightly different angle. Sure, it might not be as fun as an intense, steamy debate, but it will be based on facts and well-researched predictions, not opinions – which is surely no bad thing for Investors. Figure 1 hints at one of the many ways digital assets are disrupting traditional finance. It shows the indexed returns of several traditional assets (global stocks and bonds, denominated in US dollars), as well as the returns of Bitcoin and Ethereum, the two largest cryptocurrencies to date, which together account for around 70%. from space. Note that we use post-2017 data to account for data availability, mainstream media awareness of the asset class, and growing institutional interest (e.g., the launch of CME Bitcoin futures in 2017).
However, before concluding that Bitcoin and Ethereum have generated broadly similar returns to traditional assets, albeit with a more volatile trajectory, take a close look at the chart. You'll see that we had to present the returns on a compressed scale on the left side of the chart (technically known as a “semi-log scale”). And the reason is that because cryptocurrency returns have been so extreme (in fact exponential), that showing everything on a more usual linear scale would reduce bond and stock market returns to an effectively flat line.