Hold 6% of your portfolio in Bitcoin – the crypto Sharpe’s ratio

Many prominent economists have come to comment that Bitcoin does not have intrinsic value, rather, it is driven by market perception and enthusiasm. This is the general opinion that Robert Shiller, a Nobel laureate in economics, and Warren Buffet, one of the most successful investors in the world have in mind when it comes to the “people’s currency”.

Now, another prominent economist has spoken about Bitcoin, This time, however, the comment is somehow positive.

Aleh Tsyvinski is the Arthur M. Okun Professor of Economics at Yale University. He recently published a rather interesting research on cryptocurrencies and his general advice to Bitcoin enthusiasts – hold 6% of your entire portfolio in Bitcoin.

In the groundbreaking study, Tsyvinski looks primarily at three of the most liquid and “popular” digital coins – Bitcoin, Ethereum, and Ripple. His goal is to see how these three compare to each other and to possibly classify them as currencies or as stocks.

However, there is no clear classification that suits these three coins yet. There are many different properties that make currencies what they are, including unit of account and store of value. The later feature is also inherent for gold, silver and other precious metals that are common in investors’ portfolios for the simple reason that they provide long-term store of value (if force majeure event takes place, so to speak).

Interestingly enough, the professor’s research takes into consideration more than 300 industries in the US and more than 130 industries in China and studies the market sentiment native to all of them. According to the paper, Bitcoin has disruptive power, but only in the consumer goods and healthcare industries, not in finance, for example. This is a very intriguing observation, since Bitcoin and blockchain are now at the forefront of the financial world and banks are racing each other to offer innovative solutions to their customers.

Ethereum, on the other hand, seems to be very well received within the financial sector, most probably because it offers the smart contracts feature that finds multiple applications in finance.

Tsyvinski used a well known metric to compare the return over the standard deviation of the return on investment (the risk-free rate is subtracted from the average return) to show that cryptocurrencies show higher Sharpe’s ratio when compared to regular bonds and stocks. This observation means that while there is a great volatility in cryptocurrencies, the investment is worth it, since the returns are higher.

Overall, Tsyvinski believes that for an optimal construction of your portfolio, one should hold 6% in Bitcoin, while those who are less enthusiastic should hold 4%, but in any case, 1% of your portfolio should go to Bitcoin for diversification and especially if one believes in the future potential of the coin.

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