Research Disclaimer
Crypto.com Research and Insights disclaimer for research reports
Executive Summary
- When looking at the average returns over the past 10 years, we can conclude that adding BTC to the investment portfolio consisting of the S&P 500, Core US Aggregate Bond, Gold, and Real Estate Investment Trust (REIT) helped increase the yield by 0.4% to 2.0%.
- Adding both BTC and ETH to such a portfolio shows the same trend as a portfolio with only BTC, though the effect is stronger, as the average returns increase by up to 2.5%. In negative scenarios, performance drops by 0.9% to 7.1%.
- Adding 1% to 5% of BTC and ETH to the portfolio above does not show a significant rise in the risks for the overall portfolio:
- With BTC accounting for 1% to 5% of the portfolio, the overall volatility reduces by around 1.23%.
- With BTC + ETH accounting for 1% to 5% of the portfolio, the overall volatility increases by around 4.55%.
- The Modern Portfolio Theory (MPT) is adopted to compile portfolios by adding BTC or BTC plus ETH. We explore the efficient frontiers based on the selected assets to discover optimal portfolios:
- Without adding crypto assets, the portfolio consisting of S&P 500, Core US Aggregate Bond, Gold, and REIT can achieve a maximum Sharpe Ratio of 0.7050, with the return, risk (volatility), and risk-free interest at 9.61%, 0.1161, and 1.44%, respectively.
- When adding BTC as the only crypto asset with limited weight (less than 5%), one optimal portfolio is found. The corresponding return and risk are 10.67% and 0.1106, with a Sharpe Ratio of 0.8345.
- When adding both BTC and ETH with limited weights (less than 5%), one optimal portfolio is identified. The corresponding return and risk are 11.43% and 0.1047, with a Sharpe Ratio of 0.9539.
1. Introduction
The global financial markets faced significant turbulence in August 2024, marked by a sharp crash, the yen carry trade unwinding, shifting interest rate expectations, geopolitical tensions, and regional performance divergence.
During the last 10 years, Bitcoin and Ethereum have led the performance in eight of them amongst other major traditional assets. With the newly launched spot Bitcoin and Ethereum exchange-traded funds (ETFs), cryptocurrencies have become another avenue for institutions to diversify investment and hedge risk.
Additionally, the correlation between traditional asset classes and crypto assets were relatively low, which makes cryptocurrencies a good alternative for diversification.
The institutional adoption of spot Bitcoin ETFs saw a significant uptick during the second quarter of 2024 despite Bitcoin’s recent correction, with over 1,000 professional firms holding the US spot ETFs, including the giants like Goldman Sachs and Morgan Stanley. Similarly, retail investors also utilise the cryptocurrencies to achieve the growth of assets.
We’ve compiled two reports to explore performance and risk from the view of asset allocation with the integration of traditional financial (TradFi) vehicles and crypto assets. This report is the first, mainly discussing the returns.
2. Methodology
We selected the most commonly traded asset in TradFi to compile investment portfolios and examine the returns and risks with adding 1% to 5% in crypto assets. The selected assets should fulfil the criteria:
- Liquidity: Only highly liquid assets are considered to ensure ease of trading.
- Market Capitalisation: Focus on large-cap equities and crypto to minimise volatility.
- Diversification: Spread across various asset classes to reduce risk.
Based on the above criteria, the selected assets and their share in the portfolio are listed below:
| Asset Class | Assets Selected | Rationale |
|---|---|---|
| Equities | S&P 500 index funds | Broad market exposure and potential for long-term growth |
| Bonds | US Treasury bonds (iShares Core US Aggregate Bond ETF) | Stability and regular income |
| Commodities | Gold | Hedge against inflation and economic uncertainty |
| Alternatives | Real estate (S&P REIT Index Fund) | Income generation and diversification |
| Crypto | Bitcoin and Ethereum | The largest coins in market cap with relatively less volatility |
| Asset Class | Equities |
|---|---|
| Assets Selected | S&P 500 index funds |
| Rationale | Broad market exposure and potential for long-term growth |
| Asset Class | Bonds |
| Assets Selected | US Treasury bonds (iShares Core US Aggregate Bond ETF) |
| Rationale | Stability and regular income |
| Asset Class | Commodities |
| Assets Selected | Gold |
| Rationale | Hedge against inflation and economic uncertainty |
| Asset Class | Alternatives |
| Assets Selected | Real estate (S&P REIT Index Fund) |
| Rationale | Income generation and diversification |
| Asset Class | Crypto |
| Assets Selected | Bitcoin and Ethereum |
| Rationale | The largest coins in market cap with relatively less volatility |
2.1 Return
We first created the portfolio that includes just the traditional assets for reference. Then we added 1% to 5% BTC or 1% to 5% BTC+ETH to the original portfolio and checked the returns. The details of the asset allocation for each portfolio are shown below:
Price data of the traditional assets is from Yahoo Finance, while Bitcoin and Ethereum price data is from CoinGecko.
2.2 Risk
As cryptocurrencies are commonly cited for high volatility, it’s crucial to evaluate the risks when adding crypto assets to investment portfolios. Typically, volatility is used to estimate the portfolio risk, and Sharpe Ratio measures the risk-adjusted performance. Additionally, we also measured the Sharpe Ratio of each portfolio.
Sharpe ratio measures the excess return per unit of risk (volatility). It is calculated by subtracting the risk-free rate from the investment’s return and then dividing that result by the investment’s standard deviation. A higher Sharpe Ratio suggests that the investment’s returns are more favourable compared to its risk. This is generally viewed as a positive sign, indicating effective risk management and a potentially more attractive investment.
Furthermore, we adopted the Modern Portfolio Theory (MPT) to build portfolios that maximise the overall returns within an acceptable level of risk. To achieve this, we performed the below analysis:
- Compiled efficient frontiers for the selected assets: traditional assets, traditional assets + Bitcoin, and traditional assets + Bitcoin + Ethereum.
- Found the tangency portfolio for each combination of the assets.
- Identified the portfolios with the weights of crypto assets accounting for 1% to 5% of the overall portfolio.
The annual returns used in the generation of risk and efficient frontier are calculated by the formula: for BTC and ETH, r = average daily return * 365; for traditional assets, r = average daily return * 252.
The risk-free yield we used is the average yield of US T-Bills during the past 10 years:
| Year | T-Bills Yield (Avg.) |
|---|---|
| 2014 | 0.11% |
| 2015 | 0.30% |
| 2016 | 0.60% |
| 2017 | 1.17% |
| 2018 | 2.25% |
| 2019 | 1.99% |
| 2020 | 0.36% |
| 2021 | 0.10% |
| 2022 | 2.68% |
| 2023 | 4.84% |
| Average | 1.44% |
| Year | 2014 |
|---|---|
| T-Bills Yield (Avg.) | 0.11% |
| Year | 2015 |
| T-Bills Yield (Avg.) | 0.30% |
| Year | 2016 |
| T-Bills Yield (Avg.) | 0.60% |
| Year | 2017 |
| T-Bills Yield (Avg.) | 1.17% |
| Year | 2018 |
| T-Bills Yield (Avg.) | 2.25% |
| Year | 2019 |
| T-Bills Yield (Avg.) | 1.99% |
| Year | 2020 |
| T-Bills Yield (Avg.) | 0.36% |
| Year | 2021 |
| T-Bills Yield (Avg.) | 0.10% |
| Year | 2022 |
| T-Bills Yield (Avg.) | 2.68% |
| Year | 2023 |
| T-Bills Yield (Avg.) | 4.84% |
| Year | Average |
| T-Bills Yield (Avg.) | 1.44% |
3. Return Analysis
In this section, we examine the return of each portfolio in Section 2.1 during the last 10 years (2014–2023) plus the latest returns in 2024. The results are shown below:
The data shows that BTC helped increase the returns of the portfolio most of the time, except in 2018 and 2022, when a global financial crisis and geopolitical conflict occurred. Additionally, adding BTC could worsen performance by 0.8% to 6.1% in a situation where the global economy is in a downtrend.
When looking at the average returns over the past 10 years, we can conclude that adding BTC to the portfolio helped increase the yield by 0.4% to 2.0%.
Next, we review the performance of adding 1% to 5% of BTC+ETH (adding BTC and ETH with the same amount of dollars) to the portfolio and compare the results with the portfolio without BTC. The results are shown below:
The data above shows the same trend as the one that only added BTC, though the effect is stronger, as the average returns are increased by 0.4% to 2.5%. In the negative cases, the performance is worsened by 0.9% to 7.1%.
4. Risk Analysis
In this section, we examine the risks of the portfolios we presented in Section 2.2. The processes are listed below:
- Calculated the risk (volatilities) of each portfolio.
- Calculated the Sharpe Ratio of each portfolio.
- Compiled the efficient frontier for each portfolio and calculate corresponding tangency portfolio (the portfolio with the highest Sharpe Ratio).
- Filtered out the portfolio in which the percentage of crypto assets was in the limit (1% to 5%) and the highest Sharpe Ratio.
People debate that crypto assets are highly volatile. However, after adding BTC to compile an investment portfolio, the overall portfolio volatility was reduced by around 0.001 (1.23%), while adding both BTC and ETH will increase the volatility by around 0.005 (4.55%)
Additionally, we can measure the Sharpe Ratio of the above portfolios. The data suggests that adding crypto to an investment portfolio can achieve a better risk-adjusted performance than the reference portfolio without crypto.
5. Asset Allocation With MPT
In this section, the Modern Portfolio Theory (MPT) is adopted to compile portfolios. We explore the efficient frontiers based on the selected assets to discover optimal portfolios and tangency portfolios (portfolio with a max Sharpe Ratio).
5.1 No Crypto
For reference, we first explored the efficient frontier of the portfolios without adding crypto assets, with a tangency portfolio of S&P 500 (53.57%), Gold (46.20%), Core US Agg Bond (0.15%), REIT (0.08%). Its Sharpe Ratio is 0.7050.
5.2 Add Crypto
Here, BTC is added alongside the traditional assets for diversification. The efficient frontier and the corresponding tangency portfolio are shown below. The Sharpe Ratio of the tangency portfolio is 0.8998 with BTC accounts for over 10%, which is beyond the suggested weight (less than 5%) for crypto in the portfolio.
To limit BTC’s weight to 1% to 5% in the overall portfolio, we filtered out all the portfolios with the highest Sharpe Ratios given BTC’s weight in various ranges: 0% to 1%, 1% to 2%, 2% to 3%, 3% to 4%, and 4% to 5%; the results are shown below. All of them have a higher Sharpe Ratio than the reference portfolio. This suggests that investing in BTC can help increase the risk-adjusted performance.
At last, both BTC and ETH are added to do the same analysis as above. We find that the Sharpe Ratio of the tangency portfolio reached 1.20 with BTC+ETH accounts for over 15% of the overall portfolio, which is beyond the suggested weight (less than 5%).
Again, we filtered some portfolios to limit the sum of weights for BTC+ETH to 1% to 5%. The results show that three portfolios are optimal, and all of them have higher Sharpe Ratios than the reference portfolio:
6. Limitations and Caveats
Our analysis is applicable only on the specified portfolios; there are some limitations for the results and further improvements that can be performed for the study:
- The conclusions were drawn using historical data, which do not accurately reflect potential future returns, volatility, and correlations.
- Although volatility is a widely used risk metric, it has its drawbacks. Other risk metrics, such as value at risk (VaR) and downside volatility, can be considered for future studies.
- The optimal portfolio we suggested above is for illustrative purposes only. Due to the backward-looking nature of our analysis, replicating this portfolio would very likely result in different returns. Readers should note that the results do not constitute investment advice.
- When using the Modern Portfolio Theory to construct portfolios, the corresponding assumptions were also applied in this study.
7. Conclusion
The data indicates that BTC generally enhances portfolio returns, except in 2018 and 2022 due to the failure of ICOs and the downtrend of the global economy. Over the last 10 years, Bitcoin and Ethereum have led the performance in eight of those years amongst other major traditional assets.
This report has examined the returns and risks of adding crypto (BTC and ETH) to investment portfolios as part of portfolio management. The results show positive indications that adding Bitcoin and Ethereum for diversification can achieve higher returns than solely investing in traditional assets, without significantly increasing overall volatility. Furthermore, by adopting Modern Portfolio Theory, optimal portfolios can be identified that have much higher risk-adjusted returns with limited exposure to crypto assets of 1% to 5%.
This study indicates that cryptocurrencies are a good alternative for investment diversification for both institutional and retail investors.
Read the full report: Asset Allocation With Crypto – Return & Risk Analysis
Interested to know more? Access exclusive reports by signing up as a Private member, joining our Crypto.com Exchange VIP Programme, or collecting a Loaded Lions NFT.
Authors
Crypto.com Research and Insights team
Get the latest market, DeFi & NFT updates delivered to your inbox:
Be the first to hear about new insights:
