I’ve long been intrigued with cryptocurrencies (not an early adopter by any means though) and whether the space can evolve into some sort of portfolio diversifier that I can use for clients. I had a short term trade (just a couple of weeks) in the Grayscale Bitcoin Trust (GBTC) in the middle of it’s parabolic run late last year that worked out well and have just been watching since then.

In trying to assess any potential value as a diversifier, here is a two year chart comparing Bitcoin to the euro/US dollar pair and the S&P 500. I’m including EURUSD in the chart because proponents view Bitcoin as a potential currency.

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Potential utility as a currency makes no sense to me with that kind of historical volatility profile. Matt Hougan wrote a research paper back in Q1 of this year showing the diversification benefit of varying percentages of Bitcoin exposure in an otherwise traditional portfolio (meaning a 60/40 portfolio). The numbers are of course compelling, otherwise why publish it? The period studied obviously includes that parabolic run up along with a decent chunk of the decline that started last December. I would not be comfortable adding an asset for diversification purposes based on data that included a run like that. Either those returns are not repeatable in which case the data has no forward looking value or those returns will repeat which I would argue would be impossible to model. To get Matt’s report, click here, scroll to the bottom and click on The Case For Crypto In An Institutional Portfolio.

Looking toward the right side of the chart though, the volatility appears to be ratcheting down. A segment on Bloomberg TV noted the series of lower highs along with the fact that the $6000 level has thus far held. That TV segment noted that $6000 might be holding because that is the cost to mine Bitcoin. Here is a three month chart that isolates the relatively lower volatility.

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The action of the last few months is a big step toward utility as a diversifier. I think it needs to log some time in a narrower range to then provide data to study. In regard to equities I’ve said before that the S&P 500 is less likely to drop 50% after it just dropped 50%. I would be less confident in saying that about Bitcoin but maybe, after dropping by 2/3rds it much less likely to drop by two thirds.