Where Does Bitcoin Fit In Your Portfolio?

The two subjects that Registered Investment Advisors and high net worth investors ask me about are: VIX or volatility in general & Bitcoin or cryptocurrencies in general

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For many investors the decision isn't about "IF" bitcoin belongs in their portfolio, but "where" does it belong in their portfolio (personally, at current valuations I would be cautious, but I think it is still helpful to think about where it belongs).    With the growth of passive investing, it is even more crucial to allocate cryptocurrency "investments" to the right risk bucket, or else some of the principles of passive investing will fail.

Bitcoin is NOT a Currency

Despite being called 'cryptocurrencies' they are not like currencies, at least not in terms of where they fit into your asset allocation strategy.  While you can buy things directly with them, in some cases, many brokerage accounts have debit cards that can be used - and  I wouldn't consider that to be a 'currency'.

The cryptocurrencies are just far too volatile to be considered currencies.  They don't behave like currencies - even the most speculative emerging market currencies tend to have far less volatility.  They don't respond to news or information flow the way a currency would.  Currency based ETFs have been around almost since the inception of ETFs and yet none seem to be generate the excitement and buzz surrounding the possibility of cryptocurrencies.

When thinking about how cryptocurrencies fit into your overall portfolio - treating them as part of your currency or even more dangerously as part of your 'cash' allocations seems far too aggressive.

Bitcoin is NOT an Income Product

It seems that relatively few people compare cryptocurrencies to bonds or other forms of income products.  I agree with that assessment, so I won't belabor the point.

Bitcoin May be a Commodity

I am not entirely comfortable with treating cryptocurrencies as part of an allocation to commodities, but there are some compelling arguments.  Gold and Bitcoin seem to react similarly to some types of news, 'flight to safety' type of news in particular.  In many ways, the portability of Bitcoin and its ability to cross international boundaries makes it superior, in theory, to products like gold (though without the thousands of years of being treated as money).

The volatility in Bitcoin is extreme, but I could get comfortable that it is more in line with some esoteric commodity volatility.  Even oil, one of the most widely traded (and allegedly well understood) commodities often has daily swings in excess of 3%.  Bitcoin swings far more than that, but if you attempt to 'beta adjust' your sizing, it seems defensible to consider some portion of a cryptocurrency play to fit into your commodity bucket.

Bitcoin Fits Best In the Highly Speculative Bucket

I think investors should have some portion invested in highly speculative situations.  Whether small cap stocks, options, or some other high risk/high potential reward strategy - there should be an allocation made to these types of trades.  The size of this allocation needs to be controlled carefully as these are meant to be "home run" types of trades.  Where if the trades work out, even a small investment can have a meaningful impact on your overall portfolio value - knowing that the risk is high.

When advising people on how to think of Bitcoin in terms of asset allocation - I think Bitcoin is an appropriate use of this capital.  If you like Bitcoin, you might use this entire allocation to Bitcoin.  If you don't - then you can still find other speculative but interesting investments.

I Risk Being Underweight Crypto, But That Is a Risk I am Comfortble Taking

My view on where cryptocurrencies should fit into your portfolio, probably limits the size of your cryptocurrency investment.  The highly speculative portion of your portfolio should be relatively small.  I could be convinced, especially for someone with larger commodity exposures, to shift some of that allocation into cryptocurrencies - though you would need to acknowledge the high beta nature of crypto and possibly reduce your overall commodity exposure to accommodate that decision.

I cannot get comfortable, from an overall portfolio managment standpoint, of treating crypto as part of your cash, currency or income generating portfolio.  That may limit how much I would have allocated - as this can be a large amount of money that isn't generating much under the current regime of low yields globally, but the risk reward of treating crypto as a substitute for these 'safe' assets seems too dangerous to me.

Disclaimer: Any opinions expressed are those of Peter Tchir. This info is for educational and/or entertainment purposes only, so use at your own risk. He's not a broker-dealer or advisor of any kind.

Peter Tchir, Contributor

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