Does Crypto Belong in a Portfolio?

To make a case that Bitcoin is a store of value, Hougan made a comparison of gold to Bitcoin. He displayed a chart of gold’s high volatility and noted that gold is widely accepted as such a store of value. He went on to show that if Bitcoin only gets half the penetration of gold, Bitcoin could be worth about $448,000 a coin.

Hougan acknowledged Bitcoin’s high volatility and the possible risk of loss. He stated that Bitcoin has a high return potential, has had low correlations to stocks and bonds and, unlike stocks and bonds, has 24/7/365 liquidity.

He also showed two compelling charts as seen below. The first illustrates the higher historic returns and Sharpe ratio of adding various Bitcoin allocations to traditional 60/40 portfolios. For example, over the past ten years ending March 31, 2024, a 2.5 percent allocation to Bitcoin increased the annualized return from 6.24 percent to 8.63 percent and the Sharpe ratio from 0.447 to 0.689. The volatility and maximum drawdown was only slightly higher than the traditional 60/40 portfolio.

Hougan’s second chart showed return contributions of a five percent Bitcoin allocation over a three-year rolling cumulative average. Over every three-year period, the contributions were positive between January 1, 2014 and March 31, 2024

I’m a very skeptical person as it’s easier to data mine the past than predict the future. But I also acknowledge I’ve seen charts like these from Bitwise for the past few years and Bitwise was founded in 2016, so much of these periods include the time that Bitwise has been helping investors buy crypto.

The case against crypto

First, I disclosed that I bought a tiny amount of Bitcoin in 2017 in order to factcheck a story. Today, my $200 is worth nearly $3,200 and I wish I had bought at least $200,000 instead. I also acknowledged Hougan’s statements in 2017 that Bitcoin has good likelihood of being a rival to gold, but a near zero chance it would be used to buy things like coffee or lunch. Hougan is looking far better than Jamie Dimon, who stated it’s not a real thing and will eventually be closed. Other famous investors, including Warren Buffett, have predicted a bad ending for Bitcoin.

Yet the $1.2 trillion value of Bitcoin pales in comparison to the $109 trillion value of the global stock market. Those roughly 12,000 publicly traded companies create jobs, products and services, and a vibrant economy that makes our lives so much better. It’s a bet on capitalism. Bitcoin and other crypto are more like gold, which has virtually no industrial uses. Though they are not pretty like gold, they are easy to transport to anywhere in the world with lightning speed.

Let’s say Hougan is right that Bitcoin could eventually rival gold. Gold has a long history, since at least the days of the Roman empire, of only keeping up with inflation. That’s a zero percent real return – negative after taxes. I bought $6,700 of gold back in 1980, which is up about $17,000. That’s less than inflation. Had I instead bought the S&P 500 index fund, I’d have made an additional $800,000. Going forward, I think capitalism is a much better investment than gold or crypto.

And even if crypto becomes a mainstay, there is still the question of which cryptos will win out and which won’t. So, in many ways, Ethereum is superior to Bitcoin in that it’s both programable and can produce income through what’s called staking. As of June 18, Coinbase is obtaining a 2.67 percent annual income for investors owning Ethereum and selecting this option. Thus, it can actually provide some cashflow. The upcoming Ethereum ETFs will likely not have this income option due to current regulatory limitations. And new coins using new technologies could dethrone both Bitcoin and Ethereum. Which do you choose?

I also have some ethical concerns on the use of crypto. By some estimates, 2.3 percent of all U.S. electricity is used to mine Bitcoin. Further, Bitcoin ransomware attack payments hit a record $1 billion last year while Russian military companies use crypto to avoid sanctions. Hougan countered that the internet is often used for fraud but we don’t want to outlaw the web.

Other risks include regulatory actions and the fact that owning crypto increases IRS audit risk.

I concluded that, though there are incredible decentralized uses of blockchain technology, this valuable technology should not be confused with Bitcoin or any single cryptocurrency. My position is a soft no to crypto meaning that, if the client requests it, I’m okay with an allocation up to two percent, which is consistent with my longstanding view that it’s okay to have a little fun with a gambling portfolio. Hougan and I both agreed that one must be able to ride out the inevitable plunges in these very volatile crypto currencies. Investors often say they will ride out a plunge only to sell when the plunge actually occurs.

Conclusion

The audience voted overwhelmingly that they were more likely to use crypto after the debate. Matt’s arguments were persuasive, as I knew they would be. He wasn’t arguing that crypto would replace fiat currencies nor that it should be a very large part of an overall portfolio. The Bitcoin price set an all-time high the day of the debate. Hougan, gracious in victory, wrote me “Your arguments were extremely strong. We just had a biased audience :).”

In the end, Hougan and I weren’t that far apart. We both believe the vast majority of the portfolio should be invested in good old capitalism such as stocks and bonds, and we both believe in low-cost diversified funds such as index funds. Hougan was a co-founder of what’s now ETF.com. And, if I were sure Bitcoin would eventually be worthless, I’d cash in my $3,200 fun money and take the win.

The mere mention of cryptocurrencies, especially Bitcoin, seems to bring strong emotional responses from investors. Irrespective of your position on crypto, try to show your clients more logic-based arguments covering both the pros and cons of this new asset class.

Author’s note: Matt Hougan reviewed a draft, and I incorporated all of his valuable comments.

Allan Roth is the founder of Wealth Logic, LLC, a Colorado-based fee-only registered investment advisory firm. He has been working in the investment world of corporate finance for over 25 years. Allan has served as corporate finance officer of two multi-billion-dollar companies and has consulted with many others while at McKinsey & Company.

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