Bitcoin traded at more than USD 100,000 for the first time in 2024, taking returns to about 120% for the year. We look at what factors investors should consider when deciding whether to hold Bitcoins or other cryptocurrencies in their portfolios.
Since its inception, Bitcoin and other cryptocurrencies have sparked debates among enthusiasts and critics about their nature and value. One view is that cryptocurrencies lack the characteristics of a fiat currency, even though they can serve as a medium of exchange. That view is often held by central banks. A debate moreover continues about whether cryptocurrencies qualify as financial assets, considering factors such as their ability to store value or their underlying utility.
Our view is that cryptocurrencies are investment vehicles as demonstrated by their increased use and capitalisation, but they are not assets or a store of value comparable to those we hold in our strategic asset allocations. Moreover, cryptocurrencies have volatilities and drawdowns (declines from price peaks over a given period) that are far larger than any other financial asset, which has implications in investment portfolios that we outline below. We therefore do not include cryptocurrencies in our asset allocations. Nevertheless, for investors who hold cryptocurrencies in their portfolios, we provide a rough guide on their portfolio effects to help them to manage the collateral effects of their outsized volatility and the losses that can occur in any holding period.
Cryptocurrencies are investment vehicles… but they are not assets or a store of value comparable to those we hold in our strategic asset allocations
Mining, halving, and market dynamics
A useful perspective for understanding cryptocurrencies is to examine how they are created, or ‘mined.’ A new Bitcoin is digitally ‘mined’ when a complex cryptographic puzzle is solved by ‘miners.’ This process allows miners to validate and record transactions on the network’s blockchain, for which they are rewarded with newly created Bitcoin and transaction fees. The market price of Bitcoin is determined by overall supply and demand, and influenced by factors including investor sentiment, adoption, technological developments, and macroeconomic conditions. This price is not directly linked to pending transactions on the network. Separately, transaction fees on the Bitcoin network (sometimes called ‘mining fees’) are influenced by the demand for transaction settlement and available mining capacity. When the demand for transactions exceeds the network’s processing capacity, these fees increase. Hence, when we think about cryptocurrencies, we think of digital settlement processes that create rewards, and have a monetary value that fluctuates as a function of demand and supply. An additional feature is that Bitcoin’s protocol caps the total supply at 21 million coins, creating scarcity. This scarcity is maintained through a supply-cutting process, which halves the rate of Bitcoin mining every 210,000 blocks. This typically happens every four years or so. The most recent halving occurred in April 2024. However, volatility around historic price trends since inception has been higher than any other financial asset, and regulation or market dynamics that definitively shift demand could halt any past trend.
A history of volatility
In late 2009, Bitcoin first traded at a price of USD 5.02 for 5,050 Bitcoins and was first used for a real-world transaction in 2010 when 10,000 Bitcoins were exchanged for two pizzas. The cryptocurrency has recorded numerous peaks, followed by declines of as much as 80%, before rebounding. As a result, the average annual return and volatility are extreme. The cryptocurrency has averaged annual realised returns of almost 170% since mid-2010 with 109% annual volatility. This far exceeds the volatility of traditional financial assets. The resulting Sharpe ratio, a measure of returns versus risk, is higher on average than for other financial assets. Correlations of Bitcoin to other assets are also very low. This said, what really sets Bitcoin apart is its extreme volatility, and outsized drawdowns, in comparison to other financial assets. As a result, even a small Bitcoin allocation of 2% can dramatically change a portfolio’s overall volatility, accounting for an equivalent of the volatility from all of a portfolio’s US equity market positions. Increasing a Bitcoin allocation to 5% of a ‘balanced’ portfolio completely changes its risk profile, raising volatility by one third. In the case of a 10% Bitcoin allocation, the overall volatility of the portfolio is multiplied around two times, and the cryptocurrency contributes two thirds of this risk. The profile is therefore changed entirely, bringing the portfolio closer to the risk of a growth strategy.
Even a small Bitcoin allocation of 2% can dramatically change a portfolio’s overall volatility
Energy intensity and other risks
As mining cryptocurrencies becomes more complex, the energy needed to create a coin increases. In the last five years, total electricity demand for crypto mining has risen ten times, and is currently estimated at more than 129 terawatt hours per year, almost one third more than Switzerland’s, according to auditor PwC. Around two-thirds of electricity used for Bitcoin mining in 2020-2021 was sourced from fossil fuels, the United Nations has found. Since sustainably sourced electricity is now cheaper than fossil fuel sources, the energy used in crypto mining may increasingly shift to green alternatives. But for now, the energy footprint remains unfavourable.
Other risks include the safety of cryptocurrency wallets and the use of cryptocurrencies for illicit or criminal activities. Europol, the EU’s law enforcement agency, reports that the illicit use of cryptocurrencies is predominantly associated with money laundering, the online trade of illicit goods and services, and fraud. The scale of cryptocurrencies’ unlawful use is uncertain. Estimates cited by Europol vary widely, from between 0.34% and 23% of all cryptocurrency transactions.
A supportive environment does not mean that volatility has evaporated and that risks have subsided
Outlook 2025
We do not forecast Bitcoin prices as we cannot monitor the factors driving the cryptocurrency’s value. We do however use technical analysis to watch its trends and momentum. With Bitcoin below the USD 100,000 barrier, the technical support levels for a falling Bitcoin price are at USD 88,740 and USD 78,705, corresponding to levels at which the market may stabilise. To the upside of USD 100,000, the next levels of technical resistance are at USD 102,145 and then USD 106,975. These are the thresholds at which we might expect the market to pause, testing the strength of demand versus supply as prices rise. Mr Trump’s election, and his appointments of cryptocurrency-supporters to key posts in his administration, may well lead to more supportive US institutional frameworks, and the wider use of cryptocurrencies for payments and settlements. Lower interest rates in 2025 will also likely support prices. However, a supportive environment does not mean that volatility has evaporated and that risks have subsided. Investors who decide to hold cryptocurrencies should in particular be suitably cautious about how much weight they give to them in their portfolios, given the potential that cryptocurrencies have to upset the balance of risk in any multi-asset portfolio.
CIO Office Viewpoint
Bitcoin: Handle with care
