How Bitcoin, Tether and Other Cryptocurrencies Stack Up as Investments

The crypto fever has quieted down, but the roller-coaster trading has raised the stakes for investors to figure it out.

Are they financial assets, currencies, commodities or something entirely new? Bitcoin and other cryptocurrencies have defied easy categorization since they burst into the public consciousness last year, fueling an intense debate over how they should fit into the average investor’s portfolio—and whether they belong at all.

However you define them, cryptocurrencies have become hard to ignore since Bitcoin’s meteoric rise to $20,000 last December (as of May 2, it’s now $9,145 after a recent selloff). While past performance is of course no guarantee of future results, we’ve analyzed the last 16 months of action in digital tokens to shed light on what to expect if—as crypto diehards say—you decide to HODL (hold) despite the FUD (fear, uncertainty and doubt).

Wild Swings in Value

This won’t come as a surprise to anyone following Bitcoin’s wild swings, but volatility and virtual currencies go hand in hand. That can be a good thing when values are rising (It hit $10,000! Now $20,000!). But it’s scary when markets are going south, one reason why investors tend to demand higher returns from more volatile asset classes.




This is the whole universe

of assets, located by their

average daily return

and volatility.

This is the whole universe

of assets, located by their

average daily return

and volatility.

This is the whole universe

of assets, located by their

average daily return

and volatility.


Over the past 16 months, cryptocurrencies have recorded bigger swings than stocks, bonds, commodities and traditional currencies. The few non-crypto investments that are as rocky as most tokens included shares of Steinhoff International Holdings NV, the South African company embroiled in an accounting scandal, and bonds issued by Bank Otkritie FC, the recipient of Russia’s biggest-ever financial bailout.

Extreme volatility is perhaps the biggest argument against treating cryptocurrencies as you would the dollar or the euro. One of the cardinal rules for a good currency is that it should provide users with a stable store of value. You wouldn’t want to spend Bitcoin on groceries today if you thought the cryptocurrency’s value might soar tomorrow, or take your salary in Bitcoin if you thought it might plunge.

Bitcoin Towers Above Its Peers

Compared to stocks or bonds, trading activity and market capitalization among cryptocurrencies are very concentrated within a small group of players. While Bitcoin has become less of an outlier in recent months amid the rise of so-called alt-coins like EOS and Litecoin, the original still towers above its peers.

Among the most traded stocks, market values are relatively evenly distributed

In contrast, Bitcoin dominates the crypto market, both in terms of trading volume and market value. Liquidity dwindles sharply for smaller coins

One takeaway for investors is that selling lesser-known cryptocurrencies may be more difficult than it appears. Buying these smaller tokens should be thought of as like early-stage venture capital investing, which often involves holding an investment for a long time, according to David Drake, founder of multi-family office LDJ Capital, which invests in cryptocurrencies.

How Assets Affect Each Other

Money managers can anticipate how moves in one market will affect prices in another because most stocks, bonds, commodities and currencies have established relationships. Investing in a portfolio of assets that behave in different ways can help to reduce the risk investors face.
In the following grid, which is organized by asset class, each tiny square represents the relationship between two investments. Some investments (e.g. U.S. and European stocks) share characteristics that mean they tend to rise and fall together




, whereas risky assets (emerging-market bonds) and safe havens (gold, the yen) usually move in opposite directions




. Some assets simply have no correlation with each other.

Investing in a portfolio of assets that behave in different ways can help to reduce the risk investors face.





Cryptocurrencies have very weak

correlations with other asset classes

Cryptocurrencies tend to move together

Safe-haven currencies, silver and gold

tend to rise when returns on stocks fall

Unlike other asset classes, commodities

are not correlated among themselves

Equities and bonds move in different

directions

Cryptocurrencies have very weak

correlations with other asset classes

Cryptocurrencies tend to move together

Safe-haven currencies, silver

and gold tend to rise when returns

on stocks fall

Unlike other asset classes, commodities

are not correlated among themselves

Equities and bonds move in different

directions

Cryptocurrencies have very weak correlations with other asset classes

Safe-haven currencies, silver and gold tend to rise when returns on stocks fall

Cryptocurrencies tend to move together

Equities and bonds move in different directions

Unlike other asset classes, commodities are not correlated among themselves


Cryptocurrencies have weak relationships with established asset classes, which can be good or bad depending on what role you want them to play in your portfolio. This could change if more institutional investors such as banks and hedge funds start buying digital tokens, but for now cryptocurrencies mostly just move in line with each other.

That said, there’s a lot more activity in this space than a year ago, even though some newer investors have fled.

“Anything that’s a $400 billion asset will not be ignored for long,” Dan Morehead, chief executive officer of $1 billion cryptocurrency hedge fund Pantera Capital Management LP, told Bloomberg TV last week.

Getting In First

It’s a time-tested stock-market strategy: snapping up a company’s shares in its initial public offering in the hope of earning quick gains once the shares start trading. In an initial coin offering, where digital tokens are on offer rather than shares, a similar dynamic plays out. CoinDesk estimates ICOs have raised nearly $13 billion for blockchain-related startups.

IPO returns over the first 90 days

ICO returns over the first 90 days

Note: Data is shown on a logarithmic scale: the distance from 10 to 100 is the same as the distance from 1 to 10, whereas in a linear scale the distance would be ten times as great. See real scale

While the quality of ICOs varies wildly and the range of returns has been much wider than for technology IPOs, a majority of the larger coins have delivered attractive short-term gains. How long that will last is anyone’s guess as governments around the world step up scrutiny of the offerings.

It’s important to remember that, as in any market, the historical performance of cryptocurrencies is at best a rough guide to what the future holds. As regulators start to pay more attention and the hype surrounding Bitcoin and its ilk fades, it may very well be that the recent selloff is a harbinger of tougher times to come. Or maybe it’s just a blip before the next big leg up. Either way, investors should tread carefully.

Crypto Destroyer

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