Nakamoto Meets Markowitz: Analyzing Bitcoin In the Context of Modern Portfolio Theory

Abstract

Bitcoin is a digital currency that relies on a decentralized peer-to-peer network to confirm transactions and store funds and is not backed by any central bank or government. While still in its infancy,Bitcoin is becoming more relevant in the financial sphere as seen with the introduction of Bitcoin futures by the CME and CBOE. Using weekly return data over the 2010-2018 period, I analyze a bitcoin investment from the standpoint of a U.S. investor with a well-diversified portfolio including both traditional and alternative assets. Over the time-frame of the study, a Bitcoin investment had exceptionally high average returns and volatility. Interestingly, Bitcoin also exhibited remarkably low correlations with traditional (equity, fixed income, hard currencies) as well as alternative (real estate, private equity, commodities) asset classes. My results indicate that including a Bitcoin investment in an otherwise efficient portfolio has a positive impact on both absolute returns and risk and thereby a tremendous impact on the portfolio’s risk-adjusted returns