Founders' Perspective: Crypto as an Asset Class, or Why Not 100% Bitcoin?

Feb 22, 2024

Why Not 100% Bitcoin?

As quants, we at Truvius are trained to identify fundamental value, construct and deploy high-capacity portfolios of diversified assets that exploit relative differences in value in a systematic way, and communicate portfolio attribution and behavior to clients.

Underlying that investment process is a foundation of financial theory—a longstanding academic field of research and real-world implementation by asset managers—that, among other basic investment principles, shows that diversification is not only good, but improves expected returns per unit of risk.

Unfortunately, the crypto space—including many existing SMA platforms—currently seems to be overlooking this principle.

A timely new post from our founding team’s professional alma mater, AQR, provides a direct “TradFi” equivalent to the problem of under-diversification. In a recent post, AQR co-founder and CIO Cliff Asness rebuffs a recent paper that effectively poses the question, “Why not 100% equities?” In the post, he recounts certain tenets of introductory financial theory, largely amounting to “owning one asset is suboptimal”:

“We (academics, practitioners, anyone who’s taken a cursory look at modern finance) prefer a diversified portfolio because we believe it has a higher return for the risk taken, not a higher expected return…

… In finance 101 we are taught that in general we should separate the choice of 1) what is the best return-for-risk portfolio?, and 2) what risk we should take? This new paper, and many like it, confuse the two. If the best return-for-risk portfolio doesn’t have enough expected return for you, then you lever it (within reason). If it has too much risk for you, you de-lever it with cash. Remarkably this has been shown to work… “

Asness harkens back to the basics of modern portfolio theory to show that you can own a single asset, but don’t expect that one asset to outperform a portfolio of diversified (i.e. not perfectly correlated) assets on a risk-adjusted basis. (And if the diversified portfolio has a lower expected return vs. the single asset, lever the portfolio, don’t concentrate in a single asset.)

“100% equities”-style thinking tends to resurface during bull markets, and it’s not the first time Asness has done battle with it.

Crypto investors should ask themselves a similar question: why not 100% Bitcoin?

Given Bitcoin’s outsized media attention, market commentators often still equate “crypto” with “Bitcoin,” driving tentpole narratives around a single BTC-focused idea or event (ETF approval, April supply halvening, etc.) and breezing past the expansive use-cases of numerous other digital assets that together comprise a diversifying and innovative asset class supported by fundamental blockchain value.

While the regulatory approval and institutional offering of vehicles for exposure to Bitcoin like spot ETFs may be an important first step toward broad-based investor adoption, a conspicuous industry departure from the golden rule of diversification has emerged—a departure that could stall serious longer-term efforts toward TradFi adoption of crypto.

Asness offers a reminder for equity investors to separate the question of “What is my desired level of risk?” from “What’s the best way to achieve that risk?” For some crypto investors, this reminder may be a first-time consideration:

“…this article focuses on whether 100% equities is the best way to gain more exposure to risk. The answer, generally, is that it is not, because a portfolio of 100% equities ignores the benefits of diversification … A diversified portfolio historically delivers more return, while not increasing risk…”

Equity markets have repeatedly shown that owning a single asset delivers worse risk-adjusted returns over the long-term compared to a portfolio of diversified assets. Does the same hold true for crypto?

Buying the Haystack

Investing legend (and noted crypto cynic) John Bogle once penned, “Don't look for the needle in the haystack. Just buy the haystack!”

His point was more about the merits of passive versus active investing, but we borrow it here to support the efficacy of asset diversification.

Below we examine four crypto portfolios going back to 2018[1]: Bitcoin Only and Ethereum Only (no diversification), an equal-weighted allocation to Bitcoin and Ethereum (a little diversification), and a passively weighted portfolio of the Top 10 assets in any given month (better diversification).[2] The bottom line: diversification matters for crypto.

The Bitcoin Only and Ethereum Only portfolios produced similar annualized returns of about ~24%, but the Ethereum Only portfolio exhibited higher volatility, resulting in worse risk-adjusted performance compared to Bitcoin. Annualized returns of this magnitude may satisfy “Bitcoin Bulls” and “Ethereum Maximalists,” but could investors construct more efficient portfolios? Yes.

By combining Bitcoin and Ethereum and constructing a simple equal-weighted basket of the two assets, we observe improved risk-adjusted returns. Compared to the Bitcoin Only portfolio, the annualized risk increases somewhat (about 1.1x that of Bitcoin Only), but the increase in return (about 1.5x that of Bitcoin Only) is greater than the increase in volatility, resulting in superior risk-adjusted performance. If this slight increase in volatility wasn’t acceptable to an investor, the investor could hold some cash in the equal-weighted BTC-ETH portfolio to bring volatility in line with Bitcoin while still achieving better returns. This portfolio looks even better compared to Ethereum Only: volatility falls and return increases.

Adding more assets to the portfolio improved risk-adjusted returns even further. With a passively weighted portfolio of the top 10 assets by circulating market capitalization, annualized volatility effectively remained constant compared to the equal-weighted BTC-ETH portfolio while annualized returns increased meaningfully, raising the annualized Sharpe ratio again to 0.45.

Gaining exposure to a variety of crypto assets representing differentiated fundamental values and return sources improved the overall portfolio.

Despite crypto’s brief and volatile history, early figures suggest an outcome that traditional markets have repeatedly shown: owning a single asset delivers worse risk-adjusted returns over the long-term compared to a portfolio of diversified assets.

Diversify. Systematize. Repeat.

If digital asset managers want traditional money managers to add crypto as an asset class alongside equity and fixed income allocations, crypto needs to be treated like an asset class. Nearsighted marketing-driven narratives endorsing a single asset do not comport with basic financial theory and tend to crumble under bear markets.

Quantitative digital asset research lives at the heart of Truvius and plays a critical differentiating role for our investment products. Below we recap some of our research-related materials that showcase the power of diversification and our systematic approach toward digital asset allocation:

Beyond Bitcoin and Ethereum: Investing in the Full Fundamental Value of Digital Assets

Exploring fundamental value and a multi-sector digital asset allocation for investors.

What Correlations Tell Us About the Value of Multi-Asset Crypto Portfolios

Investors who limit their exposure to a small concentration of mega-cap assets may not capture the full value proposition of digital assets in their portfolios.

Truvius Product Learning Series

We present deep-dives on our three portfolio types: Market, Smart Beta, and Alpha.

Crypto 2024 Outlook by Truvius

We provide our view of crypto markets, upcoming catalysts, and institutional investor perspective for 2024.  

[1] While Bitcoin dates back to 2009, many other crypto assets emerged during the 2017-18 ICO Boom. We use 2018 as an approximate start date for this analysis.

[2] See the Data and Disclosures section for portfolio methodology.

Data Disclosures and Disclaimer

Data is for the period 1/1/18 - 2/21/24. Pricing data shown above for illustrative portfolios are sourced from Santiment, Messari, and Token Terminal.

The portfolios shown herein represent hypothetical backtests and do not represent live, currently investable products. The universe of assets for the backtested equal-weighted BTC-ETH and Top 10 portfolios include only tradable assets, excluding meme tokens, stablecoins, and wrapped/pegged tokens. These backtests are rebalanced monthly and are gross of both fees and t-costs. The Top 10 portfolio herein is weighted by the square root of circulating market capitalization. Past performance does not guarantee future results.

This Truvius commentary has been prepared by Truvius (the “Company”) solely for informational purposes and should not be construed as legal, business, tax, regulatory, accounting, investment or other advice. The information contained herein does not purport to be all-inclusive or to contain all of the information a reader or prospective or existing investor may desire. In all cases, readers and interested parties should conduct their own investigation and analysis of the Company, its products, and the data set forth in this information. The Company makes no representation or warranty as to the accuracy or completeness of this information or its construction and shall not have any liability for any representations (expressed or implied) regarding data or information contained in, or for any omissions from, this information. This Information includes certain statements, backtested data, and estimates provided by the Company with respect to the historical performance of the Company, its products, and other asset classes described above. Such statements, backtested data, estimates, and projections reflect various assumptions by management, which assumptions may or may not be correct. No representations are made as to the accuracy of such statements, backtested data, estimates or projections. Inevitably, some assumptions will not materialize, and unanticipated events and circumstances may affect the ultimate financial results of the Company and its hypothetical products. Projections are inherently subject to substantial and numerous uncertainties and to a wide variety of significant business, economic and competitive risks, and the assumptions underlying the projections or expected performance of products may be inaccurate in any material respect. The Company's and its products’ actual future results may differ materially from those suggested by both simulated historical and forward-looking statements, depending on various factors including those described in this material or any other written or oral communications transmitted by the Company. Neither the U.S. Securities and Exchange Commission nor any U.S. state or non-U.S. securities commission has reviewed or passed upon the accuracy or adequacy of this Truvius commentary. Any representation to the contrary is unlawful.

Connor Farley