What Does the Research Say about Crypto Investments?
Though cryptocurrency is a relatively new investment option for the public compared to other assets, many people have already made up their minds that it’s too unstable to be part of a long-term investment strategy. However, many institutions and governments are beginning to integrate cryptocurrency into their financial spheres, particularly Bitcoin. The adoption of Bitcoin as an accepted currency in El Salvador in 2021 was only one such example. New York City’s mayor-elect, Eric Adams, recently announced his intention to take his first three paychecks entirely in Bitcoin.
Many universities and financial research firms are actually studying cryptocurrency quite closely, including some of the most respected institutions in the world.
Those who are hesitant about cryptocurrency often think that not enough is known about it to feel confident about its power in a market, but many universities and financial research firms are actually studying cryptocurrency quite closely, including some of the most respected institutions in the world.
Who’s Studying Crypto?
Top universities like Harvard, Princeton, and Yale all have extensive coursework related to cryptocurrency and blockchain technology. Stanford even has an entire Center for Blockchain Research, and MIT has a Digital Currency Initiate. Many major private financial research firms are looking into cryptocurrency as well. Because the world’s leading institutions are investing resources into researching cryptocurrency and blockchain tech, it’s clear that cryptocurrency is worthy of serious consideration.
In the past few years, institutions such as Yale University’s National Bureau of Economic Research (NBER), FTSE Russell (a subsidiary of London Stock Exchange Group), Western Sydney University’s school of business, and many others have taken deep-dives into the financial performance and potential of cryptocurrency to find out its place in a portfolio.
In the past few years, institutions such as Yale University’s National Bureau of Economic Research (NBER), FTSE Russell (a subsidiary of London Stock Exchange Group), Western Sydney University’s school of business, and many others have taken deep-dives into the financial performance and potential of cryptocurrency to find out its place in a portfolio. By examining cryptocurrencies such as Bitcoin, Ethereum, and Ripple, these institutions theorize that while crypto certainly has its drawbacks, there’s an ideal amount for many investors that can optimize the benefits while bracing against excessively high levels of risk.
What are Researchers Finding?
One of the key points that research teams across multiple schools and institutions found was that fully diversifying a portfolio is an important way to safeguard a crypto investment long-term. This fits into conventional wisdom about other investment types as well: the more diverse types of assets a portfolio contains, the less likely the investor will be to experience catastrophic losses if one asset or industry struggles. In the world of finance, the old saying “don’t put all your eggs in one basket” holds especially true.
The more diverse types of assets a portfolio contains, the less likely the investor will be to experience catastrophic losses if one asset or industry struggles.
While all three institutions examined here recommended portfolio diversification as a key strategy, the teams took different approaches to finding this data, and focused on different aspects of market performance and investor activity.
Yale
According to the National Bureau of Economic Research at Yale University in their report, “Risks and Returns of Cryptocurrency,” the sweet spot for the amount of crypto that most investors should aim for is between 1% and 6.1% of their portfolio. This relatively low amount of the total leaves the rest of the portfolio to be distributed among other types of conventional assets that typically maintain more stability.
Relatively small amounts of crypto, however, can give investors the potential to see large returns without risking it all on a deregulated market. The NBER team found that when cryptos are performing well, returns are typically higher among crypto assets than traditional ones. Not surprisingly, they discovered that the standard deviations are particularly high for cryptocurrencies.
Yale’s researchers found that Bitcoin’s market performance has a standard deviation of 16.64, which is, to quote from their report, “an order of magnitude higher than those for the traditional asset classes.”
Put simply, the term “standard deviation” is a statistical measure that describes how far data points tend to vary from the average. A low standard deviation means that most data points are clustered somewhere near the average, whereas a higher standard deviation indicates a more spread out data set. Yale’s researchers found that Bitcoin’s market performance has a standard deviation of 16.64, which is, to quote from their report, “an order of magnitude higher than those for the traditional asset classes.” Researchers determined this by comparing the highs and lows in the crypto market to the stock market, and found much higher peaks and valleys among crypto than traditional assets.
Their key finding about the relationship between these markets was that the stock market does not seem to work in tandem with the crypto market, and factors that influence peaks and valleys in one may not affect the other. By comparing crypto and stocks within the same time frame, and during the same events and general economic trends, the team found no strong correlation between how the two markets performed. So, crypto may be soaring while most stocks are slumping, and vice versa.
An especially interesting point researchers uncovered is that cryptocurrency is particularly affected by social media trends. In a recent example, when Elon Musk tweeted that he wanted to grow his fortune using the meme currency Dogecoin in October of 2021, its prices skyrocketed, while the stock market was largely unaffected.
FTSE Russell
FTSE Russell is an organization that analyzes markets. They are a subsidiary of London Stock Exchange Group, and they employ top academics and analysts to investigate market conditions and the factors that influence them.
FTSE Russell's investigation into portfolio optimization through crypto yielded promising results that greatly support those of Yale.
Recently, a report by Martin Howard for FTSE Russell described the methods used to determine what could be done to mitigate the risk levels of Bitcoin specifically. Bitcoin has historically been known as a volatile asset. The average 12-month rolling volatility level of Bitcoin during the study was around 71%, and the market even saw loss levels as large as 83%.
However, this same research indicates the potential for very high returns. The report indicates that investors who are reasonably comfortable with risk, but who maintain a goal of protecting the majority of the portfolio through low-risk assets, may find Bitcoin a useful asset. Evaluating the safety and ideal numbers for crypto investments required a combination of mathematical calculations and market trend evaluations. In their trials, the team found that increasing the allotment of Bitcoin in a portfolio from 2.5% to 5% resulted in an excess return that rose from 3.2% to 6.4%.
Their investigation into portfolio optimization through crypto yielded promising results that greatly support those of Yale. Both institutions seem to indicate that the range of 1-5% of the portfolio is the optimal allotment of crypto for most investors who are somewhat risk-tolerant and comfortable with digital assets.
WSU School of Business
A study published in the Journal of Risk and Financial Management indicates that researchers at Western Sydney University’s school of business came to similar conclusions as the researchers at Yale and FTSE Russell. This team acknowledges the need for further research into this area, but notes that Bitcoin “could act as a diversifier in normal market conditions, and it might also have some borderline hedge to safe haven properties.”
The team notes that in every model, the portfolios that had some amount of Bitcoin as an asset had higher performance attributes than the portfolios without it.
One essential point that this research team stresses is that the appropriate amount of cryptocurrency in a portfolio is different from one investor to the other. According to them, one of the key factors that influences the percentage of cryptocurrency an investor should consider is their comfort with risk. Though no investment is free from risk, there are investment types that are typically more stable than cryptocurrency, such as mutual funds and bonds, and this makes crypto intimidating to many investors.
The research team at WSU found that risk-averse investors should largely steer clear of investing in cryptocurrency, or should cap their investments at a small percentage of their portfolio. Risk-tolerant investors, however, can feel confident diverting a larger percentage of their portfolio, which may have the potential for higher gains, but higher losses on those portions of their portfolios as well.
The team notes that in every model, the portfolios that had some amount of Bitcoin as an asset had higher performance attributes than the portfolios without it. However, it is important to remember that, as with the studies done at other institutions, the percentages of portfolio assets moved into Bitcoin in these trials were relatively small, with 10% being the highest.
What are these Institutions Doing?
It’s easy to see why blockchain and crypto are compelling points of study. Cutting edge technology and socioeconomic trends are always of interest from a research standpoint. But one vital indicator of the potential value of cryptocurrency as an investment is the fact that the institutions who are researching it are also buying it.
If the top institutions in the world are not only studying it, but buying it, it seems that cryptocurrency has its place in a well-rounded investment strategy.
In 2021, it was revealed that several large investment firms connected with major universities had been quietly diverting a portion of their assets to cryptocurrency for a few years. Included on this list are Harvard, Yale, Brown, and others. If the top institutions in the world are not only studying it, but buying it, it seems that cryptocurrency has its place in a well-rounded investment strategy.
New Avenues for Diversifying with Crypto
As more institutions, platforms, and everyday users adopt cryptocurrency, the technology and products that support cryptocurrency are changing to meet investors’ needs. Apps like Coinbase now allow investors to easily maintain direct control over their crypto wallets using their smartphones. In addition, some companies are debuting products that harness cryptocurrency with safeguards in place to bolster against high risk and position crypto as a long-term investment.
With initial contributions capped at 5% of the portfolio balance, and 5% of ongoing contributions, the Alt401(k) follows the findings of the academic research.
For instance, in 2021, ForUsAll announced the upcoming launch of the Alt401(k), the first ever 401(k) that allows participants to designate a portion of their retirement savings to cryptocurrencies. With initial contributions capped at 5% of the portfolio balance, and 5% of ongoing contributions, the Alt401(k) follows the findings of the academic research. The 5% cap keeps investors from placing what researchers might deem “too much” of their retirement savings into cryptocurrency, while still allowing risk-tolerant investors to further diversify using this avenue. As long as investors diversify their holdings and invest wisely, while staying within their comfort zone regarding risk levels, cryptocurrency can be a beneficial asset in a well-rounded portfolio.
