7 min readInvestors typically turn to asset classes that are considered ‘stores of value’ during periods of high inflation and global instability. Gold, given its longevity, is traditionally their first choice. However, bitcoin is challenging gold’s status as the ultimate store of value because it shares many of the same characteristics, some of which mean it could be even more effective.
This article explores the similarities between bitcoin and gold before explaining how bitcoin could enhance returns in a balanced portfolio.
Gold’s Traditional Role vs. Bitcoin’s Emergence
The earliest documented example of gold’s role as a commodity was around 5,000 years ago when the Egyptians started creating jewellery and other decorations with it. Its first use as a medium of exchange came several thousand years later when the Lydians, whose kingdom was located in western Turkey, minted the first gold coins in 564 BC. It has maintained its status as a key cog in the global financial system since, such as when countries linked their currency to its value. The gold standard, as this monetary tool became known, was originally adopted by the UK in the early 1800s and, despite occasional suspensions, was widely employed until the US terminated it in 1971.
Gold has earned a reputation as a store of value, meaning it retains its value over time, because of several qualities:
Scarcity- according to the World Gold Council, just over 210,000 tonnes have been mined, with another 59,000 tonnes still underground.
Divisibility- gold can be split into smaller pieces
Portability- it’s relatively easy to carry (in small quantities)
Durability- gold survives for thousands of years without degrading
Gold serves various roles in an investor’s portfolio, primarily as a hedge against inflation because it retains its purchasing power. When prices rise, a currency loses its purchasing power because customers buy fewer goods for the same amount of money, but gold tends to maintain or increase its value. For instance, when EU inflation rose from just less than 1% in January 2021 to 10.6% in October 2022, gold rose by around 13%. It also offers a safe haven that investors turn to in times of geopolitical or economic instability and helps to diversify a portfolio, a strategy covered in the next section.
Bitcoin’s history as an asset class is much shorter. Pseudonymous founder Satoshi Nakamoto published a whitepaper proposing the idea of a digital currency in 2008, and the genesis block, the first batch of transactions, was mined in January 2009.
While bitcoin launched as a medium of exchange, it has become recognised as a store of value, or ‘digital gold’, even though it may seem to have little in common with the precious metal. Firstly, Satoshi limited the total supply of bitcoin to 21 million. 94,14% are already in circulation (as of 16th October 2024), with the final coins expected to be mined by 2140. Bitcoin is also durable thanks to the decentralised nature of the blockchain technology underpinning it. The network’s uptime since 2009 stands at 99.9%, with the last outage occurring in 2013. Finally, it's easily divisible- the smallest denomination, a Satoshi, represents 100 millionth of a bitcoin- and portable because holders can store it in a digital wallet.
Bitcoin’s place in a balanced portfolio
Diversification is an investment strategy that involves spreading capital across different asset classes, such as shares, bonds, cash and crypto, although it can also apply to different global regions and industries. The aim is to minimise the impact of an underperforming holding on a portfolio’s overall returns.
Correlation is a key concept when building a diversified portfolio because it measures the degree to which two assets move in the same direction. Investors are increasingly seeking exposure to bitcoin because it’s typically uncorrelated with other asset classes. According to CoinShares, since 2019 bitcoin’s correlation with the S&P 500, an index of the 500 biggest companies listed on the US markets, is relatively low at 30%, which means they only move in the same direction around a third of the time. And despite bitcoin’s status as digital gold, its correlation with the physical precious metal is even lower at 19% since 2019.
How much bitcoin investors should hold depends on their risk appetite. Research by CoinShares, which included measuring the impact of different allocations on a portfolio’s volatility (the fluctuation of returns), suggests the optimal allocation ranges from 4% to 10%.
To demonstrate the effect bitcoin had on overall performance, CoinShares has been tracking five model portfolios since 2017:
A standard allocation of 60% shares and 40% bonds
A standard allocation with a 4% bitcoin holding
Ray Dalio’s All Weather Portfolio, replacing gold’s 7.5% allocation with bitcoin
Dylan Grice’s Cockroach portfolio, replacing gold’s 7% allocation with bitcoin
The Yale Endowment investment strategy (which doesn’t hold gold), replacing the 7% allocation to real estate investment trusts with bitcoin
As the results below (as of 15th October 2024) illustrate, adding bitcoin to any of these portfolios enhanced returns, while having a limited impact on maximum drawdown (the biggest single drop in the value of a portfolio) and volatility. It also significantly improved diversification, as shown by the lower correlation (compared with the standard allocation).
Sometimes, a holding can outperform, distorting the portfolio’s asset allocation and increasing its risk profile. For instance, if a particular share rallies, it could skew the allocation in a standard portfolio to 70% shares and 30% bonds. When this happens, investors need to implement a risk management strategy known as rebalancing, which involves buying or selling holdings to revert to the original allocation.
Learn more about rebalancing.
Conclusion
Bitcoin has established a reputation as a store of value because it’s scarce, divisible, portable and durable. As a result, it could serve the same purpose as gold in a portfolio: as a hedge against inflation, a safe haven during geopolitical or economic instability and a source of diversification.
Building a diversified portfolio involves investing in different asset classes, and in some cases, different countries and industries. Bitcoin has been an effective source of diversification because it’s uncorrelated with other risky assets like shares. Research by CoinShares shows that allocating between 4% and 10% to bitcoin since 2015 has improved the performance and diversification of standard portfolios while having a limited impact on maximum drawdown and volatility.