Do You Want To Hop On To The Crypto Bandwagon?

Do You Want To Hop On To The Crypto  Bandwagon?

A New Asset Class

There is a certain amount of mystery and curiosity about Bitcoin, more so because the New York Stock Exchange has now introduced a Bitcoin-linked ETF. With an increasing number of investors looking at crypto currency with interest, it is time to take a deeper look and understand this new game

Crypto currency is no doubt at the top of your mind given the media buzz that has surrounded it in recent times. October 2021 marked a milestone for investors around the world. On October 19, crypto currency hit the New York Stock Exchange with the introduc- tion of a new Bitcoin-linked fund. This new exchange-traded fund (ETF) is offered by ProShares and is the first of its kind anywhere in the world. The best part is that within two days of its launch, it reached assets of USD 1 billion. According to Bloomberg it has been the quickest ETF to touch this AUM.

A New Asset Class
If we look at the history of asset classes, there hardly has been any asset class created in the last 100 years. It has been the same old equity, debt, commodity, currency and real estate and art for some high-net-worth individuals that have been in existence for years. Nonetheless, the introduction of ETF based on Bitcoin has added a new asset class for investors even though Bitcoin, a crypto currency, is not a new phenomenon. It has been there for around 12 years, starting in the year 2009. However, the launch of the ETF has given it institutional backing and credence as an asset class.

An asset class is a grouping of investments that exhibit similar characteristics in terms of risk and returns and usually very little correlation and in some cases a negative correlation between different asset classes. This helps in the diversification of a portfolio. Now let us check if Bitcoin qualifies as an asset class. First, we check the correlation between Nifty 50 and CCIL Bond Broad TRI, which serve as performance benchmarks for the bond markets. The CCIL Bond Broad TRI consists of top 20 traded bonds and the index provides change due to both the price movement and accrued interest. The following graph shows the correlation between the price movement of Bitcoin against bonds and Nifty 50. We see there is very low correlation between Nifty 50 and Bitcoin. It is a mere 0.072 while with bonds it is negative, but we could not find it as statistically significant.

Now let us check the 12 -month rolling correlation between Bitcoin and other assets. Again, we see that there is very low co-relation between Bitcoin and other asset classes. The overall beta of Bitcoin against Nifty for the last seven years is 0.3, which means that these two assets do not move in tandem and hence Bitcoin can be used as an asset class. 

The Investment Dilemma
As the popularity of the Bitcoin increased, its price also soared along with rise in volatility. Looking at the very tempting returns by Bitcoin in the last few years, many investors will assume this as an obvious choice. Since the start of 2015, the price of Bitcoin denominated in USD has moved up from USD 315 to USD 50,480 as of December 8, 2021, which means a return of 160 times in a span of seven years and an annualised return of a whopping 108 per cent. This implies that your investment would have more than doubled every year. Contrary to this, Nifty 50 has also doubled itself but it took all the seven years to show such movement. The following graph shows the movement of different assets in log terms.

Adding Bitcoin to the Portfolio
Sometimes the most obvious choice may not be the best choice. In the case of Bitcoin, we saw it doubling every year; however, most of the rise has been since April 2020. Between December 2017 and December 2018, the price of Bitcoin slipped by more than 80 per cent. More recently, between the month of April 2021 and July 2021, its price dropped by 53 per cent. It recovered, however, but was still down by 25 per cent from its recent peak.

Therefore, adding Bitcoin to your portfolio can be a double- edged sword. On the one hand, when it is rising it can lift the return of your portfolio exponentially but when falling, even the best performance of other assets cannot make up the losses.

The following table shows the key risk and return stats of the key asset classes

Looking at the characteristics of this new asset class, we believe it would be prudent on the part of investments to simply avoid it. This is because investing in an asset class does not only require money but also the temperament. If your investment is down by 80 per cent and you can still remain unconcerned or continue to have sound sleep, well, you could look at this new asset class. Nevertheless, this investment should only be used by those who wish to diversify their portfolio and are comfort-able with higher daily volatility and most importantly, it should not exceed more than 5 per cent of the portfolio. In addition, do not forget to rebalance your portfolio at regular intervals.

If your investment value is down by 80 per cent and you can still remain unconcerned or continue to have sound sleep, well, you could look at this new asset class. Nevertheless, this investment should only be used by those who wish to diversify their portfolio and are comfortable with higher daily volatility

The Investment Method

If you want to plunge yourself into this new asset class, the following information will help you. The excitement for Bitcoin futures-based ETF has cooled off as is now reflected in the recent fall of the Bitcoin price. It is down by almost 30 per cent from its recent peak. For many investors waiting to invest in this digital asset, this fall gives them a good opportunity to invest. However, a lot of investors do not know how to start investing in them. It cannot be done via any Indian exchange and hence investors might need a US’ securities account for the same. As these ETFs are traded in the stock market, it can be safely assumed that one will only be able to buy through the brokerage account. This is just the way they trade in shares in the US stock market. You need to open a dematerialisation account with foreign brokers or brokers who deal in foreign stocks where they can purchase Bitcoin ETF.

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