Modern Portfolio Theory: The Case for Allocating to Bitcoin

It’s rare that an entirely new asset class is born. Yet, through a combination of cryptography, monetary theory, economics, and network theory, Bitcoin has emerged and developed an entire asset class of Digital Assets unlike any other. As Bitcoin and Digital Assets transform our global financial infrastructure and challenge Modern Monetary Theory, we believe Bitcoin offers one of the most exciting investment opportunities of the 21st century.


At Digital Asset Investment Management (DAiM), we believe in Bitcoin's power as non-sovereign, hard-capped fixed supply, decentralized form of money and its potential to capture a share of some of the largest markets in the world (Store-of-Value, Money) while improving the efficiency and accessibility of our global financial system


New asset classes are powerful because they offer a unique return stream that can provide a diversification benefit. As the only licensed RIA for Bitcoin and Digital Assets(that we are aware of), we work with both retail and HWNI individuals, Wealth Managers/Financial Advisors, and retirement plans to achieve this benefit in a compliant way. Additionally, we believe having access to Bitcoin offers a unique investment opportunity that most investors can not get anywhere else. In this post, we will demonstrate how Bitcoin, as a brand-new asset class can enhance strategic asset allocation and help investors build portfolios with higher risk-adjusted returns.


Investment Case # 1: Modern Portfolio Theory - Diversification benefits and Higher Risk-Adjusted Returns


Consistent with Modern Portfolio Theory, we generally subscribe to the notion the optimal return-to-risk ratio for a portfolio can be found on the efficient frontier. New asset classes are powerful because they offer a unique return stream that can provide a diversification benefit. In the below analysis we will show how Bitcoin offers considerable diversification benefits that can enhance strategic asset allocation and help investors build portfolios with higher risk-adjusted returns.


Large Endowment Model Portfolio (based on David Swenson Yale) with Bitcoin

(May 2015 - May 2020)

Data Notes:

  1. David Swensen described his model portfolio in a 2015 interview with NPR, consisting of the above asset allocations. While we recognize that we can’t achieve perfect representation, the goal was to replicate the asset allocation mix with publicly available low-cost substitutes for modeling purposes.


Correlation


Despite its volatility, Bitcoin did not exhibit any significant correlation with other asset classes over the same period, with a median correlation coefficient with other asset classes below 0.20. Irrespective of the study period, Bitcoin remains uncorrelated with all other non-crypto financial instruments and asset classes. As illustrated in the chart below, Bitcoin has the lowest correlation compared to other asset classes.

Key Findings:


Looking at the results above, each portfolio strongly benefits from a small allocation to Bitcoin on both an absolute and risk-adjusted basis. The excess return, relative to the excess risk for just a 1% allocation to Bitcoin more than compensates investors for the slight increase in additional volatility while improving annual returns by 50%. Additionally, a 1% allocation to Bitcoin offers investors almost a 50% improvement in their Sharpe Ratio.


  • a 1% allocation to Bitcoin in the Large Endowment Model Portfolio:

  • increased annual returns by 277 bps, offering a 50% improvement in annual returns

  • Improved total return over 5yr period by over 14%, for an additional 47bps of risk.

  • Improved Sharpe Ratio over the same period by 50%

  • during the worst year, the portfolio WITHOUT any allocation performed almost the same as the portfolio with 1% allocation to Bitcoin. This includes the 75% Bitcoin drawdown in 2018, with the max drawdown between both portfolios being virtually the same as well

  • a 3% allocation to Bitcoin in the Large Endowment model portfolio over the same 5yr period would offer a considerably lower standard deviation of 12.18% vs the S&P average of 14.52% while offering returns of 13.46 vs 9.88% over the same time period

  • The most inefficient portfolios are all portfolios with ZERO allocation to Bitcoin


Given our understanding of portfolio theory, this is not all surprising. Since Bitcoin is uncorrelated with traditional assets over a multi-year basis, combining it with traditional multi-asset portfolios can enhance strategic asset allocation and help investors build portfolios with higher risk-adjusted returns. Based on the above analysis, it is our strong belief that zero exposure to Bitcoin at this point is the wrong allocation and at least a 1% allocation to Bitcoin is warranted.


Investment Case # 2: Store-of-Value/Digital Gold


Bitcoin is considered sound money because the supply of Bitcoin is fixed at 21mm units. This makes Bitcoin extremely scarce, relative to US Dollars, Euros, YEN and other fiat currencies which can be created out of thin air in infinite amounts. Because there’s a finite supply, once all of Bitcoin is issued, that’s all there ever will be available. The price of Bitcoin is not linked to the US dollar, rather it is a function of supply and demand.


New money comes into existence through stages: Collectible, Store of Value (SoV), Medium of Exchange (MoE), and Unit of Account(UoA), Full Global Money. When applying “The Szaboian Theory of Money Origins” to Bitcoin, it is reasonable to conclude we just barely left the "collectible phase" and are now witnessing it’s first steps into "Proto-money”. This phase, which is characterized by its primordial exploration of the SoV properties of the commodity, can easily take decades to properly mature. Price Volatility is part of this maturing process.


Paul Tudor Jones recently announced his investment in Bitcoin (BTC), saying it reminds him of gold in the 1970s. Bitcoin offers a similar thesis to gold, but is considered more portable, divisible, transactional, and scarce. The least attractive quality about Bitcoin is its established history which is a function of trust over time. Should Bitcoin capture just fractions of gold’s market cap, the implied prices would be much higher from here.


“So that was the flavor behind some of the discussions that were had when scoring the suitability of each asset as a store of value. What was surprising to me was not that Bitcoin came in last, but that it scored as high as it did. Bitcoin had an overall score nearly 60% of that of financial assets but has a market cap that is 1/1200th of that. It scores 66% of gold as a store of value but has a market cap that is 1/60th of gold’s outstanding value. Something appears wrong here and my guess is it's the price of Bitcoin. -Paul Tudor Jones

Investment Case # 3: Impact Themes Consistent with ESG Investing


Bitcoin satisfies multiple ESG themes including Economic Inclusion/Human Empowerment, Environmental Sustainability, and Governance. Access to finance that no single entity can stop is a radical change to finance as we knew it 10 years ago. Over 1.7 billion people globally are unbanked, lacking a bank account or credit card to partake in the tools and services that create economic sustainability. An additional 4 billion people live under authoritarian regimes. The creation of Bitcoin has sparked a revolution centered around individual empowerment and opting out of the traditional system. The Human Rights Foundation notes that “for individuals in closed societies, or for anyone facing hyperinflation, capital controls, sanctions, or financial surveillance, Bitcoin can be a tool of freedom.”


In terms of environmental sustainability, Bitcoin is often criticized for having a negative impact on the environment. However, that is anything but the case. Bitcoin mining is mainly located in global regions where there are ample supplies of renewable electricity available. A conservative estimate of the renewables penetration in the energy mix powering the Bitcoin mining network at 74.1%(see linked report), making Bitcoin mining more renewables-driven than almost every other large-scale industry in the world.


Pure Exposure to Bitcoin is the Investment


While there are many other cryptocurrencies and “blockchain solutions”, Bitcoin is still the most exciting project to watch in this space. The killer app of the Bitcoin blockchain is trustless, censorship-resistant, cost-efficient, reliable financial settlement at scale. Bitcoin is king because nothing else is competing with it for money. It is a tool not a promise and is already being used as censorship-resistance money around the world. Bitcoin can do anything any other cryptocurrency can do but it's intentional slower addition of new features aids in keeping stability and security.


Investing in Bitcoin directly rather than a fund and/or index of digital assets offers absolute, transparent and liquid exposure to the only digital asset with a clear use case. Investing in digital assets through funds employing an algorithmic strategy, high-frequency trading, or derivatives, heightens volatility, increases costs and complexes the investment that can often leave the investors underexposed during times when there are large breakout moves. Investing in Bitcoin does not need to be more exotic or over complicated. By investing in Bitcoin directly, you are gaining exposure to the most scarce monetary asset known, that many see complex in the simplest way possible. Owning Bitcoin directly is the best way to get off zero and get exposure to this new and exciting asset class.


We are making the case for allocating 1% of client assets to Bitcoin using DAiM


At Digital Asset Investment Management (DAiM), we believe in Bitcoin's potential to capture a share of some of the largest markets in the world (e.g., Money, Store-of-Value) and to improve the efficiency and accessibility of our global financial system. This is why we’ve built the first Registered Investment Advisor properly licensed to manage and advise for Bitcoin and Digital Assets. While it’s still early in the adoption process for Bitcoin and Digital Assets, there is a compelling case for investors to allocate a small portion of their portfolio to Bitcoin for diversification purposes and to achieve higher risk-adjusted returns.


If you are interested in opening a brokerage and/or qualified retirement account(401k, Traditional IRA, Roth IRA, SEP,)


If you are a Wealth Manager or Financial Advisor, DAiM wants to partner with you


As a licensed and regulator vetted Investment Manager, DAiM can offer Wealth Managers a regulated and direct way to allocate Bitcoin to client portfolios in two ways:


As your Sub Advisor:

  • DAiM works for you, the advisor. Our relationship and contract is with you the advisor while the client retains its relationship with you.

  • Performance is net of our flat mgmt fee

  • Your ADV Fee will need fee-sharing language. Both you and DAiM count AUM

  • You have ongoing due diligence and monitoring requirements, monthly statements

  • DAiM sets up SMA’s for custody, KYC/AML, account type (cash or qualified). DAiM makes the investments, handles trading and clears the trades

As your TPAM:

  • The contract with the client is direct with DAiM

  • Fees are paid to DAiM, DAiM shares the fees associated with each client with you

  • AUM for digital assets only counts for DAiM. You review the initial contract and monitoring the services are being delivered


Through our license and our process and procedures, we can fulfill your due diligence process. This will be done through a separately managed account that will allow your organization to get long Bitcoin directly with secure and transparent Institutional Cold Storage Custody.


We are:

  • Properly licensed and regulated- our operational process and partners have been vetted by regulators

  • Only working with other licensed and regulated counterparties. This ensures proper compliance and accountability

  • Developed a secure way to custody Bitcoin while never taking control of client assets

  • Not a hedge fund. We charge a flat fee to manage and advise, do not charge for performance nor add any hidden fees or fund expenses

  • Custody - $200MM in total insurance coverage dedicated for Gemini Custody. Insurance brokered by Marsh LLC. Gemini has successfully completed a SOC 2 Type 1 and Type 2 and SOC 1 Type 1 examination by Deloitte & Touche.

For more information please contact Bryan Courchesne at bc@daim.io or Adam Pokornicky at adam@daim.io Both of us can be reached at 949.298.7582.



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