5 Ways Bitcoin Can Play a Role in a Portfolio

Recently, a well-known bitcoin writer tweeted, “If your financial advisor hasn’t recommended bitcoin yet, fire them.” A tweet like this gets polarizing quickly. Right or wrong, there is greater nuance to the role of bitcoin in portfolios.

As a fiduciary, you cannot disregard an asset that is the best-performing asset of the 21st century. Whether that sits well with you or not, bitcoin is not going anywhere. So what are some of the ways bitcoin can fit into the portfolios of the future? Below, I’ll guide you through some of the main narratives for incorporating bitcoin into a portfolio.

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I have used the “digital gold” narrative early in my bitcoin journey, but cryptocurrency is far more than a gold replacement. The role that gold has historically played is protecting wealth: An ounce of gold in Roman times bought you a nice tunic, and an ounce of gold today buys you a nice suit. The idea of maintaining your purchasing power has been gold’s appeal. The inflation rate of gold is below 2%, so you can store wealth over generations as its devaluation happens slowly versus a purely fiat-backed currency. So if you only see bitcoin as a commodity holding to replace gold, then a weighting like Ray Dalio’s risk-parity recommendation to allocate to gold would make sense. A 7.5% weight for bitcoin then would be the recommendation under this type of approach.

If you like the idea of a core and satellite approach, you may want to allocate to thematic growth themes. The concept of core and satellite is to own the broad market, but to complement that with a 10%-20% allocation in opportunities you view as being able to outperform. Bitcoin is the fastest-growing asset of the past decade, so it fits into that narrative.

You can also look at the network effects of big tech, such as Google, Apple, Amazon and Facebook – once a dominant digital network surpasses $100 billion market cap, it’s here to stay. Bitcoin today has crept right back under the $1 trillion market cap. Venture capital has historically looked at where the demand curve is today versus where opportunity via adoption cycles is going, and network effects are powerful. People usually learn and share a tool or technology and then need to see a massive 10x or greater improvement to then move and “upgrade” to what’s better. A maximum of 10% weight would be the recommendation under this approach.

Greg Foss, a veteran trader with more than 30 years of experience in high-yield credit markets, is whom I credit with the idea of bitcoin being default insurance for fixed-income investors. In a recent piece, Foss articulated the contagion and cascading risk in the credit markets for bond investors, claiming that today the biggest risks are in credit markets, where risks can get hidden from the average investor.

Think of collateralized debt obligations in 2008 – the lessons from that period were not learned and are being repeated via looser and looser credit ratings on bond holdings as everyone is chasing yield in a world of low rates. The counterparty risk is usually unknown until it is too late – but bitcoin, when self-custodied, has no counterparty risk. This peace of mind and security is undervalued in today’s market.

Foss doesn’t claim that bitcoin’s price wouldn’t be affected in a credit meltdown, but that event would be a buying opportunity as more and more investors learn the merits of counterparty risk. The recommendation here for the client with a 60/40 portfolio, which has 60% in equities and 40% in bonds, is a 5% weight from their bond exposure.

Chris Cole of Artemis Capital Management wrote a research paper titled Rise of the Dragon: From Deflation to Reflation. He advocates that everyone construct a portfolio that can last 100 years regardless of what the markets do over any given cycle. The Dragon Portfolio is constructed to be resilient and offer actual diversification; the allocation includes equities, bonds, commodity trend, gold and long volatility. Each is between an 18% and 24% weight, so it’s almost an equal-weight approach. All of these holdings counterbalance each other to allow for a unique, independent return generator.

By avoiding large corrections, the compounding over years leads to a better 100-year portfolio that Cole argues cannot be beat. If you believe in his detailed research, it makes sense that bitcoin will replace gold given that we are moving from an analog age to a digital one. Gold has passed the baton to bitcoin, and it slides into that allocation for this portfolio style. It does not correlate with any other of the allocation weights and provides an independent return stream. A 19% weight would be the recommendation in this approach.

I can hear you now: What if your client won’t own bitcoin directly, and you don’t like the idea of paying 2% for Grayscale Bitcoin Trust (GBTC), the main way investors have sought exposure to bitcoin without their own wallets? (Disclosure: Grayscale is owned by Digital Currency Group, the parent company of CoinDesk.) I’d suggest adding the stocks of bitcoin miners and others that hold bitcoin on their balance sheet.

The most well-known company with a bitcoin balance sheet is MicroStrategy, led by Michael Saylor. An allocation to an index-style approach here provides exposure, allowing an equity weighting versus owning bitcoin directly. I would not say this is a 1:1 replacement, but it could be a solution for you today. This then allows you to get up to speed on the proper way to help clients own the asset directly. The recommendation here is of no more than a 5% weight for one company, and a basket approach is best.

All of the above narratives give you various rationales and different conclusions on the appropriate weight to hold in bitcoin for clients. When looking at the risk of owning bitcoin, even a “Mark Yusko position” of getting off zero and holding 1% is far less risky in the long run than owning 0%. Yusko is the founder, CEO and chief investment officer of Morgan Creek Capital Management and the managing partner of Morgan Creek Digital. He has worked in the endowment space for years and worked with some of the largest allocators in the U.S.

When you run a financial plan for clients, for instance, how often do you run a scenario of the U.S. dollar losing its reserve status? When do you run the consistent and accelerating devaluation of the U.S. dollar in a plan? Never? The facts are that bitcoin, even in a small amount, allows you to solve this what-if for clients. You can run a scenario of a small allocation of bitcoin going to $0 and the client still having a successful outcome.

The role of a financial plan should be to provide peace of mind and certainty. We’ve all seen clients become too conservative too early and jeopardize their future success – the same can be said for advisors who refuse to review the merits of bitcoin in a financial plan.

Bitcoin helps solve a real issue for clients trying not to outlive their money. Only you, as the partner to your clients, can know what the right fit is for bitcoin, but the evidence is clear that it does belong in everyone’s portfolio.