Tuesday, October 27, 2020

Fidelity makes it clear: Bitcoin volatility is worth the risk for institutions

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In a recently released report titled Bitcoin Investment Thesis, Fidelity Digital Assets demonstrated how portfolio managers could increase their returns by allocating a portion of their holdings to Bitcoin (BTC). The report also speculated that in the near future, increased institutional interest could expand Bitcoin’s market capitalization by hundreds of billions of dollars.

Fidelity Digital Assets

Source: Fidelity Digital Assets.

To prove its thesis, Fidelity simulated sample portfolios starting with a default allocation of 60/40 between equities and fixed income instruments. They then diversified these with Bitcoin at a rate of 1 to 3 percent. In every scenario considered by Fidelity, portfolios holding higher Bitcoin allocations outperformed their less diversified counterparts.

Assets that are negatively correlated or exhibit low correlations with the rest of the market provide additional benefits to portfolio managers. They allow for a reduction in volatility without having to sacrifice returns. Simulated portfolios that continued to hold Bitcoin benefited from the asset’s low correlation with traditional assets. The report acknowledged, however, that the increasing adoption of Bitcoin by the financial industry may lead to greater correlation in the future, thus reducing diversification benefits.

Fidelity’s report additionally estimated the potential redistribution of investments from alternative investments and fixed income to Bitcoin. The former’s market is valued at $13.4 trillion, thus if Bitcoin were to capture 5% of this market, its market cap would increase by $670 billion. If it were to capture 10%, the market cap would increase by $1.3 trillion. The bond market is approximately worth $50.3 trillion. If Bitcoin were to capture 1% of that market, this would translate into another $500 billion.

Ever-decreasing bond yields, the report argues, could push asset managers to this risky endeavor. If the most optimistic forecasts were to materialize, Bitcoin’s capitalization could increase to $2 trillion.

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