The Banking Executive Magazine - May 2022 Issue

Cryptocurrencies and Blockchain Technology WHAT COULD A CRYPTOCURRENCY ALLOCATION MEAN FOR A 60/40 PORTFOLIO? Taking a total portfolio view, we ask what the expected return for various Bitcoin allocations to a 60/40 portfo- lio would have to be in order to maintain the portfolio’s volatility-ad- justed return (Sharpe ratio). The an- swer: The required return is extremely high, and any allocation should be approached with caution. For example, assuming Bitcoin volatility remains at its historical level, the analysis shows that even a 2.5% allocation to Bitcoin increases the annualized volatility (risk) of the portfolio by close to 2%. Given Bit- coin’s extreme volatility, an annual- ized return of 33% – or 316% over five years – would be needed to maintain the portfolio’s Sharpe ratio and for the investment to be consid- ered an appropriate use of the risk budget (Figure 8). n other means, off- setting Bitcoin’s impact on portfolio risk requires a high expected return. CENTRAL BANK DIGITAL CURRENCIES The most important macro implica- tions of Cryptocurrencies is the pres- sure they place on central banks to issue digital currencies. The rise of Cryptocurrencies and sta- blecoin has induced dozens of cen- tral banks to study, prepare and launch a digital currencies of their own. These currencies are designed to be direct claims on a country’s central bank and equivalent to its physical currency. While some CBDCs may use Blockchain technol- ogy, in many ways they would amend the pseudo-anonymity of Bit- coin by providing central banks with much more visibility into transac- tions throughout the economy. For example, the People’s Bank of China (PBOC) has been researching a digital Yuan since 2014. Its pro- gram resulted, in 2021, by opening of almost 25 million e-CNY wallets, enabling citizens and companies to ISSUE 161 MAY 2022 the BANKING EXECUTIVE 41 Table1: Expected Rates of Return Needed To Maintain A 60/40 Portfolio’s Sharpe Bitcoin Allocation 60/40 allocation Portfolio Risk Portfolio Return Required Bitcoin expected return to maintain a sharpe ratio 0 1.0 2.5 5.0 10.0 100.0 99.0 97.5 95.0 90.0 8.28 8.72 10.13 13.69 22.58 4.33 4.5 5.05 6.44 9.9 N/A 21 33 46 60