Bitcoin is so volatile its risk-adjusted return is worse than stocks

Bitcoin: Goes up fast and comes down fast, too.Business Insider

• Bitcoin is so volatile that its risk-adjusted return may have been as low as 3.1% in 2017, according to an analysis by Mizuho, an Asian investment bank.
• The risk-adjusted return of stocks in the same period was 11% to 13.8%.
• Risk-adjusted returns account for how likely it is that you can buy an asset at just the right time and sell it at just the right time.
• Bitcoin is so volatile that your ability to buy and sell at the right price is diminished, hence the lower risk-adjusted returns.

The fantastic recent gains in the price of bitcoin since the election of US President Donald Trump are much less compelling once you adjust for risk, according to Vishnu Varathan, the head of Economics & Strategy at Mizuho bank.

In fact, bitcoin is so volatile that an average bitcoin investor will have done less well than someone who put the same money into stocks in the post-Trump period, he wrote in a recent note to clients. The S&P 500 and the Euro Stoxx both produced far higher risk-adjusted returns than bitcoin in the same period.

• Risk-adjusted returns year to date 2017:
• Euro Stoxx: 13.8%
• S&P 500: 11%
• Bitcoin: 3.1%

Varathan made his calculation using the Sharpe Ratio, which factors risk into investment returns. His analysis is interesting given the central problem of valuing bitcoin. The cryptocurrency is so novel that it has largely defied traditional financial valuation attempts. Morgan Stanley, for instance, recently suggested its true price might be zero, given how few retailers accept it for payment.

The Sharpe calculation works like this: Sure, in theory, if you had bought bitcoin at exactly the right time and sold at exactly the right time, your investment would have gained nearly 2,000%. But most investors can’t be that lucky.

The price of bitcoin is so volatile — it moves so dramatically and so quickly — that even if you have good gains today they are frequently wiped out in the next day’s trading. So it makes sense to account for that volatility by comparing it to a risk-free return, such as an investment in US Treasuries. Bitcoins gains are only valuable if they return more than the risk-free option of investing in treasury bonds. So Varathan factors in this risk by calculating a standard deviation for the price of bitcoin, and comparing that to treasuries.

“Compelling returns of Bitcoin are distinctly less so once the returns are ‘risk-adjusted,'” he told clients. “Using the Sharpe Ratio concept – to normalize excess returns (over returns on USTs) for volatility (standard deviation) – Bitcoin returns look meagre.”

Mizuho

Varathan concludes:

• Bitcoin returns have varied dramatically, from 1500% to 2500%, depending on the precise point of valuation – epitomized in last week’s “wild” swings from $19,666 peak on 17th (Dec) to abrupt $10,775 crash before rebounding above $16,000, then slipping to $14,000.
• The prospect of losing almost half the value of this “asset” (?) in just days (if not hours) is arguably not adequately mitigated by evidence of fairly quick price restorations; not even with the cumulative returns that remain unrivalled.
• Specifically, once inherent risk is accounted for, Bitcoin’s return appears to be below average compared across the spectrum of assets. And the upshot is that Bitcoin’s allure is certainly overstated for those inclined to ignore the risks (at their own peril).