HEATH MUCHENA: From volatility to value — reimagining portfolios with crypto

In the world of finance, bitcoin and ethereum have transformed from obscure digital experiments into formidable investment assets.

These decentralised cryptocurrencies, free from the control of central banks, have reshaped the financial landscape by offering unique opportunities for diversification and growth in investment portfolios.

But what do they really bring to the table, and how do they interact with traditional assets? Let’s explore their story and how they fit into today’s macroeconomic realities. 

Bitcoin, introduced in 2008 by the mysterious Satoshi Nakamoto, was designed to be a decentralised alternative to traditional currencies. Its scarcity — capped at 21-million coins — and independence from central authorities, sparked curiosity among tech enthusiasts and libertarians. Ethereum, launched in 2014, took bitcoin’s principles a step further by introducing smart contracts, enabling programmable transactions on a decentralised blockchain. 

Both cryptocurrencies gained mainstream attention during the bull market of 2017, with bitcoin surging from $1,000 to nearly $20,000 and ethereum following suit. After a lull in 2018, renewed interest sparked during the Covid-19 pandemic as global monetary policies introduced unprecedented stimulus, eroding trust in fiat currencies and boosting demand for digital assets. 

Fast forward to 2024, and cryptocurrencies entered a new phase. The US Securities & Exchange Commission’s approval of spot bitcoin and ethereum exchange traded funds (ETFs) has revolutionised accessibility for institutional and retail investors alike. No longer must investors grapple with complex wallets or exchanges; instead, they can integrate cryptocurrencies seamlessly into traditional portfolios through ETFs. 

Recent studies highlight the profound impact of including cryptocurrencies in diversified portfolios. Bitcoin and ethereum exhibit low or even negative correlation with traditional assets such as stocks, bonds and real estate, making them valuable tools for diversification. While cryptocurrencies are undeniably volatile, their potential for outsize returns can enhance a portfolio’s risk-return profile. 

When constructing an investment portfolio balancing risk and reward is key. Traditional portfolio optimisation often uses the mean-variance approach, aiming to minimise risk for a given level of return. However, this method can falter when asset returns deviate from a normal distribution — a hallmark of cryptocurrencies, which exhibit skewness and kurtosis (indicating rare but significant price swings). 

Here, Conditional Value-at-Risk (CVaR) offers a more robust framework. By focusing on tail risks — the extreme losses that might occur — CVaR better captures the risk profile of assets such as bitcoin and ethereum. Research shows that portfolios incorporating these cryptocurrencies, especially bitcoin, tend to outperform in terms of return at higher levels of risk tolerance. 

While both bitcoin and ethereum enhance portfolio performance, bitcoin often edges ahead due to its lower correlation with traditional assets such as stocks and real estate. This makes bitcoin a stronger diversification tool, though ethereum’s programmability and higher average returns still make it an attractive option for risk-tolerant investors. 

Moreover, Bitcoin’s status as a “digital gold” has been cemented in a macroeconomic environment rife with uncertainty. Geopolitical tensions, inflationary pressures, and the potential for slowing economic growth have driven investors towards assets that offer stability and independence from government intervention. Ethereum, with its utility-driven ecosystem, appeals to a different segment of investors, particularly those optimistic about the future of decentralised finance and non-fungible tokens. 

The rise of cryptocurrencies cannot be separated from macroeconomic trends. As central banks navigate post-pandemic recovery, the interplay between inflation, interest rates and fiscal policy remains pivotal. Bitcoin, with its fixed supply, often thrives during periods of monetary expansion or distrust in fiat systems. Ethereum, meanwhile, benefits from the growing adoption of blockchain technology, which continues to disrupt industries from finance to gaming. 

Institutional interest further validates cryptocurrencies’ role in the financial ecosystem. The approval of ETFs signals regulatory maturity, making these assets more palatable to traditional investors. Simultaneously, innovations such as decentralised finance challenge conventional systems, prompting a re-evaluation of how value and trust are exchanged. 

Bitcoin and Ethereum are more than volatile assets; they represent a paradigm shift in how we think about money, investment and technology. As part of a diversified portfolio they offer not only high returns but also the opportunity to hedge against macroeconomic uncertainty and evolving financial landscapes. 

For investors, the question is no longer whether to consider cryptocurrencies but how best to integrate them into a balanced strategy. As the financial world continues to evolve, bitcoin and ethereum stand as beacons of innovation, reshaping our understanding of value in the 21st century. 

• Muchena is founder of Proudly Associated and author of ‘Artificial Intelligence Applied’ and ‘Tokenized Trillions’.