Balmoral Digital

Is Bitcoin or gold a better portfolio diversifier?

Firstly – why are we looking at alternate asset classes?

Although valuations of traditional assets have come off slightly over 2022 they remain in the range of expensive to extreme relative to history. This means limited upside potential but lots of downside potential.

Government bond yields remain in negative real return territory, heavily suppressed via monetary policy. The additional compensation available for taking credit and/or equity risk is severely compressed as so much private capital has been forced down the risk spectrum.

Bitcoin, or Gold?

This article takes a look at two popular alternate assets – Bitcoin and gold – and seeks to compare the two with a view to determining which is a better compliment to global shares (MSCI World Index). To do that we will consider expected risk, return and correlations over 1, 3, 5 and 10 years, as well as recent demand trends.

Expected Return

If you swam 50m in a pool every morning in 25 seconds, and I asked you what time you would swim 50m tomorrow, you would answer ’25 seconds’. In many cases the past remains the best way to predict a central expectation for the future. We are not yet considering the risk we do worse than expected.

Expected Return

The results presented above encompasses 10 years of monthly data to the end of March 2022. While shares and gold offer positive expected returns, Bitcoin’s expected returns are incredibly superior across all time frames.

Furthermore the last 12 months incorporates very high levels of inflation in major markets (7.9% in the United States and 6.2% in the UK) as well as significant geopolitical risk. That was an environment where gold is expected to shine. This is critical because:

  1. Developed market governments have been heavy handed with fiscal stimulus while interest rates remain very low, which stokes global demand. Concurrently global logistics (Covid) and energy prices (Russia) are constraining supply. Strong demand and limited supply is a highly inflationary combination, and
  2. Geopolitical risks are expected to remain high.

In expected return terms Bitcoin looks to be a better portfolio allocation than gold.

Expected Risk

Having derived expected return, our central case, we now turn to the risk that we will earn less than our expected return by understanding a likely range an asset will trade in. This is where volatility comes in – the more the value of an asset goes up and down, the higher the chance our actual return will be below our expected return (or even negative). The measure of total risk is standard deviation.

Expected Risk

Bitcoin exhibits a lot more volatility than gold. This means Bitcoin brings a lot more risk in that its actual return may be well under its expected return. Having said that the risk in Bitcoin has been progressively reducing.

This quantification of total risk allows us to frame an expected range or distribution of outcomes, which is central to risk management. The starting point for developing an investment strategy is risk appetite, often expressed as maximum tolerance for potential loss. Using our standard deviations we can now project expected outcomes over a month as follows:

Standard Deviation and Expected Outcomes

We can project with 95% confidence that Bitcoin will change in value between -37.6% to +59.7% per month, and gold will change in value between -6.6% to 8.2% per month. This is useful information.

I am going to exclude the earliest Bitcoin data, contained in the 10yr numbers, given we would be going back close to Bitcoin’s inception where early adopters were effectively gambling on its ongoing existence. That risk is now insignificant. For example on 7 April 2022 Wayne Byres, the Chairman of Australia’s prudential regulator APRA, made clear APRA’s expectations that digital assets are now a permanent asset class:

The digitization of the Australian and global economies has continued, as consumers and businesses have chosen to rely everymore on mobile phones, digital wallets and online transfers to pay for every day goods and services. Noone seriously expects this trend will be reversed… Even central banks are conducting pilot exercises to test the use case for central bank digital currencies (CBDCs).”

Sharpe Ratio = Expected Return per unit of Total Risk

So far we have figured out expected return and the risk we will earn less than our expected return. The real magic however happens when we consider both of these together to produce an expectation of how much active return we expect per unit of risk. This metric is known as the Sharpe ratio, one of the key risk adjusted return measures in investment management.

The Sharpe ratio is calculated using expected return less the risk free rate all divided by the standard deviation. For the risk free rate I have used 5 year Australian Commonwealth Government Bonds, a proxy for a 5yr investment timeframe, yielding 2.8% at the time of writing.

Sharpe Ratio

What the Sharpe ratios tell us is that even though Bitcoin is a higher risk investment, the expected return per unit of risk significantly exceeds gold and global shares. You can also note the steady improvement in Bitcoin’s Sharpe ratio as its risk profile has progressively improved.

For portfolio builders with a risk budget, if Bitcoin’s risk is higher than your risk appetite this does not need to be a binary choice. Because expected return per unit of risk is so much higher with Bitcoin than with gold we can allocate a lower weighting to Bitcoin in the portfolio and still generate higher expected return for the risk budget than with a higher allocation to gold.

Its also worth noting that gold offers no active return per unit of risk over the 10 year horizon. For a long term portfolio holding this is a potential red flag.

Portfolio Construction Characteristics

In a recent Money Management article I provided the 5-year correlations between Bitcoin and Gold to a range of other growth assets. Using those correlations, combined with the risk and return expectations above, we calculate the outcomes of blending either gold or Bitcoin at a 25% weight with global shares. The expected risk and return of the two portfolios are below:

Gold vs Bitcoin Portfolio Allocations
Gold vs Bitcoin Portfolio Expected Return and Risk

What we see is that a 25% allocation to Bitcoin results in a more than double the expected return per unit of risk than a 25% allocation to gold. A smaller allocation to Bitcoin is expected to achieve better results for the portfolio than a higher allocation to gold using the same risk budget.

Relative Demand and Use Case

Bitcoin’s appeal is its exceptional expected returns. We need to understand what is driving Bitcoin’s return and whether that can be maintained into the future.

Both Bitcoin and gold have incrementally increasing supply, with some finite total supply expected to be reached in the future. The difference is demand.

According to the Gold Council gold demand increased 45% (using exchange traded gold products as a proxy for total demand) between 2020 and 2021. In contrast according to Chainalysis cryptocurrency usage increased 567% between 2020 and 2021.  

In the first three months of 2022 we had:

  1. Hawkish central banks, resulting in bond market pricing in rising interest rates, and
  2. A European war, with the risk of NATO/Russia escalation leading to a nuclear strike.

In that environment demand for gold increased 8%. Is this is as good as it gets for gold? Recall that between 1990 and 2005 we had 15 years where the price of gold remained flat, stuck in the low US$400s per ounce.

In contrast the future of cryptocurrencies is only just beginning.

Bigger Picture?

Bitcoin was the first cryptocurrency and remains the largest and best known digital asset. Bitcoin has known challenges, for example being limited to 3-5 on-chain transactions per second and its proof of work processes consumes a lot of energy (resulting in transaction fees are relatively high). Both of those challenges are being addressed by off-chain solutions, such as through the integration of BTC’s Lightning Network by Robindood. Newer cryptocurrencies such as Solana evolved around these problems from inception, for example Solana can process 65,000 transactions per second with each transaction using less energy than a Google search.

Digital assets are technologically advanced and evolving to better suit real world needs. This future facing potential, along with better regulation, will enhance their adoption. In contrast the uses and challenges of gold have remained largely unchanged for thousands of years.


Investing is about taking calculated risks: great investing achieves return objectives with the minimum risk.

Bitcoin offers superior return per unit of risk than gold both on a stand alone basis and when blended with shares as a portfolio diversifier.

Cryptocurrency demand continues to grow substantially faster than demand for gold, even accounting for the rapid increases in gold demand given high inflation and increased geopolitical risks. History suggests demand for gold experiences cycles, while cryptocurrency adoption is only just moving into the mainstream.

Cryptocurrencies are technologically advanced and future facing. They evolve to enhance their utility. Gold’s use cases and challenges have remained largely unchanged for thousands of years.