Lesson 7 of 7 · 14 min
Risk, return and diversification of digital assets
Cryptocurrencies earn returns only through price appreciation driven by demand for a limited supply; history shows high returns, very high volatility, deep drawdowns and low correlations with traditional assets, so a small allocation may diversify a portfolio, although correlations have risen, especially in stressed markets.
In short
- No cash flows: returns come only from price appreciation; demand for a limited supply is a key driver (Bitcoin is capped at 21 million coins, hence 'digital gold').
- Bitcoin's record: high average return, high volatility (falling but still far above equities), positively skewed returns and deep drawdowns, so entry and exit timing matters hugely.
- Regulatory risk is non-trivial: unclear legal protection, rampant fraud, and some countries ban crypto outright.
- Returns are driven by adoption, network effects, technology, regulation, speculation and risk appetite, factors partly unique to the asset class.
- That gives low historical correlations with stocks and bonds and potential diversification benefits, but correlations have risen, particularly in periods of high uncertainty.
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