Caveat Emptor: Does Bitcoin Improve Portfolio Diversification?

Bitcoin is an unregulated digital currency originally introduced in 2008 without
legal tender status. Based on a decentralized peer-to-peer network to conrm transac-
tions and generate a limited amount of new bitcoins, it functions without the backing
of a central bank or any other monitoring authority. In recent years, Bitcoin has seen
increasing media coverage and trading volume, as well as major capital gains and
losses in a high volatility environment. Interestingly, an analysis of Bitcoin retur ns
shows remarkably low correlations with traditional investment assets such as other
currencies, stocks, bonds or commodities such as gold or oil. In this paper, we shed
light on the impact an investment in Bitcoin can have on an already well-diversied
investment portfolio. Due to the non-normal nature of Bitcoin returns, we do not
propose the classic mean-variance approach, but adopt a Conditional Value-at-Risk
framework, which is better suited to capture the risk involved with a Bitcoin invest-
ment and ensures coherence of the risk measure compared to other alternatives. Our
results indicate that Bitcoin should be included in optimal portfolios. Even though
an investment in Bitcoin increases the CVaR of a portfolio, this additional risk is
overcompensated by high returns leading to better return-risk ratios.