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Virtual currency, tangible return: Portfolio diversification with bitcoin

Bitcoin (BTC) is a major virtual currency. Using weekly data over the 2010–2013 period, we analyze a BTC investment from the standpoint of a US investor with a diversified portfolio including both traditional assets (worldwide stocks, bonds, hard currencies) and alternative investments (commodities, hedge funds, real estate). Over the period under consideration, BTC investment had highly distinctive features, including exceptionally high average return and volatility. Its correlation with other assets was remarkably low. Spanning tests confirm that BTC investment offers significant diversification benefits. We show that the inclusion of even a small proportion of BTCs may dramatically improve the risk-return trade-off of well-diversified portfolios. Results should however be taken with caution as the data may reflect early-stage behavior that may not last in the medium or long run.