Bitcoin (BTC) Investors Shouldn't Be Fooled by High Risk-Reward Ratio

News
Sun, 01/26/2020 - 22:40
Alex Dovbnya
The potential returns of Bitcoin (BTC) greatly outweigh its risk but there's a catch
Cover image via 123rf.com
Contents

Stock-to-Flow model creator PlanB recently revealed that Bitcoin is the only asset whose Sharpe ratio, which is used for determining risk-adjusted returns, is above 1. Thus, BTC significantly surpasses U.S. bonds, gold, and even FAANG stocks.       

However, he faced some criticism from on-chain analysis Willy Woo who pointed to the fact that Bitcoin, due to its relatively short history, cannot be compared to assets that have already endured one or more bear markets. 

Related
Peter Schiff Says He Was Right About Bitcoin (BTC) for Decade. Price Charts Disagree

Upping the ante  

The Sharpe ratio was introduced by Nobel prize-winning economist William F. Sharpe to measure the returns of a portfolio while simultaneously taking into account its risk. A certain asset is compared to investments that are considered to be risk-free such as U.S. Treasury bills.   

Any asset with a high Sharpe ratio is an attractive option for investors because it can potentially generate extremely high returns. 

As the graph below shows, the Sharpe ratio is nearly zero for traditional assets such as U.S. bonds and gold since they have little to none volatility. The obvious downside of risk-free portfolios is that investors will not see any significant gains.

Related
Peter Brandt Names Four Reasons Why Bitcoin (BTC) Price Unlikely to Drop Further

Not enough data  

In his response to Woo, the Dutch analyst wrote that applying the same time period to Bitcoin and other assets could potentially lead to 'practical challenges.' For example, if to take into account only 2018-2019 data, this would not include the 40 percent stock market crash in 2008 as well as the dot com bubble in the late 90s that was even more severe than the crypto one in 2018.

Related
John Bollinger Shares His Take on Bitcoin's (BTC) Price Action. Should Bulls Be Worried?

Does it work for Bitcoin? 

Famed statistician Nassim Nicholas Taleb tweeted that the Sharpe ratio doesn't work for Bitcoin at all, which means that the above-mentioned comparisons didn't make any sense. Plan B agreed that it would be better to use fractal dimensions for his analysis. 

Taleb once reiterated that the variance of Bitcoin is infinite. In layman's terms, it means that Bitcoin cannot be overpriced.

image by @nntaleb

What's your take on PlanB's chart? Feel free to leave a comment!         

Subscribe to U.Today on Twitter and get involved in all top daily crypto news, stories and price predictions!

About the author

Alex Dovbnya (aka AlexMorris) is a cryptocurrency expert, trader and journalist with extensive experience of covering everything related to the burgeoning industry — from price analysis to Blockchain disruption. Alex authored more than 1,000 stories for U.Today, CryptoComes and other fintech media outlets. He’s particularly interested in regulatory trends around the globe that are shaping the future of digital assets, can be contacted at alex.dovbnya@u.today.

Top 10 Best Cloud Mining Sites in 2020
TOP 20 Best Bitcoin Trading Bots in 2020

This site uses cookies for different purposes. Please set your preferences in Cookie Settings and visit our Cookie policy for more information on how and why cookies are used on this site. Click here for cookie policy