Liquid Finance LogoLiquid Finance

Bitcoin 101 Part 5: Bitcoin in a Diversified Portfolio

Vaishnav Kuruvanka
Vaishnav Kuruvanka
Bitcoin 101 Part 5: Bitcoin in a Diversified Portfolio

Bitcoin 101 Part 5: Bitcoin in a Diversified Portfolio

Diversification Benefits of Bitcoin

Low Correlation Asset

One of the most compelling reasons institutional investors consider Bitcoin is its low correlation to traditional asset classes. Modern portfolio theory tells us that adding uncorrelated assets can improve a portfolio’s overall risk/return profile. Historically, Bitcoin’s price movements have shown little correlation with those of equities, bonds, or commodities (aside from sporadic short-term risk-on/risk-off episodes). For example, over multi-year spans, Bitcoin’s correlation to U.S. stocks has often hovered near zero. State Street Global Advisors noted that in recent years, stocks and Bitcoin have exhibited only a weak linear relationship (correlations largely between 0.0 and 0.4) (Crypto Correlations: Perception vs Reality - Coinbase Institutional Monthly Outlook). Likewise, Bitcoin has no fundamental link to bond performance or real estate, etc. This means Bitcoin’s returns are driven by different factors (adoption rate, network growth, crypto market cycles) than traditional assets, which is valuable from a diversification standpoint. In a period when, say, stocks and bonds are both declining (as happened in 2022), Bitcoin might not follow the same pattern – indeed, seeking uncorrelated return streams is a key reason 65% of surveyed institutional investors found digital assets appealing (Digital Assets: The Next Frontier for Markets and Investors).

Enhanced Risk-Adjusted Returns

The ultimate test of adding any asset to a portfolio is whether it improves metrics like the Sharpe ratio (return per unit of risk). There is growing evidence that a small allocation to Bitcoin historically would have done exactly that. Fidelity analyzed a traditional 60% stocks/40% bonds portfolio over a recent four-year period and found that adding a Bitcoin allocation improved performance significantly. A 5% Bitcoin allocation (95/5 portfolio) from 2020–2024, rebalanced quarterly, would have increased the Sharpe ratio by up to ~40% relative to a 60/40 portfolio with 0% Bitcoin (). Even a 1–3% allocation showed Sharpe improvements, with higher allocations yielding greater enhancement. The portfolio with 5% Bitcoin had annualized returns about 4.5 percentage points higher than the base portfolio (). Importantly, volatility did rise, but not by as much as the returns rose – meaning the risk/reward trade-off improved. The maximum drawdown of the portfolio with Bitcoin was only slightly worse than the 60/40 alone, thanks to Bitcoin’s low correlation cushioning the impact (). These findings indicate that Bitcoin, when used in moderation, can act as an efficient diversifier that boosts returns more than it increases risk. It’s rare for an asset to have such properties, and it’s a core reason why many forward-thinking portfolio managers are exploring Bitcoin.

Diversification Across Macroeconomic Regimes

Bitcoin’s performance drivers can differ from those of traditional assets under various economic conditions. For instance:

In times of monetary expansion or currency debasement, Bitcoin might soar as investors seek hard assets (similar to gold’s behavior) – this is a scenario where stocks might also do well (due to liquidity) but bonds might suffer (due to inflation), so Bitcoin could complement the losing side.

In a deflationary bust or equity bear market, Bitcoin’s record is mixed (in March 2020’s liquidity crisis, Bitcoin initially crashed along with everything else, but then it massively outperformed in the recovery). Some see Bitcoin as a hedge against extreme systemic crises – a form of “disaster insurance” – which might provide tail-risk protection if, say, a major fiat currency has a crisis. This potential hedge aspect can diversify scenarios that are otherwise hard to guard against.

Geopolitical turmoil: Gold is known as a crisis hedge, and Bitcoin has started to exhibit some similar properties (e.g., during certain geopolitical events or bank crises, Bitcoin price strengthened, presumably as some moved assets into a independent refuge). While it’s too early to conclusively label Bitcoin a safe-haven, its behavior doesn’t strictly track equities or bonds, giving it the chance to shine in scenarios where traditional assets falter.

Caveat – Volatility Spillover

It should be noted that while Bitcoin can improve risk-adjusted returns, its volatility can still affect short-term portfolio stability. A portfolio that includes Bitcoin will see more day-to-day fluctuations. This is why the allocation size is usually kept small. If uncorrelated, even a volatile asset can help (because volatility’s impact diversifies away to an extent). And as mentioned earlier, Bitcoin’s volatility, though high, has been on a downward trend as the market matures (Bitcoin Volatility Guide: Trends & Insights for Investors | iShares - Blackrock) and as more institutional capital (with longer horizons) enters. The hope for many investors is that over time Bitcoin behaves somewhat like a commodity or alternative asset – providing returns outperformance and diversification, with volatility that eventually settles at more moderate levels.

Portfolio Context Matters

The benefit of Bitcoin in a portfolio can depend on what else is in that portfolio. For instance, an all-equity portfolio might experience more diversification benefit from Bitcoin (since Bitcoin’s correlation with equities is low and its return potential high). A portfolio already heavy in alternatives (say real estate, gold, venture capital) may find Bitcoin one more uncorrelated asset among others. In any case, most analyses (BlackRock, Fidelity, CFA Institute, etc.) conclude that for a wide range of traditional portfolios, adding a small Bitcoin slice historically improved outcomes. And given Bitcoin’s still modest penetration (most portfolios have 0% crypto), there could be a secular trend of increasing inclusion which in itself might drive positive returns (the “adoption effect”).

Allocating Bitcoin in a Traditional Portfolio

Sizing the Allocation

As emphasized, the typical recommendation for Bitcoin (for those choosing to include it) is a small single-digit percentage of the portfolio. Common allocation ranges discussed are 1% to 5%. At 1%, Bitcoin is almost a “why not?” allocation – it won’t hurt the portfolio much even if Bitcoin goes to zero, but if Bitcoin doubles or more, it will contribute nicely. At 5%, it becomes a high-conviction allocation that can move the needle on portfolio performance, but it will also introduce noticeable volatility. Institutions tend to lean on the lower end; for example, a 2022 survey found many wealth managers were considering ~2-3% allocations for clients interested in crypto. The right number depends on risk tolerance: an aggressive institution might go higher, whereas a conservative one might just dip a toe. It can also depend on the mandate of the fund (a tech-focused fund might justify a larger slice than a conservative income fund). The key is that position sizing is the primary risk control lever – by limiting exposure, you cap how much Bitcoin can hurt you, without capping how much it can help (downside is capped to that 1-5%, upside theoretically could be many multiples).

Which Vehicle to Use

Investors have several routes to gain Bitcoin exposure:

Direct Holdings

Buying actual bitcoin and holding it (via an exchange or OTC broker, then custodying it). This gives the most control and lowest ongoing fees, but requires dealing with the operational aspects of storage and trading.

Bitcoin Funds/Trusts

Passive vehicles like the Grayscale Bitcoin Trust (GBTC) or other trust structures have been popular for institutions (particularly before ETFs). These trade like stocks (sometimes at premiums/discounts) and offer simplicity – you buy shares in a brokerage account. However, they may have higher fees and tracking error.

Exchange-Traded Funds (ETFs)

With the advent of Bitcoin ETFs in various jurisdictions (and expected broad availability in the U.S. soon or already, depending on timing), this is likely the easiest method. Bitcoin ETFs allow investors to get exposure through standard brokerage accounts, with the fund handling custody and tracking the price closely. BlackRock’s iShares Bitcoin Trust (IBIT) is one such example aiming to provide convenient access (iShares Bitcoin Trust (IBIT) | Spot Bitcoin ETP | BlackRock). ETFs come with a management fee but in exchange offer high liquidity, regulatory oversight, and no need for the investor to manage keys.

Professional Managed Funds

Some hedge funds or digital asset managers offer actively managed crypto funds. These funds might trade around positions, use derivatives, or invest in a basket of crypto assets including Bitcoin. They can potentially add alpha or reduce drawdowns (e.g., by going partially to cash when indicators turn negative), but they also charge higher fees (performance fees, etc.). For HNWIs who want exposure but not the hassle, allocating to a reputable crypto fund can be a solution.

Futures and Derivatives

Institutional investors sometimes use Bitcoin futures (CME futures are cash-settled) to gain or hedge exposure without touching the underlying asset. Futures can be handy for short-term adjustments or if an investment policy forbids direct holdings. Similarly, options on Bitcoin can be used to hedge downside or generate income (through writing covered calls, for example), though these are advanced strategies.

Integration into Portfolio Construction

If adding Bitcoin, investors often categorize it under “Alternatives” or “Alternative Investments” in their portfolio breakdown. It can be bucketed alongside assets like commodities, private equity, or hedge funds. Some might categorize it as an “inflation hedge” or part of the “opportunistic” allocation. The point is to incorporate it into the portfolio structure with a clear role. For example: Diversifier/return enhancer.

A CIO might say: “We’ll fund the 2% Bitcoin allocation by taking 1% from stocks and 1% from bonds,” thus slightly reducing each to make room for Bitcoin’s diversifying role.

Or an individual might decide: “I’ll allocate part of my gold holdings or cash holdings to Bitcoin for higher growth potential.”

Rebalancing and Management

Once included, treat Bitcoin like any other asset in terms of monitoring and rebalancing. If its allocation grows after a price run-up, trim it; if it shrinks after a fall and your thesis is intact, consider topping up. This discipline turns volatility into an advantage (buying low, selling high systematically). As noted earlier, rebalancing can significantly reduce volatility drag. Some investors rebalance based on fixed intervals, others when allocation thresholds are breached (e.g., if Bitcoin allocation meant to be 3% doubles to 6%, trigger a rebalance).

Risk Controls

Institutions might set specific risk limits for their Bitcoin exposure:

Max Drawdown Limits: e.g., cut the position if it falls X% from peak.

Stop-loss or Tactical Rules: e.g., have a rule to reduce exposure if Bitcoin enters a certain downtrend or if volatility exceeds a threshold.

Counterparty Risk Management: If using exchanges or funds, ensure diversification among them and keep an eye on their creditworthiness.

Compliance Checks: Ensure holding Bitcoin doesn’t violate any investment guidelines or covenants (some older fund mandates might not yet allow crypto – though that’s changing).

Performance Evaluation

Investors will want to evaluate Bitcoin’s contribution over time. It may be helpful to track the portfolio’s performance with and without Bitcoin to see the impact. Metrics like Sharpe ratio, Sortino ratio, and maximum drawdown can be compared for portfolios with various Bitcoin weights. This ongoing analysis can inform whether to maintain, increase, or decrease the allocation. For example, if after a year Bitcoin indeed improved outcomes, one might justify a slight increase in allocation. Conversely, if it underperformed and added too much volatility, one might scale back or revisit the thesis.

Investor Education and Buy-in

In an institutional context, adding Bitcoin often requires educating investment committees or clients about why you’re including it. It can help to present research (like BlackRock’s or Fidelity’s findings) that show tangible benefits to portfolios () (). Emphasize that it’s a calculated, small allocation aimed at improving the overall portfolio’s resilience and return potential, not a speculative gamble. Many institutions have gone through this process – the narrative has shifted from “Why invest in Bitcoin?” to “Here’s how we responsibly invest in Bitcoin.”

Tax and Regulatory Considerations

Remember that adding Bitcoin can have tax implications (realizing gains/losses on rebalancing, etc.) and operational considerations (valuations, custody in fund statements). Work with accountants or service providers to integrate it smoothly. For U.S. taxable investors, the IRS treats Bitcoin as property, meaning each sale is a taxable event (which is different from how stock index rebalancing might be handled in qualified accounts, etc.). Using funds or futures might offer different tax treatments (e.g., Bitcoin futures ETFs might be treated like commodities with certain tax rates).

Role of Bitcoin in Liquid’s Structured Fund

Liquid Finance has uniquely integrated Bitcoin into commercial real estate (CRE) lending, creating a fund that goes beyond traditional strategies by offering investors enhanced returns, meaningful diversification, and improved resilience against market volatility and inflation.

Elevating Returns Beyond Conventional CRE Debt

Traditional CRE debt funds often reference an 8% market interest rate, typically yielding net investor returns between 6–7% after fees. Liquid Finance, however, utilizes an innovative approach that blends stable senior CRE loans (approximately 80% of the portfolio) with a carefully managed Bitcoin exposure (approximately 20%). This balanced integration significantly amplifies net returns without increasing borrower interest costs or materially elevating investment risk.

Under identical conditions (an 8% benchmark rate), Liquid’s structured fund delivers notably higher net yields starting at roughly 6.7–8.7%, rising progressively as principal repayments are reinvested and the Bitcoin portion appreciates. Over a seven-year modeled period, Liquid’s blended portfolio yield dramatically outpaces traditional CRE debt—achieving cumulative yields several times higher—demonstrating a distinct advantage in total investment performance.

Harnessing Bitcoin’s Low-Correlation Advantage

The rationale behind pairing CRE debt with Bitcoin lies in their exceptionally low historical correlation (approximately 0.1 over the last five years). While commercial real estate lending generates stable, predictable income, Bitcoin serves as a growth engine with asymmetric return potential. This dual-yield structure provides two clear advantages:

Balanced Growth and Stability: During strong market cycles, Bitcoin’s appreciation can significantly enhance portfolio returns. Conversely, the stable income generated from senior CRE debt acts as a buffer, mitigating the volatility inherent in Bitcoin investments.

Regular Portfolio Rebalancing: Liquid actively manages portfolio allocations, regularly rebalancing to maintain the optimal mix between stability (CRE loans) and growth (Bitcoin). This disciplined approach reduces exposure to extreme market fluctuations, offering lower volatility and smoother returns compared to standalone Bitcoin exposure.

Improved Inflation Protection

In a macroeconomic environment characterized by persistent inflation, preserving purchasing power is paramount. Liquid’s strategy combines two inflation-resistant components into a single, cohesive fund:

Inflation-Indexed Real Estate Income: Senior CRE loans inherently provide a level of inflation resistance through adjustable interest rate structures, enabling investors to maintain stable real yields even in rising-rate environments.

Bitcoin’s Historical Outperformance: Despite short-term volatility, Bitcoin has consistently exhibited substantial growth over longer multi-year horizons, significantly outpacing inflation and delivering strong real returns. When integrated alongside CRE debt, Bitcoin enhances the portfolio’s capacity to maintain—and often increase—investor purchasing power over time.

Institutional-Grade Transparency and Liquidity

A notable differentiator for Liquid Finance is the unprecedented transparency, liquidity, and cost-efficiency afforded by blockchain-based tokenization:

Real-Time Visibility: Investors gain continuous, on-chain insight into asset performance, loan repayments, and collateral coverage, dramatically exceeding the transparency offered by traditional quarterly reporting.

Enhanced Investor Liquidity: Tokenization enables near-instantaneous redemptions and portfolio adjustments, eliminating cumbersome lock-up periods and illiquidity constraints typical in institutional real estate credit investments.

Reduced Fees and Increased Net Returns: Liquid caps total management costs at just 1.0%, well below the 1.5–2.0% industry average. This structure allows investors to retain a higher proportion of their returns, significantly improving net yield.

Why This Matters for Investors

Liquid Finance’s innovative use of Bitcoin within its structured CRE debt fund isn’t simply a novelty—it's a strategic advancement tailored specifically for investors seeking higher returns, reduced volatility, and meaningful protection against inflation. By thoughtfully combining stable fixed-income assets with growth-oriented digital assets, Liquid creates a more efficient portfolio structure, delivering returns 2–5 times higher than traditional approaches at comparable or lower risk profiles.

Sources