While bitcoin is down several hundred dollars since hitting its all time high of $4,483.55 earlier this morning, the cryptocurrency is still on an absolute tear this year.
Bitcoin’s ascent viewed over a longer time horizon is impressive. On a year-over-year basis, bitcoin has risen about 600 percent. Its price has risen over 150 percent in the last one hundred days. Six months ago, on Valentine’s day 2017, bitcoin was trading just above the $1,000 mark – so its price, even with the recent drop, has more than quadrupled in the last 6 months.
Gains at those levels sound massive – but just how big are they? Compared to investments in other asset classes, how well is bitcoin faring? And, as this afternoon’s price declines allude to, are the downside risks understood?
One way to try to flesh out answers is to compare stock market returns with the returns on bitcoin.
How big are the gains?
A fair place to begin measuring traditional stock market returns is the S&P 500 Index, which professional investors typically use as a benchmark to track their investments.
As a baseline way of thinking about the rise in the price of bitcoin consider this: Over the last 90 years, the average annual rate of return on the S&P 500 index has been just 9.8 percent.
If we compare bitcoin’s performance this year to the average return of the S&P 500, it’s immediately clear bitcoin’s moonshot rise has beaten the average rate of return on the S&P 500 by a stratospheric 6,000 percent.
For a slightly different proxy of price movement, let’s take a look at how long it took the S&P 500 to double in value to its current level. At press time, the S&P 500 Index is trading around 2,466. Cutting that number in half, we get 1,233.
The last time the S&P 500 traded below that level was August of 2010. So it took the S&P 500 almost seven years to double – thirty times longer than it took bitcoin to double in value.
Bitcoin’s performance is also quite impressive when analyzing it against equities by sector.
For instance, the top three equities sectors by performance over the last year have been Financial, Technology and Industrials.
For the sake of argument, let’s just say you were able to divine that these three sectors were the ones to invest in. The rate of return in S&P Sector Tracker Spyder ETFs, which serve as a proxy for the underlying stocks over the last 12 months, have been 29.5 percent for Financials, 23 percent for Technology, and 17.1 percent for Industrials.
So, on a twelve month basis, even if you were lucky enough to pick the top performing sector, bitcoin outperformed the sector ETF by about a 20 fold.
And that outperformance assumes that you picked the best performing sectors to invest in. If an investor had instead picked other sectors, such as Energy and Real Estate, which were the two worst performing sectors over the last 12 months, they would have actually lost 7.2% and 4.1%, respectively, as of press time today.
How large are the downside risks?
While the case for bitcoin may sound very bullish when you’re just looking at recent returns, there are potentially very large downside risks to investing in bitcoin — and, in this sense, bitcoin’s very nature makes it quite challenging to compare it to stocks in an apples-to-apples way.
One of the virtues of investing broadly in stocks via the S&P 500 Index is diversification.
The S&P 500 is made up of a basket of five hundred companies, comprising many of the largest publicly traded corporations in America.
The stocks in the S&P 500 are drawn from eleven different sectors across twenty-four different industry groups. That kind of diversification means people are shielded, in large measure, from risks to any one company and, to a lesser extent, shielded from risks to any one industry group or market sector.
Bitcoin, on the other hand, is an investment in a single asset. In a certain sense, investing in bitcoin is roughly analogous to investing in a single stock.
Although that metaphor probably doesn’t go far enough, still. What you’re really investing in is a single implementation of one technology, a single instance of code.
This means that investing in bitcoin rather than the S&P massively concentrates your risk, and as we’ve seen today, that risk can equate to hundreds of dollars per bitcoin.
That’s not to say, though, that investing in the S&P 500 with all its diversification ensures investors won’t lose money.
Investors can and do lose money investing in stocks – even when they diversify their risks by investing broadly in an index like the S&P 500.
In the last 89 years, the S&P 500 went down on a yearly basis two dozen times. The worst year stock investors suffered in the last nine decades was in 1931, during the Great Depression, when the S&P 500 lost nearly 44 percent. More recently, in 2008, during the depths of The Great Recession, the S&P 500 suffered its second worst loss of all time, dropping 36.5 percent.
Proceed with caution
Bitcoin has only been in existence since 2009. Moreover, it’s interest as an investment vehicle was really only established in early 2013, when it hit $266 after a price rally where its value was growing between 5 percent and 10 percent daily.
The one thing we can say for certain about bitcoin is that it does not possess a long enough track record for investors to understand the long-term historical price patterns in the same way they understand the directional swings of the S&P 500.
That absence of historical data, if nothing else, should signal to investors and potential investors to be wary.
Bitcoin and blockchain are exciting technologies – but investors should not lose their heads.
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