Abstract

Since the launch of Bitcoin in 2008, cryptocurrencies have garnered a lot of attention in the financial world. This paper analyzes whether cryptocurrencies can be used as a hedging instrument or a store of value, or whether they are just highly volatile assets with gamble-like traits. To investigate this, I compare cryptocurrencies to lottery-like investments in the CRSP universe and find that the two major cryptocurrencies, bitcoin and ether, possess high idiosyncratic volatility and idiosyncratic skewness. This implies cryptocurrencies have lottery-like behavior and activities on these networks could be motivated by speculative behavior of investors. To examine hedging instrument traits of cryptocurrencies, I perform a spanning-test to determine if adding cryptocurrencies to the market portfolio reduces risk. The addition of cryptocurrencies to a traditional asset portfolio with assets such as S&P500 stocks, Gold, Silver, Real Estate, and commodities, is found to reduce portfolio risk, but expose investors to significantly high tail-risk due to the cryptocurrency’s intrinsic skewness. Adding cryptocurrencies shifts the portfolio frontier significantly to the left, but this better risk-return ratio is offset by exposure to high volatility of the test asset class. From the viewpoint of a store of value, cryptocurrencies may not possess characteristics like the store of value component in gold, but the results are weak and inadequate to draw any strong conclusions. Overall, the analysis seems to suggest that even though cryptocurrencies are not likely to possess attributes of a store of value, they offer diversification benefits to investors at the cost of exposure to larger potential losses.