Spot Bitcoin ETFs are coming. Beware of risk.

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Last month, BlackRock Inc., the world’s largest fund manager, applied to the Securities and Exchange Commission for approval of a spot Bitcoin exchange-traded fund, a fund that would invest directly in the digital currency rather than through futures markets. BlackRock joins dozens of other smaller ETF providers with the same request, so far without success. But with BlackRocks behind the growing demands for a bitcoin cash fund, it’s only a matter of time before the SEC relents.

And it should. A spot ETF would allow investors to buy, sell, and hold Bitcoin more easily, cheaply, and securely than they can today. In a crypto industry awash with scams, regulatory oversight would also give investors and fund managers confidence that they are buying a financial product in good faith, especially if it bears the BlackRocks name.

When they become available, spot Bitcoin ETFs will become a fixture in many portfolios, and rightly or not, the conversation will be less about whether Bitcoin is a fraud and more about its merits compared to traditional investments such as stocks and bonds. Crypto cheerleader and founder of Galaxy Digital Holdings Ltd., Mike Novogratz, recently gave investors insight into this conversation, saying that Bitcoin has produced a higher Sharpe ratio, a popular measure of risk-adjusted return than any other investment over the past three years and urging others to do the math for themselves.

So I did. The first thing that stands out, of course, is Bitcoin’s incredible growth, primarily due to investors gaining access to it early in its lifecycle. Unlike stocks, which are offered to the public long after companies are established and begin to grow, almost anyone could have bought Bitcoin from the start. Those who did and snagged their coins have pocketed an unheard of return of 176% per year since July 2010, which is as far back as the record I’m using.

After factoring in the risk, however, Bitcoin doesn’t seem so exceptional. The Sharpe ratio that Novogratz refers to compares an investment’s excess return over cash with its volatility, with a higher ratio indicating a better risk-return trade-off. While Bitcoin has significantly outperformed the S&P 500, for example, it has also been 13 times more volatile as measured by annualized standard deviation, so its Sharpe ratio isn’t much better. Bitcoin has generated a ratio of 0.92 since 2010, barely above the S&P 500 ratio of 0.89.

The Sharpe ratio recognizes that volatility is just as important as return, because the higher an investment’s volatility, the less likely it is that investors will lag to capture the return. Nowhere is this truer than with Bitcoin. Indeed, Bitcoin’s record since its inception is largely irrelevant as few people bought it in 2010 and have held it ever since; investors more often dipped in and out along the way. The long-term record of Bitcoin is no longer useful to day one investors, as its rate of growth has slowed over time and will continue as it matures.

The better question, then, as Novogratz suggests, is how Bitcoin performed on shorter rolling timeframes after accounting for risk. From the past three years, Bitcoin has produced a Sharpe ratio of 0.63 through June, well below the S&P 500 ratio of 0.8 and matching the ratio of the MSCI ACWI Investable Market Index, a global equity index that includes large and small companies. So, for starters, Bitcoin hasn’t produced the best Sharpe ratio in the past three years, not now or when Novogratz said otherwise.

Bitcoin’s full track record is no more impressive. It has a median Sharpe ratio of 0.94 for all three-year periods, which is lower than the S&P 500 and comparable to that of the Bloomberg US Aggregate Bond Index. Bitcoin’s median Sharpe ratio is higher than that of the global stock index, although the time since Bitcoin’s launch has been unusually disappointing for non-US equities. Over the longer term, foreign equities should produce a Sharpe ratio comparable to that of US equities.

There is also more variability in the results of Bitcoins, which means that investors had very different results depending on when they invested. Bitcoin’s three-year Sharpe ratios are three times more volatile than stocks and nearly twice as volatile as bonds. Its Sharpe ratio has only beaten the S&P 500 about 40% of the time for three consecutive years. It has a better balance sheet versus non-US bonds and stocks so far, but still loses most of the time. So how Bitcoin performs against other investments is a gamble in itself.

Bitcoin also carries a risk that the Sharpe ratio is not designed to detect. The ratio is most often used to size diversified baskets of stocks, bonds and other assets, where the risk is market volatility and not permanent loss. But Bitcoin is a unique cryptocurrency, and like any individual stock or bond, it can be wiped out, regardless of its strength. The same cannot be said for major stock indices, which makes Bitcoin riskier regardless of the Sharpe ratio.

As Bitcoin cash ETFs approach, more will be said about the merit of Bitcoins over other investments. There’s no better way to test these claims than to look at the numbers, and when you do, don’t be surprised to find that much of what is being said simply isn’t.

More from Bloomberg Opinion:

Bitcoin deserves a place in your wallet: Alexis Leondis

Cryptos Hotel California traps the Winklevoss twins: Lionel Laurent

Remember scary inflation and exciting bitcoin? : Authors & Lee

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Nir Kaissar is a Bloomberg Opinion columnist covering the markets. He is the founder of Unison Advisors, an asset management company.

More stories like this are available at bloomberg.com/opinion

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