Investing.com — Extreme price swings have long been a concern for conventional investors. Many consider their volatility to be a significant risk and inappropriate for portfolios focused on capital preservation.

However, analysts at BCA Research say this volatility may not be a drawback, but a unique feature that could escalate bitcoin’s value in a diversified portfolio.

BCA argues that rather than viewing volatility as a negative, Bitcoin’s high volatility can actually be an advantage if you look at it from the right perspective.

Historically, investors have avoided Bitcoin due to its dramatic swings. Over the years, the cryptocurrency has averaged a monthly volatility of 76.1%.

In comparison, conventional assets like bonds have a much lower volatility of 5.4%. Bitcoin’s history is full of significant declines, with two cases where it lost more than 70% of its value.

For conservative investors, these numbers are alarming and often lead to the conclusion that Bitcoin is too risky to seriously consider adding it to any portfolio.

BCA Research argues that looking at Bitcoin or any other asset solely through the prism of its volatility is misleading. What really matters is how the asset fits into the overall portfolio and affects its risk and return.

Focusing solely on volatility fails to see the bigger picture of how assets can add value in a diversified investment strategy.

A recent AQR paper that BCA Research applies to Bitcoin reframes the high volatility problem. Asness argues that high-volatility assets can be more capital-efficient than their lower-volatility counterparts.

This is because high-volatility assets like Bitcoin allow investors to earn higher returns without committing a enormous portion of their portfolio. This frees up capital for other investments, allowing for more pliant portfolio construction.

BCA Research illustrates this by comparing Bitcoin to a hypothetical low-volatility asset called Boringcoin.

Both Bitcoin and Boringcoin have the same risk-adjusted return profile, with identical Sharpe ratios of 0.61, meaning that on a risk-adjusted basis, both assets perform equally well. However, they differ in terms of volatility.

Boringcoin has the same volatility as bonds, 5.4%, significantly lower than Bitcoin. In practice, this means that investors would need to allocate more capital to Boringcoin to achieve the same portfolio returns they would get from a smaller allocation to Bitcoin.

The difference becomes obvious when we look at a portfolio targeting 10% annual volatility. In the case of Bitcoin, only 8% of the portfolio needs to be invested to achieve the ideal risk-return balance.

“For a Boringcoin wallet, there is a large gap between the unconstrained and constrained versions, as a Boringcoin wallet would need to be leveraged by more than 100% to fully maximize the expected returns per unit of risk from the assets contained within it, the analysts said.”

To expand on this, BCA Research conducted a portfolio optimization study comparing conventional stock and bond portfolios with portfolios including Bitcoin and Boringcoin.

Bitcoin’s high volatility allows it to deliver high returns with a relatively diminutive allocation, freeing up capital for other assets. In a well-constructed portfolio, Bitcoin’s volatility becomes a tool for maximizing capital efficiency, rather than a source of risk to be avoided.

Highly volatile assets like Bitcoin support achieve better returns per unit of risk that more conservative assets like Boringcoin cannot achieve without leverage.

However, managing an asset as volatile as Bitcoin in the real world comes with challenges that go beyond what portfolio theory suggests.

BCA Research points out that human emotions can complicate matters. Managing money for clients isn’t just about numbers; it involves dealing with how people react to market swings. In fact, investors may struggle with Bitcoin’s wild ups and downs, especially during gigantic drops.

While Bitcoin has seen losses of more than 70% at times, Boringcoin, with its lower volatility, has fallen by only 7% over the same period. This emotional challenge makes it hard for investors to stick with high-volatility strategies, even if they theoretically offer better returns.

In fact, BCA makes a compelling comparison between the price charts of Bitcoin and Boringcoin. Boringcoin, with its smoother trajectory, would be a much easier sell to a board of conservative investors than Bitcoin, which resembles a financial rollercoaster.

While Bitcoin may offer higher returns in the long term, the emotional burden of holding it in the face of edged declines in its value can lead to premature selling, erasing the benefits.