Bitcoin’s Sharpe Ratio slides to lowest since 2022. Here’s what it means.

Bitcoin $BTC$62,867.66 has dropped by 28% so far this year, a brutal slide that looks even worse through the lens of the Sharpe Ratio, a metric professional investors use to determine what slice of their portfolio should be allocated to a specific asset.

The Sharpe Ratio is the gold standard for measuring risk-adjusted returns and was developed by Nobel Prize-winning economist William F. Sharpe.

Bitcoin’s 365-day rolling Sharpe Ratio plummeted to -21 at the end of June, the lowest since late 2022, according to data source CryptoQuant. It was recently hovering just short of -20.

This deeply negative reading indicates that a bitcoin investor over the period took on extra market volatility while generating a return far worse than they could have earned on a risk-free investment, such as the 10-year U.S. Treasury note. The benchmark bond recently offered a yield of around 4.45%.

The Sharpe Ratio is calculated by subtracting the risk-free rate from the asset’s total return over a specific period, then dividing the result by the asset’s standard deviation (a measure of price volatility). A positive ratio means investors are being rewarded for taking the volatility risk. A negative ratio suggests they are being punished.

Professional investors don’t just look at a coin’s price relative to its long-term average to assess whether it’s cheap. They use metrics such as the Sharpe Ratio to determine position sizing.

Imagine two coins: A and B. Coin A has fallen 30% from its recent high, but in a fairly steady way. Coin B has also fallen 30%, but its price is all over the place, jumping up and down by big percentages every day. Looking only at the drop from the high, both coins look equally “cheap.”

A professional investor would look beyond the price drop and consider the risk-adjusted return.

In this case, A’s smoother price path might give it a Sharpe Ratio of, say, 1.5, while Coin B’s wild swings leave it with a Sharpe Ratio of just 0.5. So even though both have the same 30% drop, Coin A clearly outperforms per unit of risk, making it the more attractive choice for sizing a position.

Historical context

While a -20 Sharpe Ratio reflects a year of poor volatility-adjusted performance, it also lights up a rare bottoming signal for the token’s price.

Historically, every time the yearly risk-adjusted return has reached this level of “unattractiveness,” it has marked the point of maximum seller exhaustion.