Analysis of Cryptocurrency as a Financial Instrument

Abstract

This paper provides a comprehensive analysis of cryptocurrency as a financial instrument, examining its underlying mechanisms, market structure, and risk characteristics. The study begins with an overview of cryptocurrency fundamentals, including blockchain technology and the evolution of the cryptocurrency market. Through quantitative analysis of daily returns for six cryptocurrencies and six traditional assets between January 2018 and December 2021, the research demonstrates cryptocurrency's distinctive risk-return profile. Principal Component Analysis reveals three major risk factors driving cryptocurrency returns, while clustering analysis identifies meaningful groupings among cryptocurrencies. The findings indicate that cryptocurrencies exhibit significantly higher volatility and tail risk compared to traditional assets but provide substantial diversification benefits when incorporated into conventional portfolios. Tangency portfolio analysis shows that adding cryptocurrencies to traditional assets substantially improves risk-adjusted returns, with the combined portfolio achieving a Sharpe ratio of 2.72, compared to 0.39 for traditional assets alone. The study further examines regulatory challenges, tax implications, and emerging frameworks, particularly within the European Union. This research contributes to understanding cryptocurrency's role in modern investment portfolios while highlighting the unique risks and regulatory considerations that accompany this emerging asset class.