Assessing the market efficiency of cryptocurrencies and its impact on portfolio performance

Abstract

This study employs variance ratio tests to examine the efficiency of Bitcoin and Ethereum markets and evaluates their contribution to long-only equity, bond, and cash portfolios. Efficiency is analysed over 2015-2024 and across three crisis windows: the US-China trade tensions (2018), the Covid-19 shock (2020), and the Russia-Ukraine conflict (2022). Bitcoin displays comparatively stable weak-form efficiency, while Ethereum shows clear post-2019 improvement, consistent with evidence of evolving efficiency in major cryptocurrencies. Both Bitcoin and Ethereum experienced a marked efficiency breakdown in 2020, consistent with evidence that strong price appreciations attract noise traders and speculative flows, increasing return predictability. In contrast, the 2018 and 2022 drawdowns coincide with periods in which efficiency remains intact, aligning with studies showing that declining markets tend to be dominated by relatively informed trading, thereby preserving weak-form efficiency even under stress. Employing both the Markowitz mean-variance and Black-Litterman optimisation frameworks, this study assesses the impact of time-varying efficiency in Bitcoin and Ethereum on their portfolio value across various crisis regimes. The findings indicate that during the trade and geopolitical disruptions of 2018 and 2022, both assets demonstrate relatively stable weak-form efficiency; however, their high volatility contributes to increased total and idiosyncratic portfolio risk, thereby limiting diversification benefits. Conversely, the Covid-19 shock in 2020 is associated with a significant decline in efficiency and increased return predictability. Portfolio analysis reveals that cryptocurrencies offer conditional enhancements in risk-adjusted performance, particularly within higher-risk allocations. Overall, the results suggest that Bitcoin and Ethereum function as context-dependent diversifiers, with their effectiveness varying according to prevailing market efficiency conditions (shaped by the type of market crisis) and investors' risk tolerance, rather than serving as universal hedging or safe-haven instruments. Taken together, the results establish a testable link between time-varying return predictability and the conditional diversification benefits of cryptocurrencies. For investors, the evidence suggests that Bitcoin and Ethereum act primarily as context-dependent diversifiers rather than as true hedges or safe-haven assets, and their high volatility requires careful portfolio allocation. In the South African setting, the findings point to potential diversification gains in equity-heavy portfolios an insight that may be relevant given that regulatory frameworks such as Regulation 28 currently preclude cryptocurrency exposure.