The Sharpe ratio was developed by Nobel laureate William F. Sharpe and is used to help investors understand the return of an investment compared to its risk. The ratio is the average return earned in excess of the risk-free rate per unit of volatility or total risk. Volatility is a measure of the price fluctuations of an asset or portfolio.
The Sharpe ratio is calculated as follows:
- Subtract the risk-free rate from the return of the portfolio. The risk-free rate could be a U.S. Treasury rate or yield, such as the one-year or two-year Treasury yield.
- Divide the result by the standard deviation of the portfolio’s excess return. The standard deviation helps to show how much the portfolio’s return deviates from the expected return. The standard deviation also sheds light on the portfolio’s volatility.
Cryptocurrency has a fabulous Sharpe. Bitcoin is fearsomely volatile, but it has more than made up for that with appreciation. The Coin Metrics Bletchley Index clocks bitcoin’s Sharpe ratio over the past five years at 1.6.