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Bitcoin is a pretty crazy asset and has the ability to make sensible investors behave completely irrationally.

When the price is rising, people suddenly feel they need to buy before they miss out. When it falls sharply, many of those same people decide the whole thing was a mistake and prematurely sell at a loss.

I prefer a much simpler approach. I want to understand what Bitcoin is, accept the volatility that comes with it, and give it a small, controlled place within a my much broader portfolio.

For me, that means a maximum allocation of just 2%.

Bitcoin is a digital asset that operates without a central bank, government or company controlling it.

It was launched in 2009 and is supported by a global network of computers. Instead of transactions being recorded by a traditional bank, they are recorded on a public digital ledger known as the blockchain.

The easiest way to think about the blockchain is as a giant shared accounting book.

Every Bitcoin transaction is grouped into blocks, and those blocks are linked together in chronological order. The network checks that transactions are valid before they are added.

Because the system is distributed across many computers, there is no single organisation sitting in the middle controlling it.

That decentralisation is one of Bitcoin’s defining features.

One of the most important things to understand about Bitcoin is that its supply is limited.

There will only ever be 21 million Bitcoin.

New Bitcoin enters circulation through a process called mining, where computers compete to validate transactions and add new blocks to the blockchain. Successful miners receive newly created Bitcoin and transaction fees.

However, the amount of new Bitcoin created gradually falls over time. Roughly every four years, the reward paid to miners is cut in half in an event known as the halving.

That means the supply of new Bitcoin becomes increasingly restricted.

This scarcity is a major part of the investment case. Unlike pounds or dollars, more Bitcoin cannot simply be created because a government or central bank decides that more is needed.

This is one reason Bitcoin is often described as digital gold.

Scarcity alone does not make something valuable. A company can generate profits. A share can pay dividends. A property can produce rental income.

Bitcoin does none of those things.

Its value depends on supply, demand and what investors are prepared to pay for it. Bitcoin has delivered extraordinary gains at different points in its history, but it has also suffered very severe falls. Declines of 50% or more have happened several times.

Anyone buying Bitcoin should be comfortable with the possibility of large losses along the way.

I limit my Bitcoin ownership to a maximum of 2% of my overall portfolio value.

My core investments remain diversified equities. Those are the assets I expect to do most of the work over the long term. Bitcoin sits alongside them as a small satellite holding.

I like this balance because it gives me exposure to Bitcoin’s potential without allowing it to dominate my portfolio. If Bitcoin performs exceptionally well over the next decade, a 2% position can still make a meaningful contribution.

If it performs badly, or ultimately fails to live up to expectations, the damage to my wider portfolio should remain limited.

I would rather own a small amount comfortably than own too much and spend every downturn worrying about it.

I currently use Kraken as my cryptocurrency exchange, and deposit around £50-£100 per month.

An exchange is simply the platform where you convert normal currency into Bitcoin. In that sense, it is similar to using an investment platform to buy shares or funds.

I transfer money onto Kraken, buy Bitcoin, and then decide where I want to hold it. I also prefer buying gradually and regularly rather than trying to predict the perfect entry point. This approach is known as “dollar cost averaging” and remains quite a common stocks investing strategy amongst investors today, especially those who like to try and balance out the risk associated with large one-off deposits.

Bitcoin can move very quickly in both directions, and trying to time those moves can easily turn investing into speculation and spell disaster.

Once you own Bitcoin, you also need to think about custody. If you leave Bitcoin on an exchange, the exchange holds it on your behalf. That is convenient, but it means you are relying on a third party to keep your assets secure. There have been countless examples of hackers accessing Bitcoin exchanges, so you have to be careful.

The alternative is self-custody.

A cold wallet is a hardware device that allows you to control the private keys linked to your Bitcoin while keeping those keys offline.

The Bitcoin itself does not physically sit inside the device. The wallet protects the digital credentials that prove you control it.

Keeping those credentials offline can reduce exposure to online attacks, but it also means you are responsible for keeping them safe. Losing your cold wallet and/or the associated passcodes for example, may prevent you from ever accessing your Bitcoin again in the future.

Bitcoin is one of the most interesting assets I own. It combines technology, scarcity, economics and speculation in a way that is very different from conventional investments.

I am happy to have exposure to that potential and I am equally happy to keep that exposure small. My equities remain the foundation.

Bitcoin gets 2%.

And that is more than enough for me!

The Compounder
Long-term investing made simple.

The Compounder is for financial education and commentary only. I am not authorised or regulated by the Financial Conduct Authority and I do not provide financial advice, investment advice, or personal recommendations. Nothing published here should be taken as a recommendation to buy, sell, hold or switch any investment, fund, pension, ISA, crypto asset or financial product. Always do your own research and consider speaking to an FCA-authorised financial adviser if you are unsure.