While cryptocurrencies have historically been very short-term, speculative investment plays, there is now growing interest in crypto as a long-term retirement option. In April, for example, Fidelity Investments announced new Bitcoin (BTC -0.13%) investment options for 401(k) holders. And some political leaders in Washington, D.C., are now advocating for new legislation that will clarify exactly how crypto can be used by retirement plans.

But not all cryptos are suitable for retirement. Bitcoin, as the oldest and most valuable currency of this type, is really the only one that potentially belongs in your retirement portfolio. Here's a closer look at the risks and rewards of investing in Bitcoin for retirement.

High upside potential

The primary allure of Bitcoin, of course, is that it has the potential for stratospheric returns. Over the 10-year period from 2011 to 2021, Bitcoin dramatically outperformed a wide array of asset classes, including major benchmarks in stocks, bonds, commodities, and real estate, delivering average annualized returns of 230% per year. That annualized rate was more than 10 times higher than the second-ranked asset class (high-tech growth stocks) during the same period. 

Coins with the Bitcoin logo on them stacked on top of a stock market screen.

Image source: Getty Images.

Bitcoin will likely not deliver the same kind of returns over the next decade. After all, past performance is no guarantee of future performance. However, a number of influential Wall Street portfolio managers and Silicon Valley venture capitalists have predicted that Bitcoin could be headed to $1 million by 2030. At today's Bitcoin price near $17,000, that would be a return of more than 50 times on your initial investment.

High volatility

Of course, the flip side of this tremendous potential is the high volatility associated with cryptocurrencies. While the decade from 2011 to 2021 may have been fantastic for Bitcoin, the cryptocurrency's price has fallen a remarkable 65% in 2022. And it has suffered at least five other market crashes of similar or even larger size over its relatively short history.

Add all the uncertainty over the 2022 market meltdown and it's no wonder that some people are questioning the value of Bitcoin as a long-term investment. Some U.S. senators are now calling for Fidelity to halt its Bitcoin 401(k) offerings, as a way to protect the public from even greater risk.

Diversification benefits

While there is still plenty of skepticism on Wall Street about Bitcoin, there is also growing consensus that cryptocurrency is a high-risk, high-return asset class. As such, it can be added to existing portfolios in order to optimize returns. Since Bitcoin now accounts for nearly 40% of the entire crypto market capitalization, it's perhaps no surprise that Bitcoin has become the cornerstone of many investors' crypto allocation strategy.

The big question, of course, is just how much of a diversification benefit Bitcoin can provide. Until 2022, the conventional wisdom was that Bitcoin was completely uncorrelated with the broader market and could act as a useful hedge against market volatility. However, as the past 12 months have shown, Bitcoin is more closely correlated with the broader market than analysts once assumed.

Therefore, says Goldman Sachs, Bitcoin is really trading more like a high-risk tech stock high now. So it's unclear how much more of a diversification benefit you might get from investing in Bitcoin than simply from loading up on popular Silicon Valley tech stocks for your retirement portfolio.

Portfolio allocation

If you are comfortable with the risk-reward profile of Bitcoin, you also need to take into account how much of your portfolio should be allocated to crypto. Certainly, going with a Bitcoin-only retirement strategy would be completely unreasonable. In a matter of just a few days, you could lose everything. That's what happened back in 2011: The Bitcoin "flash crash" resulted in Bitcoin plummeting from $32 to $0.01 in just a few days. So, depending on how risk-averse you are, allocating no more than 5% of your overall retirement portfolio to Bitcoin probably makes the most sense.

How to deploy Bitcoin for retirement

In a best-case scenario, Bitcoin might be able to help turbo-charge your retirement portfolio, at least in the short term, as long as you are willing to take on significant risk. If you are behind in your retirement savings goals, for example, then Bitcoin might be a way to help you play catch-up. Or, if you are thinking about changing your retirement age from 60 to 55, then crypto might be a useful part of your strategy to achieve that goal -- as long as you recognize that you might not succeed.

Just keep in mind that Bitcoin should be part of an overall retirement mix that includes long-term investments. Right now, we really don't know how Bitcoin will perform over the very long term, so keep your hopes and expectations in check if you are thinking about retiring early.