Can we optimize a crypto portfolio?
As a new type of asset, cryptocurrencies are gaining recognition from more and more investors. According to a survey released by Fidelity in June, more than 80 percent of institutional investors find the asset extremely attractive. VanEck, a leading U.S. asset management platform, has made an analysis of the advantages and disadvantages of Bitcoin investment. With the growth of the cryptocurrency industry, it has become consensus in the market that the allocation of cryptocurrencies can enhance returns and reduce the volatility of traditional asset portfolios.
However, what must be prioritized is that the decentralized investment of cryptocurrency has more uncertainty than that of traditional commodities. Marketing Stories have exaggerated motivations, while technical realities are difficult to align, and the cost of properly evaluating each token is high. Without a full understanding of a token, judging the value of a currency based solely on the marketing story told in the white paper and adding it to a portfolio with the goal of diversification is tantamount to making an unprepared stock investment. This only increases risk and loses the meaning of diversification. It is doubtful whether investors can actually achieve better performance at a lower cost and in a more environmentally friendly way.
This article will analyze the feasibility of crypto portfolio investment from the perspective of the risks and potential solutions of cryptocurrency portfolio investment.
The uncertainty of crypto portfolio
Risk of price volatility of cryptocurrencies
The price of cryptocurrencies fluctuates more than stocks, a high volatility and high return asset. In the past 10 years, Bitcoin has experienced three price drawdowns of more than 70%, in 2012, 2013 and 2017, while The U.S. S&P 500 has only happened once in the past 100 years. However, Bitcoin is already a relatively stable currency among thousands of cryptocurrencies, and other cryptocurrencies with small and medium-sized market capitalizations have greater risks and drawdowns.
In addition, the regulation of cryptocurrencies by different governments around the world will affect the liquidity of cryptocurrencies in the global market, thereby
affecting the value of cryptocurrencies, which in turn will aggravate price fluctuations.
This can affect portfolio adjustments. Which Token models are really valuable? Which ones will deliver solid benefits over the long term? How can traders judge the value of cryptocurrencies and adjust the portfolio at a reasonable point in time to boost the Sharpe?
Security risks in the Exchanges
In August 2021, cryptocurrency platform Poly Network was hacked and lost $610 million in customer funds. However, similar conditions are not uncommon. Investors need to carefully choose trading venues and trading volumes to avoid excessive risk aggregation.
High cost in optimization process
The key to cryptocurrencies is a store of value. The increase in value can enhance the price of cryptocurrencies. But can the increase in value continue in the future? How long can it last?
Ideally, multiple cryptocurrencies have positive market expectations and a weak correlation, so diversification can effectively reduce non-systemic risk and achievemore ideal returns. However, as with traditional asset investing, the value of assets is constantly changing, and it is very time-consuming and laborious to understand each cryptocurrency and select assets worth allocating from them. Furthermore, this optimization process may consume huge amounts of energy, which is contrary to some investment philosophies that emphasize ESG. Therefore, there is still a long way to go to achieve multi-faceted cryptocurrency portfolio optimization.
Some details to consider
Choice of portfolio target
a) Carefully allocate cryptocurrencies that you know very well, and never allocate cryptocurrencies that you don't know.
b) Increase the diversity of cryptocurrency portfolios.
c) Increase the diversity of the market-wide portfolio. Since cryptocurrencies have less correlation with traditional assets, the combination of cryptocurrencies and traditional assets can effectively reduce portfolio risk.
Frequency of reallocation
Due to the high volatility of cryptocurrencies and the uncertainty of some currency's value, cryptocurrency investment is more speculative. Therefore, it may be more effective to increase the frequency of reallocation and implement short-term investment.
Design details of strategy
There are many areas of research that can drive cryptocurrency portfolio optimization, for example, designing models to catch the volatility of cryptocurrencies.
Optimization of Exchanges
At present, the cryptocurrency trading environment is harsh, and factors such as hacking attacks and different prices on different platforms have brought great concerns to cryptocurrency investors. Therefore, the optimization of the trading environment will also bring benefits to the optimization of cryptocurrency portfolios.
From naive diversification, Markowitz diversification, and an advanced Black–Litterman model to more advanced and complex models, cryptocurrency portfolio optimization models have made great strides. But the field is still relatively young. The high volatility of cryptocurrencies, the harshness of the trading environment, and the energy consumption of cryptocurrency investment, etc. have brought great obstacles to the optimization of cryptocurrency portfolios. Perhaps in the near future, the resolution of these problems can bring breakthroughs to the optimization of cryptocurrency portfolios.