In my previous article, I argued that a passive crypto investor would have benefited more from allocating capital into BTC rather than a crypto index fund. In this article, I am looking to analyse alternative investment strategies a passive crypto investor may consider.
Methodology
To analyse the strategies, I have taken a period between 1 January 2017 and 12 June 2019, covering both a bull and a bear market. Within this period, I look at all 30+ day periods within these dates, obtaining 375,000 observations. This approach is taken in order to avoid the bias caused by picking a particular investment date and evaluation date. All strategies assume that 50% of an individual’s net worth is allocated to cash. A 20% rebalancing threshold has been chosen for reallocation between the crypto and the cash portfolio constituents. This means that the first rebalancing will be triggered roughly after the crypto portfolio doubles or halves in price.
BTC threshold rebalancing
The first improvement over a simple BTC buy-and-hold strategy one could consider is to undertake a threshold rebalancing with cash or other assets. Threshold rebalancing reduces the volatility of the overall portfolio and allows an individual to benefit from crypto volatility passively.
So, comparing returns of a portfolio consisting of 50% cash and 50% BTC with rebalancing over the same portfolio without rebalancing, we get the following results.
In 62% of observations, rebalancing produced incremental gains over a buy-and-hold strategy. The distribution of extreme over/underperformance is also favourable with 26% observations showing an improvement of over 25%, while only 5% observations underperformed by over 25%.
This suggests that rebalancing with cash or “taking profits” is a better strategy than hodling. For this reason, any subsequent strategies will be measured against this BTC rebalancing strategy.
How does index investing with rebalancing compare?
To answer this question, I will look at some institution-grade indices, including
- Bitwise100 — an index of top 100 cryptocurrencies
- Bitwise70 — an index of small caps comprising top 30–100 cryptoassets
- Bitwise20 — an index of large caps comprising top 10–30 cryptoassets
A portfolio consisting of 50% Bitwise100, 50% cash with 20% threshold rebalancing delivers subpar returns on average with only 41% observations showing better performance as compared to BTC. Similar results are achieved when looking at Bitwise20.
A potential explanation for this underperformance lies in the previously identified the trend of BTC outperforming altcoins in the long term.
Does this hold true during all periods?
There have been periods when a basket of altcoins outperformed BTC. An example of such a period is 2017 when BTC dominance halved from c. 85% to c. 40%.
Despite the favourable time to hold altcoins, in only 63% of observations investing in the Bitwise100 index proved more lucrative than investing in BTC.
A portfolio comprising 50% cash and 50% Bitwise70 index outperformed more due to lack of BTC as one of its index constituents.
A portfolio consisting of 50% cash and 50% Bitwise20 index outperformed even more with more than half observations outperforming by over 25% the BTC rebalancing strategy.
As outlined above, though, this strategy doesn’t generate superior results over longer time frames as demonstrated by looking at the full period between January 2017 and June 2019.
A potential strategy for returns maximisation would be to switch between investing in BTC and an altcoin index depending on BTC dominance trends. However, this is not a passive approach and hence does not fit the scope of this analysis.
Does allocating a portion of the crypto investments to altcoins with rebalancing allows an investor to benefit from altcoin volatility?
To answer this question, we look at how a portfolio consisting of 50% cash, 25% BTC, 25% Bitwise20 with rebalancing stacks against a portfolio consisting of 50% cash and 50% BTC with rebalancing. We see that this approach would have on average neither outperformed nor underperformed our base portfolio. However, at the extremes, it would have produced over 25% outperformance in 21% of outcomes while only 3% of outcomes would have produced a more than 25% underperformance.
Conclusion
Based on the analysis, a passive investor is still better off allocating 100% of his crypto capital into BTC and rebalancing it into cash at a 20% threshold ratio for a 50% cash, 50% BTC initial portfolio.
This strategy, however, exposes the investor to a risk of BTC losing its historical dominance. To reduce such risk, the investor may consider allocating 50% of crypto capital into an index that does not contain BTC (such as Bitwise20 or Bitwise70). On average, such a portfolio would perform in line with a 100% BTC one, but it is more likely to significantly outperform than significantly underperform the 100% BTC approach.
