Friends frequently ask me for advice on how to start and manage a portfolio of cryptocurrency & blockchain assets, such as Bitcoin and Ethereum. I’ve been investing in the space for a while, and have enjoyed some success with a “traditional” portfolio management approach, which I share with friends whenever possible. After seeing beginners lured into paying (yes, really) for courses which offer worse material, I’ve decided to open-source my investment process.
If you’re considering an investment in cryptocurrency and blockchain assets for the first time, please read through this guide carefully.
This is my personal investment strategy; nothing contained herein is legal, tax, or investment advice. Please do your own research, and make your own decisions.
Why invest in cryptocurrency?
There are many definitions for what cryptocurrencies and blockchain assets “are”. From a legal perspective, countries and regulators are divided on whether they resemble currencies, securities, commodities, or (in the U.S.) property. But one thing is for sure: they are an entirely new asset class, defined by:
- High expected returns
- Low correlation to other asset classes such as stocks & bonds
- Extreme volatility
When managed correctly over an extended timeframe, the addition of cryptocurrencies can increase your overall portfolio’s risk-adjusted returns (as measured by the Sharpe Ratio).
How much should I invest?
Your allocation to cryptocurrencies should be viewed in the context of how it fits into your broader investment portfolio. If you’re older or approaching retirement, they should be viewed with caution, and a small allocation (such as 0.1% to 0.5%); if you’re younger, have a long time to retirement, and can stomach significant declines in value, a larger (1% to 5%) allocation may be appropriate. But there is one iron-clad rule: never invest more than you can afford to lose. You have to be prepared for wild volatility and declines of 50%+ in the value of your blockchain assets, which happens pretty frequently (but this will be a source of additional returns, which we’ll touch on later).
If you’re unsure of how much to allocate, set aside 1.0% of your investment portfolio, taken from your riskiest investments.
Where do I purchase cryptocurrency?
In the U.S., the two largest exchanges that allow you to purchase cryptocurrency with dollars (or “fiat money” as its called in crypto circles) are Gemini and Coinbase. Both are regulated financial institutions, customer friendly, and simple to use.
After you sign up for Coinbase, download Google Authenticator on your phone, and enable 2-factor authentication; seriously, don’t risk your investments; always use 2-factor authentication.
What should I invest in, and why?
Before you begin investing, you should establish your core principles; otherwise you’re just gambling or following hype. If you haven’t developed your own principles yet, borrow mine:
- Knowledge: You should understand, at a basic level or better, what you’re investing in. The more you understand the technology, the better
- Humility: You are not smarter than the market, you are unable to call the top or bottom, and you can’t pick the asset with the best performance
- Context: You are investing in cryptocurrencies because they are a valuable addition to a broader investment portfolio, which you will manage for years
As for the first part, you should begin learning what you’re about to invest in:
The Starter Portfolio
With those principles in mind, you can establish your starter portfolio. My portfolio started (and to this day resembles) a very basic one, designed to capitalize on both the growth of cryptocurrencies, and the inherent volatility:
- 20% cash —this provides stability & allows you to systematically take advantage of price declines
- 30% Bitcoin
- 30% Ether
- 20% Ethereum tokens
Executing your first trade
On Coinbase Pro, there are two basic types of orders; Market orders, which buy or sell at the best available price, and Limit orders, in which you specify the price you’re willing to buy or sell at. Limit orders have reduced fees (the lower the fee, the higher your return), and guarantee you the specified price, both great traits for building your portfolio.
Calculate the amount of Bitcoin you’d like to buy (by multiplying your total balance by your target allocation, and dividing by your limit price, such as $10,000 * 30% / $4,000), navigate to the BTC/USD market, and input a limit Buy order with the results. Wait a few seconds for it to fill — congratulations, you’ve just bought your first cryptocurrency! Navigate to ETH/USD, and do the same for your target Ether allocation. Starter portfolio: complete.
Rebalancing your portfolio
So you may be asking yourself “what now?” — we’ve built our portfolio. The answer is simple; we periodically rebalance our portfolio back to our target allocations to reduce risk, and in the process, buy low & sell high.
Cryptocurrencies & blockchain assets are notoriously volatile. When an asset experiences a large sell-off, it will become underweight in our allocation; when it experiences a significant rally, it will become overweight.
Let’s say Ether appreciates in value, and is no longer 50% of our portfolio (say, it’s 60%) — we would sell Ether for both cash and Bitcoin until our portfolio is back to our target allocation of 20/30/50. If instead it depreciates, and is say 40%, we would buy it with both cash and Bitcoin. This is why we have that cash allocation. You don’t have to “time” the market, you don’t have to try to swing trade or day trade, and you don’t have to even think really. Every so often, just bring your portfolio back into your target allocations, and you’ll naturally be buying low and selling high.
The primary benefit of a diversified portfolio are the risk-adjusted returns. You could always realize a higher maximum return by taking way more risk, and concentrating everything into one cryptocurrency. But a diversified, rebalanced portfolio should almost always have the best risk-adjusted returns. And you’ll sleep way better at night.
Above is a visualization of a 20/30/50 portfolio rebalanced monthly, arbitrarily on the 16th of each month; not at a particular top or bottom of any cryptocurrency. If you instead waited to rebalance after the really big price movements, performance is even greater. Measuring by the Sharpe ratio, our standard of risk-adjusted returns (bigger is better):
- 20/30/50 Portfolio: 18.5 (winner!)
- Bitcoin: 12.7
- Ether: 17.1
The past 12 months have seen both Bitcoin and Ethereum rally wildly; this is practically the “worst case” scenario for a diversified, rebalanced portfolio; in a sideways or down market, your portfolio will beat basically any other strategy.
As you begin to become more familiar with cryptocurrency and blockchain assets, after considerable research, you can begin to expand your portfolio in new directions. And eventually, you’ll be able to buy a Lamborghini using cryptocurrency. But until then, sit tight, and view this as a fun, responsible allocation in your broader investment portfolio.
If you have any questions, comments, or ideas on what you’d like me to talk about next, please leave a comment below!