Can You Beat the Crypto-Market?

Anton Muehlemann
Aug 31, 2017 · 5 min read

Warren Buffet’s “Million-Dollar Bet” is arguably one of the most famous performance tests in the financial industry. Buffet, who has always doubted hedge-funds, prominently said:

“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients.”

His certainty led him to strike a bet on the 10 year performance of a low-cost S&P 500 index fund managed by Vanguard and the average performance of five hedge-funds picked by Protégé Partners.

With the bet concluding at the end of this year one can safely say that the oracle of Omaha has won the bet — not marginally but by a landslide. Earlier this year Buffet’s index fund did not just beat the average of the five hedge-funds but even the best performer by 23% and the worst performer by a staggering 82%.

The rise of cryptocurrency trading

Token releases per quarter.*

With the recent boom of the blockchain industry, trading of cryptocurrencies, so called altcoins, has become increasingly popular and it is natural to ask the same classical question in a new context:

Can you beat the cryptocurrency market?

Similar to the world of classical stocks, we will refer to ‘the market’ as the TOP 5 cryptocurrencies by market cap summarized in a hypothetical index fund weighted by market cap.

We would like to compare six different trading strategies. The first portfolio shall contain the TOP 5 (alt-)coins by market cap (M), the second only small cap altcoins (S) and the last one only altcoins that are priced below $0.01 (L). For each composition we analyze two different weightings — equal weighting (e), i.e. if the portfolio contains 10 (alt-)coins, then each coin receives 1/10 of the total investment, and weighting according to market cap (c). Taking into account that most coins are divisible into 18 decimal places, the composition strategy (L) is certainly the most uncommon approach from a classical point of view but corresponds to a rule of thumb among many altcoin traders. The strategy (Mc) will be identified with ‘the market’.

Six different trading strategies according to weighting and composition.

Results

Each comparison starts at the beginning of the year and after the (alt-)coins have been purchased no further re-balancing is undertaken — in simple terms we ‘HODL’. The ‘Small Caps’ portfolio contains all altcoins except the TOP 5.

Return of investments from 2014–01–01 for the six different trading strategies.*

In early 2014, a total of 66 coins were available and only 8 were priced below $0.01. With a dominance near 95%, Bitcoin was basically ‘the market’. With the collapse of Mt. Gox in February 2014, entering the market in January 2014 was perhaps one of the worst possible times within the last few years. Nonetheless, as of today, an investor in the market (Mc) — or just in Bitcoin — has around 4.5 times his initial investment and was able to beat all other strategies (Me,Se,Sc,Le,Lc).

Return of investments from 2015–01–01 for the six different trading strategies.*

In early 2015, the number of available (alt-)coins increased to a total of 273 and 161(!) of them were priced below $0.01. Bitcoin dominance decreased to 78% and even though ‘the market’ increased by an impressive 1300% its performance was dwarfed by the strategies (Se) and (Le), which yielded 6,000% and 10,000% respectively.

Return of investments from 2016–01–01 for the six different trading strategies.*

At the beginning of 2016, a total of 298 coins were tradeable and 181 of them were priced below $0.01. Similarly to 2015, (Le) is the clear outperformer. Interestingly, all other strategies outperform ‘the market’ by at least 250%.

Return of investments from 2017–01–01 for the six different trading strategies.*

In early 2017, the number of tradeable altcoins had increased to 371 and 206 of them were priced below $0.01. The rather surprising trend from the previous years continued and again the ‘biggest loser’ (with a 600% ROI) was ‘the market’. This is even more surprising if we look at the currencies that constituted the TOP 5 (Mc) — BTC, ETH, XRP, LTC and XMR.

Conclusions

Assuming that the investor entered the market after 2015, there is a very clear answer to our original question:

YES! All alternative strategies beat the market significantly!

And to make things even stranger, one of the most obscure strategies (Le) was the most successful with a performance over 10,000%. With 6,000%, strategy (Se) ranks second and again confirms the observation that an emphasis on big market cap (alt-)coins is unsuitable to achieve a maximum return on investment.

A likely explanation of this phenomenon is the infancy of the crypto market and the participation of many individuals without a classical trading background. The psychological effect of being able to buy an (alt-)coin for less than $0.01 is a likely reason for the dominance of the strategy (Le) — however unreasonable it may seem.

Given this non-classical behavior, it may be no surprise that Buffet is against the very idea of cryptocurrencies and writes:

“Stay away from it. It’s a mirage, basically…The idea that it has some huge intrinsic value is a joke in my view.”

On the bright side, this attitude will prevent him from entering a bet that — at least this time — he is unlikely to win.

*Data Acquisition and Data Normalization

All data has been obtained from coinmarketcap.com, saved as an sqlite database, queried with Microsoft Access and visualized with Chartblocks. Care has been taken to avoid performance artifacts that may arise from a naive evaluation of the market performance. Particularly, we have not used the total cryptocurrency market cap as a performance indicator but rather the price development of each currency. For classical stock indices such as Dow Jones, DAX or FTSE this distinction is usually not necessary as the composition hardly changes and the total number of stocks of each company remains the same. Thus, the performance of the index replicates exactly the performance of an investor who invested in each stock weighted by market cap. In contrast, due to the constant creation of coins (mining) and the addition of new coins (ICO’s/token sales) the development of the total market-cap of cryptocurrencies exceeds the performance of that of an investor. Furthermore, all coins with a market cap below $10,000, without a price or with low volume were excluded from the comparison. Also, we did not consider any token sales as it is often a matter of luck if one is able to get in (cf. GNO, BAT) and/or the volume is restricted (cf. ZRX, CVC). Thus, a follower of our trading strategies could not expect the same performance. Of course, once the token is listed on exchanges it was included in the comparison.

Disclaimer: Nothing contained in this article constitutes investment, accounting, tax or legal advice or a recommendation to buy, or sell any (alt-)coin or other investment, management product or service or pursue any investment strategy. You should not buy any (alt-) coin unless you are prepared to sustain a total loss of the money you have invested plus any commission or other transaction charges. Moreover, past performance is not indicative of future results.

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