In search of steady returns
This post explores the case of constructing a diversified portfolio for crypto investors.
Introduction
This is the first of a series of blog posts about general investment strategies, risk and asset allocation in crypto-assets and DeFi instruments.
Such posts aim to become increasingly more detailed over time.
Bitcoin and crypto assets have introduced many people, particularly millennials, to markets, investing, fundamentals and other economic concepts for the first time.
I personally believe this has been a phenomenal form of education and exposure that will shape a new generation of investors.
The younger generation buys Bitcoin and then stocks. Not stocks and then Bitcoin.
While many forward-thinking crypto funds are spending significant time to build the case for crypto in an institutional portfolio, I find relevant to do the opposite for first-time crypto-only investors.
The data is clear, over 82% of millennials say their investment decisions were influenced by the 2008 financial crisis when $14 trillion in wealth was wiped out from the market. A vast majority of young adults in the period 2008–10, as short-term interest rates for the various central banks in the United States and Europe moved close to zero, have seen 50% or more of their parents’ wealth wiped off.
Only one in three millennials are investing in the stock market, compared with 51% of people of the prior generation, Generation X.
Despite the unpredictable nature of the crypto market, generally speaking, millennials find investing in tokens less intimidating than putting money in traditional investments.
However, crypto-assets can be risky in isolation and blindly HODLing without proper asset allocation can be stressful, as the 65% drawdown in Bitcoin at the beginning of 2018 showed.
The significant shift in people’s relationship with money which occurred in the last decade has, however, valid roots. The combination of macro-trends in economic, political and technological forces has reasons to raise concerns.
- Decreasing trust in institutions.
- Job displacement.
- Underfunded pension liabilities.
- Raise of automation an AI replacing labor.
For more information about the subject, I strongly suggest reading the 134 pages report authored by Meltem Demirors and Marty Stenson from CoinShares Group.
Traditional portfolios offer a range of investment options including stocks, bonds, commodities, and cash. While such a portfolio has long been considered diversified, a growing number of people fear that may not be the case with respect to certain systemic risk events that seem to be growing in probability.
That is why I believe that crypto is now an essential asset class for any modern portfolio. As the chart below shows, there is little, if almost, no correlation between BTC and traditional asset classes.
Volatility & HODLing
Bitcoin had a strong performance during the 2014–2019 time frame with outstanding total returns, sometimes as high as 67.70%.
Similarly, volatility has soared significantly with it, as you can see in the chart showing price action and 30-Day BTC/USD Volatility between Jan 1, 2014, and Jan 1, 2020
There are many well-written posts on Medium explaining how HODLing destroyed thousands of portfolios, as well as, how HODLing doesn’t fit the cryptocurrency market profile related to the opportunity cost of not trading it actively.
Unfortunately, many first-time crypto investors got themselves into exactly this kind of problem in 2017 by buying and HODLling their positions without having a backup plan.
What can we take away from this? HODLing obviously is not an optimal strategy but does it mean we should all become active traders?
I believe the answer is to bring best-in-class asset allocation to the decentralized finance world.
Such instruments will provide a buy-and-hold strategy that allocates your assets in such a way that it should get you through different market regimes.
An essential ingredient to our plan to bring financial freedom to anyone.
“It’s almost certain that whatever [asset class] you’re going to put your money in, there will come a day when you will lose 50%–70%.”
— Ray Dalio
Loosing 50% of your money is never good, sometimes it can be devastating.
Fear not though! If the Star Wars saga taught us something is that:
Such risk can be mitigated by the (nearly) symbiotic relationship between diversification and rebalancing. I will elaborate more in a future post, I’ll just say for now that the two concepts are inextricably linked.
Assets like crypto and stocks have natural volatility in price movements.
Rebalancing a diversified portfolio accounts for the volatility in the form of a rebalancing premium and ensures that the portfolio remains diversified, helping to mitigate overall portfolio risk.
The importance of diversification
I think the single most important thing you can do is diversify your portfolio.
You might think about diversification as simple as: don’t put all your eggs in one basket.
Based on my experience, a portfolio allocation designed for resilience pays off, particularly in the worst cycles. It proves just as useful in crypto markets as it always has in traditional markets. No exceptions.
It also helps protect your wealth in the long term, Warren Buffet often said:
“Rule number one: never lose money.
Rule number two: never forget rule number one.”
— Warren Buffet
Lastly, thinking about diversifying your portfolio helps with a common human brain bug, the tendency to stick with what we think we know. A phenomenon that is spreading every day more in crypto communities in the form of tribalism and maximalism.
Conclusion
I want to keep these posts short enough, more will come with a greater amount of details.
As always, I invite you all to be an active part of our community, specifically, I ask you to come to talk with us about:
○ Your financial goals
○ Your risk profile in investing
○ Your investment thesis
For more up-to-date information, sign up to our newsletter, follow me on Twitter and talk to us at:
⭑ Discord: dexwallet.io/discord
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⭑ Github: github.com/dexlab-io
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⭑ Email: founders@dexlab.io
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