Are you prepared to bet only on one cryptocurrency?
Imagine you could diversify with a single click…
The cryptocurrencies market is expanding fast, it has reached market capitalization of approximately USD 150 billion and includes already more than 1000 different cryptocurrencies. While bitcoin remains the largest cryptocurrency, investing only in bitcoin does not give investor true exposure to cryptocurrencies as an asset class and is not optimal from risk perspective.
Performance of bitcoin vs other cryptocurrencies
While the bitcoin, for many investors (and public), is the synonym for the crypto market and its performance has been stellar in the past years, there were cryptocurrencies significantly exceeding performance of bitcoin.
We have analyzed the performance of ten largest cryptocurrencies by market capitalization in past 12 months, 10 September 2016 to 9 September 2017 (“the observed period”). Please note, only cryptocurrencies with available data for the whole observed period were included in the analysis.
Even though the bitcoin achieved spectacular performance in the past year, all the other cryptocurrencies included in the analysis surpassed it.
One of the key challenges when observing the crypto markets is also missing benchmark for this market (Hedge Project is launching its Crypto Currencies TOP 30 Index in coming days), so we have constructed a simple index measuring performance of a portfolio constructed on 10 September 2016 with equal weights in all the aforementioned cryptocurrencies — no rebalancing was done in between. As expected, also this portfolio significantly exceeded performance of bitcoin.
Analyzing the correlations among cryptocurrencies, we can observe these are relatively low and correlations between bitcoin and most other cryptocurrencies actually even decreased in the observed period.
Highest correlation in the observed period can be observed between bitcoin and Lisk with correlation slightly above 0,400, while correlation between bitcoin and Ripple is almost negligible at 0,145.
Correlations observed are much lower than correlations usual in equity markets (0.6–0.9).
Constructing portfolio with securities that are not perfectly correlated is one of the foundations of traditional finance and portfolio management — diversified portfolios will beat non-diversified portfolios risk adjusted performance.
Low correlations imply even greater benefits of constructing diversified portfolio of cryptocurrencies.
Volatility of crypto market
Volatility measures dispersion of returns of individual asset or portfolio of assets — higher volatility, more risky the asset.
The volatility observed in the crypto market is much higher than volatility usually observed in the equity markets. VIX, index measuring volatility of the US equity market, reached record high of 150 during Black Monday (19 October 1987) and more recently it has peaked to 80 during last financial crisis on 20 November 2008.
Ignoring these extreme periods, usually VIX is around 15 and currently stands around 12.
In the observed period selected cryptocurrencies have achieved much higher price volatilities — even bitcoin, with lowest volatility, was by this measure more than 5-times risky than equity market. The portfolio with equal weights in different cryptocurrencies was more risky than sole investment in the bitcoin, but as shown above also achieved much higher return.
As demonstrated above, the investor with diversified cryptocurrencies portfolio would in the past 12 months manage to realize much higher return compared to investing only in bitcoin. Nevertheless, this portfolio also proved to be slightly more risky.
We have calculated daily risk adjusted return ratio which adjusts the performance for volatility — it measures rate of return achieved on one unit of risk.
While the portfolio constructed with selected crypto currencies in equal weights had slightly higher volatility (93% vs 71% for bitcoin), it also brought superior returns (2507% vs 578% for bitcoin).
Risk-adjusted performance as measured by our ratio was 1,4 for Index — EW and for bitcoin 0,4.
Actually, risk-adjusted performance of our index was superior to investment in every single currency, proving the benefits of constructing diversified portfolio.
Diversify with single click…
In next couple of days, Hedge Project will launch its first index, Crypto Currencies Top 30 Index — index will track performance of Top 30 cryptocurrencies and will be a very good proxy for the whole crypto market. This index will offer even better diversification than the simple equal-weight index we have constructed in this article.
Based on this index, Hedge Project will launch a Crypto Traded Index (“CTI”) — basket of crypto currencies closely tracking index. With CTI investor will be able to diversify easily and with low costs — with single click through Hedge Project Platform you will be able to buy a basket of cryptocurrencies and enjoy all the benefits of diversification as demonstrated in this article.