The original post: /r/cryptocurrency by /u/nobjos on 2024-11-22 11:51:51.
Scottie Pippen, who is in the NBA Hall of Fame, tweeted the following on Sep 4th:
While we can all wish Nakamoto to give us stock tips in our dreams, a more realistic strategy would be to Dollar Cost Average (DCA) into crypto.
The good news is that a lot of investors are doing that — According to the report from Kraken:
- 59% of crypto investors use DCA as their primary investing strategy
- 83% have used DCA to make their investment
- The most common reason for DCA was to hedge against market volatility
The bad news is that, unlike stocks, crypto markets are relatively new, and there is little information about how a DCA strategy performs over the long term. In fact, the market is so nascent that Coinbase launched a crypto benchmark (comparable to, say, the Dow or S&P 500 for the crypto world) just last week.
The Crypto Universe
Here is a wild stat: only ~4,300 publicly traded companies are in the U.S., but more than 15,000 cryptos are actively trading right now.
Of the more than 40,000 coins that traded in an exchange at least once in the last 10 years, only 38% are still alive. So forget about making a profit — the probability that the coin you buy will survive over the long run is only ~ 1 in 3.
Total number of coins: 40,399 | Source: Market Sentiment Research, CoinGecko
What’s fascinating is that Cryptocurrencies follow the exact same power law exhibited by the stock market, where a few winners contribute massively to the overall market. As of Nov’24, the global crypto market cap was ~$2.9 trillion, of which $1.7 trillion (60%) was contributed by Bitcoin.
The top 10 coins contributed to a whopping 89% of the total crypto market. (For comparison, the top 10 companies in the S&P 500 only contribute around 30% of the index)
Bitcoin: DCA vs Lump Sum
The simple fact is that most of us cannot handle the volatility associated with Bitcoin.
Take a look at this fantastic chart put together by my friend at Ecoinometrics
Crypto Drawdowns as of Oct’22 | Source: Ecoinometrics
Holding a crypto portfolio makes the Global Financial Crisis look like a walk in the park. So, it’s natural to consider DCA as a better strategy to invest in crypto.
So, does it work?
The backtest is simple — Let’s assume that you had $100 to invest in Bitcoin every month. Either we can invest $100 every month or put $1,200 at the beginning of the year.
Here’s how your portfolio would have performed by the end of the year:
Analysis: Market Sentiment Research | Data: CoinGecko API
If you invested a lump sum into Bitcoin instead of DCA, you would have come out on top ~66% of the time. Since Bitcoin has extreme volatility, DCA outperforms only during drawdowns.
Case in point — 2018 & 2022. In both bear markets, someone who did DCA would have had a much lower drawdown than someone who invested a lump sum at the beginning of the year.
On the other hand, the same safety mechanism that helps you during bear markets will cost you during bull runs. In the 2017 Bitcoin run-up, the lump sum strategy outperformed DCA by an incredible 700%!
So, if you have a relatively long holding period (at least 12 months), investing in one go is statistically better than splitting it across the year (Given you can stomach the volatility).
Building a Crypto Index
While Bitcoin is synonymous with Crypto, investing in only Bitcoin seems reckless and entirely against the whole “have a diversified portfolio concept”. So, what if instead of just investing in Bitcoin, we split our investments across the top 10 Cryptocurrencies based on market cap?
Before we jump into the results, here is a visualization of how the Crypto market has changed over the years (I have removed stablecoins).
https://www.youtube.com/watch?v=I5amDzCTwIU
In this backtest, instead of investing $100 per month into Bitcoin, we equally split our investment into the $10 across the top 10 Cryptocurrencies (as seen above in the video) based on their market cap.
The results are stunning:
- $100 invested monthly into the top-10 cryptocurrencies starting in 2014 would have grown to $650K+ by 2018 and an incredible $1.6M+ by 2021.
- The top-10 portfolio had a CAGR of 111% (yeah, not a typo) over the last 10 years - And irrespective of the year you started, you beat S&P 500!
- Even with all this, the Bitcoin-only portfolio gave a better risk adjusted return.
Source: Market Sentiment Research
What’s interesting is that, after 10 years, both strategies have comparable final portfolio values ($1.02M for Top 10 DCA & $950K for bitcoin DCA). This mainly comes down to alt-coins having extreme drawdowns during bear markets.
While the top-10 strategy beat bitcoin-only strategy, it did so with a much higher portfolio volatility. Case in point — after the run up in 2018, your top-10 portfolio would have had a drawdown of 94%! This extreme volatility meant that a bitcoin-only portfolio provided a better risk adjusted return.
Even though both portfolios had incredible performance, crypto was barely a known asset in 2014. What if you had started late? Would your returns be significant enough to follow this strategy?
Buy & Hold Portfolio returns | Source: Market Sentiment Research
No matter which year you started, both portfolios provided significant ROI and beat the S&P 500 by a wide margin.
Why diversification wins during bull markets:
In stock market, concentrated bets are more likely to provide better returns since market cannot move so much. But given the relatively small size of the crypto market, there are benefits to splitting your investments.
To explain the outperformance of the top-10 portfolio, let’s take the example of Ripple (XRP). Ripple was the third largest coin at the beginning of Jan 2017 — But it only had a market cap of $240 million.
2017 was incredible for the crypto ecosystem. The overall market cap jumped by 25 times. But when you look closely,
- Bitcoin — 12x in 2017
- Ripple — 262x in 2017
Extrapolate this across other coins and you can see how holding alt-coins can be valuable during bull markets.
Tokenized ETFs
With the launch of Coinbase 50 Index, we are hopeful that more and more players will move into this ecosystem to bring low-cost index funds to the market. Right now, the only comparable and established option is the Bitwise 10 Crypto Index Fund which invests in the top 10 cryptocurrencies based on market cap.
While the fund has a 5-year CAGR of 45%, it’s hard to recommend it given the extraordinarily high expense ratio of 2.5%. The optimal strategy would be to get in now to get exposure and shift to future funds having a lower expense ratio once the market matures.
Optimal Allocation to Crypto
Since asset allocation is the most important decision in investing, it’s interesting to see how much of your portfolio you should allocate to crypto.
Analysts at Quantpedia created an equal-weight portfolio of globally diversified asset classes, including Bitcoin, and used the Markowitz model to find the optimal allocation to Bitcoin.
They split their analysis time periods into 2:
- 2013 to 2017 — Bitcoin was an...
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