Quantitative Analysis of Altcoins, part III

In part I and II I did a quantitative analysis on altcoins and possible strategies on how to capitalize on their weakness compared to bitcoin.

In Part III we will see how to allocate a portfolio starting with Fiat currencies.

In the table below you will find cryptos with relative gains (G) and volatility (RMS) against the dollar using all the historical data available, as data source was mainly used  poloniex and bittrex exchanges, for bitcoin has been used Bitstamp.

In red the cryptocurrencies with negative Gain against the USD.

Cryptocurrency  Gain (G) Volatility (RMS)
Bitcoin 1.0045 0.0796
Ethereum 1.0033 0.0863
Ethereum Classic 1.0031 0.076
BCash 1.0029 0.1535
Eos 1.0024 0.1355
Dash 1.0013 0.0894
Monero 1.0007 0.0781
Stellar Lumens 1.0005 0.1207
Ripple 1.0004 0.1115
Iota 0.9984 0.127
Qtum 0.9979 0.1224
Litecoin 0.9976 0.095
Bitcoin Gold 0.9966 0.0983
Next 0.9954 0.11
Zetacash 0.9902 0.1104

It’s pretty obvious that i’ll not consider any crypto with negative Gain and Bitcoin is clearly the winner with the best Gain and low volatility compared to the rest. I exclude also all the crypto with positive Gain but with high volatility because the main objective is to allocate a portfolio with the lowest possible volatility.

The remaining crypto are:

  1. Bitcoin
  2. Ethereum
  3. Ethereum Classic
  4. Dash
  5. Monero

Ideally it should be allocated the same amount of money on each asset but to compute the fraction of your capital to put on each asset i use the same formula seen in Part I & II.

F = 2P - 1

Where F is the optimal fraction of your capital to wage in a single trade and P the persistence or Shannon Probability, concepts already explained in Part I & II.

Cryptocurrency  Persistence (P) Fraction of your capital to wage (F)
Bitcoin 0.55 10%
Ethereum 0.5441 9%
Ethereum Classic 0.5317 6%
Dash 0.535 7%
Monero 0.5286 6%

Thanks to the formula F=2P-1 I know how much to wage on each crypto for a total of around 40% of your capital to invest in crypto. The remaining 60% could be invested in traditional stuff of your choice (equities, bonds, real estate). But let see in detail a simple portfolio management strategy.

Simple Portfolio Management Strategy

  1. Maintain about ten, or more, equities in the portfolio.
  2. Maintain about equal asset allocation between the ten equities.
  3. Consider the investment horizon from one to four calendar years.
  4. Be skeptical of investing in assets with less than a two and a half year history with a minimum of four and a half years.

Four simple policies listed in order of importance, and the second policy is the one that makes the money or the “engine” of the strategy. A short investment horizon is mandatory because “risk management” is an important part of financial engineerin g and given enough time, no matter how small the risk, it will bite.

At the moment there aren’t ten cryptocurrencies that satisfy my needs in terms of Gain (G) and Volatility (RMS) so I have to find a compromise, using only five crypto and, personally, i prefer to don’t maintain an equally asset allocation among all cryptos because there is a huge difference in terms of size between Bitcoin and the others. Another issue is that many altcoins have less then 2 years of history because this new sector is relatively new so it is difficult to respect rule number 4.

Another important concept is how frequent to balance the portfolio. Doing it every day is really not necessary for the casual long term investor. An interesting choice is to rebalance asset allocation if there is an asset that exceed all the others by 5-10%. Basically when one asset increased in value more than the others, money should be removed from the investment, and re-invested in all the others thus defending the gains through investment diversification.

Aggressive Portfolio

Aggressive Asset Allocation with ~40% in crypto (click to enlarge)

The suggested asset allocation is intended as very aggressive having almost 40% allocated in cryptocurrencies, I would advise not to follow this if you are over 65 or if you have a family with kids. In this case I would suggest a maximum of 10% invested in cryptocurrencies (e.g. 6% Bitcoin, 4% Ethereum or 6% Bitcoin, 2% Dash, 2% Monero).

In the case of a very conservative asset allocation, for who has a very low risk tolerance, I would not go beyond 5% allocated in cryptocurrencies.

Personally i’ve a very high aggressive asset allocation but I’ve all the time and experience to follow carefully my Portfolio and to act accordingly to new information on a daily basis.

In the future i might publish other updates about the subject with updated quantitative data on altcoins/bitcoin.

 

 

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Offtopic: Quantitative Analysis of Altcoins, part II

In part I, I did a quick analysis of altcoins compared to XBT, this time i’m going to check their performance using all available data of each altcoin since inception date using daily data instead of weekly to improve the granularity of the analysis because, the finer the granularity of the analysis, the better the insights for understanding the characteristic of the asset.

ALTCOIN Gain (G) Volatility (RMS)
Ethereum      0.998               0.072
Monero      0.996               0.073
Next      0.995               0.074
Dash      0.993               0.111
Litecoin      0.991               0.115
Ethereum Classic      0.990               0.084
Stellar Lumens      0.987               0.135
Eos      0.981               0.126
Iota      0.979               0.117
Bitcoin Cash      0.977               0.161
Ripple      0.975               0.187
Zetacash      0.947               0.201
Qtum      0.912               0.265
Bitcoin Gold      0.740*               0.570*

*Note that because of the very short size of the Bitcoin Gold dataset, its Gain (G) and volatility might change a lot in the long run.

If I were forced to assemble a portfolio of altcoins, i’ll probably opt for low volatility alts, like Ethereum, Monero, Next and Ethereum Classic. Eventually I would add Dash and Litecoin because by increasing the number of assets as a result I will reduce the final volatility of the portfolio.
At the end of this post you will find what i’d actually do if asked to diversify an initial capital of bitcoins.

To give you an idea of the Gain (G), you have to power this number to the number of days interested, for example (G)^365 will give you the average value of your asset in 1 calendar year.

For Ethereum is:

0.998^365 = 0.4815

or a 52% expected decrease in value towards XBT in 365 days.

How Much to allocate individually on each altcoin?

This is a simple question with a simple answer, the formula to obtain the fraction of your capital to wage on a particular asset is:

F = 2P - 1

Where P is the Shannon Probability and F the optimal fraction of your capital to wage. The Shannon probability of a time series is the likelihood that the value of the time series will increase in the next time interval. The Shannon probability is measured using the average, avg, and root mean square (volatility), rms, of the normalized increments of the time series as i explained in previous udpates.

For Monero is:

F = 2 * 0.4953 - 1 = -0.0096 or ~1% as an optimal fraction to wage

For Ethereum is:

F = 2 * 0.5079 – 1 = 0.0158 or 1.6% as an optimal fraction of your capital

Monero has both the Persistence and Gain negative but what about Ethereum? How is it possible to have a positive persistence and negative Gain (G = 0.998)?

Well the point is that an asset’s gain in value can be negative, even though the likelihood of an up movement is greater than 50% or 0.50 (in this case 0.5079). How can the time average of something be positive, and result in negative values?

It may seem counter intuitive, but just because the average daily gain in value of an asset is positive, is not sufficient evidence that the asset’s value will increase or be a decent investment.

Do we really see asset class with these kinds of price characteristics?

The answer is that we do. During the dotcom equities bubble of the 2000, about half of the equities had these characteristics; many were to fall the hardest, too. I think the same about many altcoins/ICO, they will end badly in comparison to Bitcoin.

This is why a possible asset allocation might be to go short against Altcoins with a fraction of your Bitcoins (says 10% shorting 5 crypto); it is a strategy that might suffer some losses in the short term if you are unlucky with volatility going against you, but it will surely win in the long run.

In the upcoming PART III – We will better understand how to assemble a portfolio of cryptocurrencies starting with EURO or USD instead of Bitcoin and it’s intended for who hasn’t yet invested in any Crypto.

 

Offtopic: Bubble Mode ON

ethusd
ETHUSD daily chart

After many requests for a possible target i tried to find a solution with a very long term price interpolation channel of this popular altcoin. I did my best to find a decent volatility factor to compute the deviation lines, the attached chart is my best fit.

I think that the next stop is around 35$ (two standard deviation), i’d be very surprised to see this altcoin above it but anything is possible at poloniex, the realm of newbies and whales:)

Aniway the very first resistance has already been broken; I, therefore, think there are chance to reach 35$ at bubble peak.

About Dash, the six sigma deviation line is around 82$, hardly this altcoin will stay above it for a prolonged period of time, eventually a quick spike to 95$-100$ before capitulation. The term “six sigma” comes from the industry and it means that if one product has six standard deviations between the process mean and the nearest specification limit, practically no items produced will fail to meet specifications; at the same time here we are almost certain that at least in the short term the price will remain below it.