Experts encourage investors to start earmarking 6% of their funds for digital currencies. Here’s why.
Seasoned investors know the importance of a properly diversified portfolio. Not only does diversification reduce exposure to risk, but it does so without diminishing returns. With the rise of cryptocurrencies, diversification can now extend to a unique and potentially lucrative pool of assets. Here’s why diversification into cryptocurrency matters more than ever.
Modern Portfolio Theory (MPT) dictates that you shouldn’t put all your eggs in one basket. As a methodology MPT enables investors the ability to construct a portfolio from several non-correlated assets—regardless of the risk each one brings to the table. Given the uncorrelated nature of cryptocurrencies, these nascent assets make a potentially viable candidate for MPT-based traditional portfolios, and the research appears to support this. According to the asset management firm, Galaxy Digital, diversifying into cryptocurrencies such as bitcoin, can increase the overall expected return of a given portfolio despite its volatility.
Moreover, with cryptocurrencies not at the whim of central bank or government intervention, they remain uninfluenced by macroeconomic factors currently plaguing the broader financial markets.
For illustration, throughout its lifetime Bitcoin has demonstrated a correlation coefficient of approximately 0 (1 representing correlation, -1 symbolizing negative correlation and 0 relying non-correlation). This implies that if current economic woes continue, bitcoin—along with other cryptocurrencies—could well prove to be a hedge against systemic risk.
The value of cryptocurrencies
It’s not just an uncorrelated nature bolstering the value proposition of cryptocurrency. These assets sit at the forefront of financial innovation. Far from a simple instrument for speculation, many cryptocurrencies embody distinct utility. Be it Bitcoin, which essentially acts as a digital form of cash or gold or the Ethereum token which quite literally fuels an entirely decentralized financial ecosystem.
Institutional and accredited investors—AKA the smart money—understand this value. During a recent interview with CNBC, Chamath Palihapitiya, a former executive at Facebook turned venture capitalist, advocated placing at least 1% of assets in Bitcoin. And Palihapitiya isn’t alone. According to an in-depth study by Yale economist Aleh Tsyvinski, Bitcoin should account for at least 6% of any diverse portfolio—even if you’re less than enthusiastic about the asset.
Tsyvinski’s findings were based on Sharpe’s ratio—a metric measuring the performance of an investment compared to a risk-free asset. The researcher confirmed that digital currencies show higher potential for return compared to traditional assets such as stocks, despite their increased volatility.
It seems investors are starting to realize this, as well. A 2020 report from PwC, one of the ‘big four’ accounting firms, reveals that family offices and high-net-worth-individuals are piling into crypto-centric hedge funds.
The opportunity beyond Bitcoin While bitcoin is often touted as the de facto sovereign of cryptocurrencies, this isn’t necessarily the case. One look at the cryptocurrency community and it’s easy to get swept up in a cultish devotion to a single cryptocurrency. But—as MPT suggests—this isn’t always the best route to investment. In fact, year to date returns for the top 50 cryptocurrencies reveals a plethora of assets outperforming Bitcoin by a considerable degree.
While Bitcoin cites a 31% (YTD) return on investment in 2020, Ethereum, the second-largest cryptocurrency by market cap, has an ROI of 57%. The same goes for the privacy-focused cryptocurrency Zcash which boasts a 68% and YTD return. Meanwhile, Tezos flaunts an impressive 100% ROI in 2020, so far.
But it isn’t just performance providing a narrative for scoping out beyond Bitcoin. As touched upon, utility, liquidity, and risk also play a significant role in gains and longevity.
However, an estimated 13% out of over 5,000 cryptocurrencies have a live use case underpinning their value. So how does one filter out the noise?
In 2019, EVAI created The Bridge rating system. Designed in conjunction with financial scholar professor Andros Gregorioum, the Bridge system is an unbiased method of distinguishing between worthwhile cryptocurrency investments.
Fundamentals aside, emotional decisions also play a critical role in investor choice making. An entirely impassive rating system based on centrally sound determinants can help mitigate emotional trading, aiding investors in determining the best investments for their portfolio.
Further, by employing both AI and machine learning EVAI’s bridge system ensures that ratings are continually developing at the same pace as the cryptocurrency market.
Diversification often proves far more fruitful than placing faith in a single asset. Being equipped with the right resources to help appropriately diversify is essential. EVAIs proprietary rating system assesses a wide range of financial risks and variables including market momentum and systematic risk to calculate and ascertain unbiased and reliable cryptocurrency ratings, enabling you to determine investments accordingly.
The information contained within this website and resource section is not intended to be a substitute for financial advice or promotional offer on the investment or purchase of Cryptocurrencies, digital tokens or related assets. Although care has been taken in preparing the information provided to you on this site and in the resource section, we are not held responsible for any errors or omissions and accept no liability whatsoever for any damage or loss you may incur through the result of your own actions and decisions when deciding to purchase or invest in Cryptocurrencies or related digital assets. You should never engage in trading unless you fully understand the nature of the transactions you are entering into and the extent of your exposure to loss. We recommend you always seek financial/or legal advice counsel relating to your investment and purchase circumstances. This material has been prepared for informational use only.