Cryptocurrency Portfolio Optimization

After the hack of Mt.Gox, I had lost interest in Bitcoin & Cryptocurrencies until the spring of 2016 when I got a chance to take a deeper dive into the world of Blockchain and Distributed Ledger Technologies. Fast forward to the present-day, and I've worked on some exciting projects using Hyperledger Fabric, Ethereum, and Corda. While I was at it, I happened to stumble upon Coinbase. Trading accounts on exchanges followed rather quickly. Before I understood where this was all going, I was partaking in ICOs & IBOs – it was all moving at a breathtaking pace.

Veni, Vidi, VC.

I'm a sucker for adrenaline and that's unmistakably counterproductive for the crypto-trading game. I decided to catch a breather during my vacation in December 2017 and take a fresh look at how the cryptocurrency markets are playing out. Until I figured it out, I decided I would just HODL.

One night, I stumbled upon the whitepaper that shows how Robo Advisor Wealthfront makes portfolio allocations. I got introduced to Markowitz’s Modern Portfolio Theory. One thing led to another, and I ended up implementing MPT (however limited in efficiency that may be) for optimization of a crypto portfolio.

The relationship between risk and return is simple. If you demand higher returns, you must take greater risks. If you know what your goals in terms of returns are, then half the battle is won because all you have to do now is find a way to minimize the risks for that target return. Except we do this for crypto.

So, here's what I did as a thought experiment: We select a bunch of coins as potential candidates for investment. By representing the historical RoI of each coin as a random variable, we estimate two parameters - covariance and mean return, for the variable. For a given risk level, our goal is to maximize the return, by selecting the optimal combination of coins. We find that by solving an optimization problem.

Here's the optimal allocation of investment dollars over 14 large-cap crypto-assets (market cap > USD 5B), based on price data from the last 180 days gathered from exchanges.

Allocating investments in a manner below is the most optimized portfolio — 406% returns.

The Efficient Frontier:

Interested to learn more about the implementation? Read my next article

Crypto markets are extremely volatile. Please do your own research & invest at your own risk. All the views expressed in this post are my own and do not represent my current or past employers. 

Thanks for reading this.