Measuring Investment Success in the Blockchain Space

In traditional finance, passive investment strategies have gained tremendous popularity. ETF saving plans are the new standard among young investor cohorts.

The idea behind them is simple. For the average investor who has little time available to analyze investment decisions the following premises hold true:

  • It is impossible to time the market.
  • It is not possible to outperform the market.

Once you accept these two premises your investment strategy becomes obvious:

  • Gradually invest in the market: This is called dollar-cost averaging. The market might move up and down but since you are gradually buying into the market the average price you enter the market gets smoothed out.
  • Passively invest in the market: once you recognize that you will not be able to outperform the market you accept the overall return of the market is the best potential return that you can obtain. Therefore you try to assemble your portfolio in a way that it mirrors the market as closely as possible.
Investment Success in the Blockchain Space

Passive Investment Strategies

People that trade or invest based on their own analysis often forget that the measurement of success is not whether they made money or not. The true measurement of success is whether they have outperformed the market or not.

Statistically only very few people and fund managers outperform the market. Therefore for the vast majority of people, passive investment strategies remain the best choice.

Passive investment strategies are designed to mirror the market performance and automatically rebalance to reflect a change in the composition of the market.

Measuring Investment Success

In the cryptocurrency space, the overall market capitalization of all cryptocurrencies represents the main investing benchmark.

Some people may only consider the top 100 or top 30 coins as the benchmark since it is impossible to have exposure to every cryptocurrency. Bear in mind that many of the small market cap coins are highly illiquid.

Let’s consider an example. Imagine you invested a 100$ in the cryptocurrency space on May 22, 2020, based on the following distribution:

Example Portfolio

CryptocurrencyAllocationPrice May 22, 2020Price October 22, 2020Performance
BNB41$16.07$29.64$84%
ADA30$0.052556$0.105787$101%
ALGO18$0.19$0.3$57%
REP11$12.27$13.44$10%
Total100$

You might have chosen the cryptocurrencies based on your best judgment. However, the majority of the market consists mainly of Bitcoin and Ethereum.

Let’s see how the overall market has performed:

Evolution of Total Market Capitalization (based on data from Coinmarketcap)

CryptocurrencyAllocationTotal Market Cap May 22, 2020Total Market Cap October 22, 2020Performance
Diversified based on Total Market Cap100$252 bn USD389 bn USD54%

Observing the Results

Based on the example above it can be seen that you were able to generate revenue based on your investment. However, not all cryptocurrencies you invested in were able to outperform the market.

At the first glance all of your investments were successful and returned a positive yield.

However, looking at the benchmark Augur (REP) significantly underperformed your benchmark in the investment time horizon. You might have made some money with REP, but if you would have just invested it in the overall market your profit would be higher.

Over the long term you are much more likely to select losers over winners. This is because there are simply more losers in comparison to the winners. 

Another reason is that there are long periods when Bitcoin outperforms almost every other coin and not being in Bitcoin during these periods means you end up with a significant loss.

Simplifying the Market Portfolio

Alternatively to investing it in the overall market you could choose to invest your money into a portfolio consisting of the top 3 cryptocurrencies by market cap which already represent around three quarters of the entire market cap. 

This essentially is reduced to the top 2 cryptocurrencies, Bitcoin and Ethereum, since the third ranked cryptocurrency by market capitalization is a stable coin which does not count with any volatility.

Therefore your alternative benchmark would be a portfolio consisting of Bitcoin and Ethereum weighted by their market cap.

Evolution of BTC/ETH benchmark

CryptocurrencyAllocationTotal Market Cap May 22, 2020Total Market Cap October 22, 2020Performance
BTC/ETH benchmark100$167 bn USD (BTC)22 bn USD (ETH)237 bn USD (BTC)44 bn USD (ETH)49%

As you can see in the table above this portfolio performs very similarly as the Total Market Cap portfolio since these two cryptocurrencies account for such a high percentage of the entire market cap.

However, it is much easier to invest in such a portfolio because it requires you to purchase only two cryptocurrencies. It is therefore an excellent reference and benchmark portfolio. 

Before You Go…

We hope that our insights help you better assess your past investment track record.

In the next post we will discuss passive investment strategies in the blockchain space. It will help you to invest in cryptocurrencies without needing to worry about underperforming the market.

If you are convinced of the future success of crypto you can easily ensure that you participate in this success by choosing your investment approach on a market based portfolio.

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