With the cryptocurrency market tumbling right now, there could hardly be a better time to take stock of your digital holdings and position yourself for a profitable New Year. I’m honored to have been given the first post by Daniel at Bitzur, and in that spirit I am going to share with you a true tried-and-tested portfolio allocation strategy that actually works. At the hedge fund I manage, we use this particular strategy and variants of it to allocate all our crypto positions and it hasn’t failed us yet, even after five years of occasional rough-and-tumble.
The portfolio allocation strategy in question is what we call the DICE strategy – that stands for the Dynamic Inflation Cryptodollar Events strategy. That may sound very jargonized to those not from the world of finance. I suppose it’s a financial markets tendency. We try and label everything with catchy-sounding acronyms that represent the most complete description of the economics that is taking place in the product.
First, let me sum up what DICE does that is so great about it. Principally, DICE aims to cap your losses when the market is moving against you in cryptocurrencies and to position you for maximum risk-adjusted profits when the market is moving in your favor. The strategy does this by taking into account surprisingly few people – even market professionals – still do when they allocate funds to cryptos: the amount of new dollar stablecoins in the market that are being printed.
Cryptodollars vs. cryptocurrencies
Dollar stablecoins such as USDT, USDC and others are what we like to call cryptodollars. They are not actually US dollars, of course, since the Federal Reserve did not create them, but they are a proxy of the USD value by way of being pegged to that currency’s value on any given day. If I sell one Tether I will get back in fiat one dollar. The amount of cryptodollars that is circulating in the crypto markets, and specifically, whether that amount goes up or down a lot over short periods of time, has an enormous effect on crypto prices.
If the amount of cryptodollars is dramatically increasing, then somehow all these new cryptodollars are going to have to be continually pegged to the US dollar. The only effective way to do that is to consistently buy them up as the new supply is introduced to market with other cryptocurrencies. This effect will necessarily make cryptocurrency prices fall, naturally, as in effect you are selling a cryptocurrency in order to buy up a cryptodollar.
Unless large amounts of cryptocurrencies were employed in buying up the expanding supply of cryptodollars in the market, then the value of cryptodollars such as Tether (assuming here it is more Tether that is being printed) would begin to decline very rapidly all things being equal, since the supply increases mean that there is a dilution in the Tether value intrinsically speaking. This is the same for every crypto, and it’s no different for Tether, either: the more of it that gets printed very rapidly over short spaces of time, the more selling pressure is created on the cryptocurrency by traders, and hence the further the price falls.
In general, what people often fail to take into account about cryptocurrency markets is that they are in many ways simply a reflection of the amount of dollars that is circulating in them, which in turn are a reflection of the amount of dollars that is circulating in the world. In this way cryptocurrencies are really cryptodollar derivatives, which in turn are derivatives of US dollars.
If you want to make the most of the profit potential of crypto markets, you simply have to develop a portfolio allocation strategy that factors in the increase of dollars that is entering the market and then harnesses the cryptodollar inflation to maximize the profit potential of cryptocurrency returns by timing it accordingly so that your holdings are positioned mostly in cryptocurrencies when crypto selling is flat and moves into cryptodollars when selling gets more aggressive. That’s the dynamic principle behind this investment strategy.
There is also a static principle we worked into the strategy, too. This principle concerns how well each individual cryptocurrency is doing compared to each other cryptocurrency. This is also a vitally important component of any cryptocurrency investment strategy, since you obviously want to be overweight in cryptos that are going up faster and more consistently and more underweight in ones that are not if you want to realize maximum profitability. Fortunately, since Bitcoin represents roughly half the entire crypto market (although this grip is not weakening over time it is still strong enough to be relevant at 42%), we can simply calculate how every crypto in our portfolio did compared to Bitcoin over the last year and this serves as a rough benchmark for baseline performance.
At the risk of sounding like a broken record here, I’ll repeat it again once more so that the point sinks in: the cryptocurrency market is really, in essence, a cryptodollar derivatives market, and cryptodollars are a US dollar (inflationary) derivative. It’s easy to get caught up in the ins-and-outs of various projects and their different potential utilities with respect to the underlying technology every currency is built around and for and forget this point. Essentially, issuers of cryptocurrencies seek to harness the value of the US dollar and compound it by unitizing that value and then applying it to various utilities that will (hopefully) store the value of a dollar more efficiently than a paper dollar bill will. If they don’t succeed at doing this, then their projects and associated cryptocurrencies will fail – it’s that simple.
Overview of Capital Allocation Approaches
With all the above in mind, let’s get into the portfolio allocation strategy that we use for our fund’s dominant positions.
I will start with the static portfolio allocation method – the bit where we try and compartmentalize various segments of the crypto market and work out which crypto is storing the value of our US dollars better than other cryptos.
To do this, we look at two criteria: the performance of a cryptos market capitalization relative to another – in this case, to Bitcoin (BTC), since Bitcoin is so dominant – over the past year or quarter, and the inflation of the cryptocurrency relative to Bitcoin’s inflation. The better that a crypto does relative to Bitcoin, and the more it is inflating, the better storage of value that cryptocurrency has relative to Bitcoin. This is because if a crypto is rising faster than Bitcoin, even though it is inflating in terms of supply more than Bitcoin is, then it is clearly on a per unit basis a much stronger value storage vehicle than Bitcoin (and hence, the rest of the market, since everything by and large trades against Bitcoin and cryptodollars).
The simplest way to group cryptos is by their market cap. For this exercise we can create four groups of cryptos:
Group 1: Top 10 coins at CMC
Group 2: Top 11th-25th placed coins on CMC
Group 3: Top 26th-50th placed coins on CMC
Group 4: Any other coins on CMC (or that may not be on CMC yet) that we like or find during the year
With any crypto investing strategy, it’s always a good idea to create a number of different portfolios this way, and manage them individually, rather than adopting the more commonly applied market-as-a-whole investment approach.
A good way that seems to work for us is to portion funds as follows in what in geometry resembles a golden circle spiraling inwards, with 43% of funds allocated to Group 1, 29% of funds allocated to Group 2, 15% of funds allocated to Group 3 and 13% of funds allocated to Group 4. Obviously, if you want to take more risk and keep it simpler, you can also just divide out whatever funds you have into 25% each and allocate those funds to each group accordingly. Be mindful though that while fantastic on the up days, this more simplistic allocation may not give you adequate protection from crypto market crashes, as we shall see.
Let’s assume that you have $10,000 to invest in cryptos and you go out to make your portfolio now, and take our first suggested allocation as the example. You now have $4,300 to invest in the Top 10 cryptos, $2,900 to invest in the next top 14 cryptos by market cap, $1,500 to invest in the next top 24 cryptos by market cap and $1,300 to invest in whatever you like the look of. This is our starting point. If this seems limiting, then wait – it will become clearer why we structure a portfolio this way as things unfold.
Determining What Amount To Invest In What Cryptos
The first question is – how do we allocate the $4,300 between the Top 10 cryptos? By equal share, with each getting $430 each? By market share, with BTC getting the lion’s share of the $4,300? Neither of these seem especially foundational in terms of validating a convincing risk-adjusted quantitative portfolio allocation strategy, that’s the problem.
This is where we begin our comparisons. We can use the prior year’s performance to gage this portfolio allocation breakdown here. If we compare how well each crypto in the Top 10 (except for Bitcoin, naturally) has fared compared to Bitcoin as a store of value, we will begin to develop a series of equations that look like this:
(BTC Market Cap on Jan 20, 2021 / ETH Market Cap on Jan 20, 2021)*(BTC supply on Jan 20, 2021)/(BTC Market Cap on Jan 20, 2021 / ETH Market Cap on Jan 20, 2021)
This will give us a number that is either a whole number or a decimal. If it’s a whole number, then BTC is a better store of value than ETH, since the BTC market cap relative to its supply is more robust if the number is whole, whereas the opposite is true the other way round. Now we can perform the same equation for Jan 20, 2022. We will now have two numbers – one for 2021 and one for 2022, either of which might be whole or fractional. Take the first number and divide it by the second number, and that is the indicator of which is acting as a better store of value. Once again, if the number is positive, then the amount that it is over 1 is the amount by which BTC is outperforming the comparison asset as a store of dollar value; if the number is a fraction, then the amount by which it is under 1 is the amount that BTC is underperforming the comparison asset as a store of dollar value.
Let’s try this now using the actual data from CMC for those two dates:
Jan 20, 2021
($661,400,102,161 / $18,276,600,992) * (18,346,687 BTC / 109,506,297 ETH) = 6.06 (meaning Bitcoin is 606% better at storing the value of a dollar than Ethereum at that point in time, or that Ethereum is 85% less efficient at storing the value of a dollar than Bitcoin is)
Jan 20, 2021
($652,400,231,216 / $278,906,229,867) * (18,937,062 BTC / 119,268,013 ETH) = 0.6 (meaning that Bitcoin is now 94% worse at storing the value of a dollar than Ethereum now, or that Ethereum is around 1,660% more efficient at storing the value of a dollar than Bitcoin is)
Now we compare Bitcoin and Ethereum as if both had 21 million units supply:
Bitcoin: $31,066.68
Ethereum (ETH): $13,281.25
We then factor in the inflation disadvantage for both. ETH has inflated by around 9.9% vs. BTC’s 1.1% in the past year, so that’s a bonus of 8.8% for ETH. Similarly, Ethereum has gained in total a 34 percentage point increase in dollar storage value over Bitcoin in the past year so we can add a total of 42.8% extra to Ethereum’s theoretical nominal 21 million units price:
$13,281.25 * 1.43 = $18,956.62
For the purposes of weighting out portfolio allocations, these 21 million unit divisions with the accompanying performance relativity premium/discount are what we use as the final tally for how allocations are distributed. In this case, you can see that if only Bitcoin and Ethereum were in our portfolio, you’d be allocating about 60 cents to Bitcoin and about 40 cents to Ethereum for every dollar allocated ($18,956.62+$31,066)/($31,066).
The reason we work with a comparison of performance parity between the years and not just the past one is that we do not want to run the risk of over-inflating the importance of a short-term trend. To beef up Ethereum’s portfolio allocation by 94% this year would be to over-state the significance of recent price trends. To see this point more clearly, consider that last year we would have ended up otherwise losing out about 5% of the portfolio to a doubling of the Bitcoin price in the first quarter had we only used the 2020-2021 numbers.
We can perform similar calculations for Tether, too. In this case, we can see that there were around 25 billion USDT in issue last year whereas now there are around 79 billion USDT. That is a substantial increase over the past one year period in the amount of inflation USDT has undergone. If Tether had a 21 million unit value, last year it would have been $1,179 per USDT whereas this year it would have increased to $3,757 per USDT. When we account for the inflation disadvantage, we get a 21 million unit value for USDT this year of $8,244 per USDT.
Let’s take the Top 3 cryptos into context now with their inflation- and performance-adjusted 21 million nominal unit values:
BTC: $31,066 (53 cents per dollar)
ETH: $18,956 (35 cents per dollar)
USDT: $8,244 (22 cents per dollar)
Already we can see just from studying the top 3 cryptos that using this comparative, inflation-adjusted method of allocating funds to a portfolio balances it much better than if we were to index the portfolio by market cap, where we would be awarding 65 cents for every dollar to Bitcoin, 29 cents per dollar to Ethereum and just 6 cents per dollar to Tether. Further, the comparative allocation methodology here also gives us a much more significant cash portion within our portfolio so that we can later on use that cash to buy up cryptos on market dips like the one that is currently going on.
Readjusting Your Crypto Portfolio
Readjusting cash positions within a portfolio can be tricky work, as it isn’t always clear when the timing is right. For our portfolio management system, what we do is to re-adjust the weights in our portfolio continually throughout the quarter on a fortnightly basis. These weights are not applied in the same way the annual adjustments outlined above are, but in proportion to the amount of extra cryptodollar stablecoins there are relative to the start of the previous quarter in our portfolio. If the amount of stablecoins is increasing over the last quarter, we sell off whatever percentage increase there was in stablecoins from the others that are cryptocurrencies in the Group and we buy up an equivalent amount of USDT. This has the advantage of positioning the portfolio very well defensively so that it doesn’t get smashed in times of market crashes.
As an example, notice that on Oct 1, 2021 there were just 68 billion USDT in issue. By Jan 1, 2022, that number had swelled to where it is now, around 79 billion USDT. The investors who correspondingly adjusted their portfolios over that period by selling off around 20% of their crypto holdings and buying up USDT with those holdings are today in a much stronger position to take advantage of the low prices on the market than those who paid the huge increase in USDT supply no attention at all. If you want to invest in cryptos, you simply must watch the stablecoin cryptodollar supply increases (and consequential non-increases) for indications of where the market is headed.
USDT supply increases totaled around 1 billion USDT per week during the last quarter of 2021; by contraction, in the past week just gone we recorded the first decrease in USDT supply (i.e. burning/locking wallets) in many months (down by around 200 million USDT). This adjustment should be dynamically impacting an investor’s portfolio allocation strategy right now, so that this week the investor is actively selling USDT to increase capital invested in cryptocurrencies. For most investors, however, they are doing the exact opposite of this by liquidating crypto positions to invest back in USDT! It’s like going up a down escalator – literally.
Key Takeaways
The strategy can be elaborated on in much more extensive detail, but I figure there is already quite a lot here for most investors to absorb already, so perhaps I will write about some of these other extensions of the DICE strategy in more detail in another post here at Bitzur.
The key takeaways are as follows:
Cryptocurrencies, no matter what anyone tells you or no matter what else they look like, are financial vehicles designed specifically to beat the dollar bill as a storage of dollar value
While all cryptoassets are storing dollar values, cryptocurrencies are storing those values in very volatile ways vs. cryptodollar stablecoins such as USDT
One way in which we can assess which cryptos are storing value better than others is by performing the equation (BTC MCAP/COIN MCAP)/(BTC supply/COIN supply) and noting that if the result is higher than 1, then BTC (which represents half the market) is beating the coin in question at storing dollar value, whereas if the result is less than 1, then by that amount percentage wise the coin in question is beating the market at storing dollar value
Make sure that you keep weekly tabs on the amount of total dollar inflation that is being represented in all the US dollar stablecoins and that as you notice more stablecoins being issued, you sell your most profitable crypto holdings and buy up more of that stablecoin that is being issued
When there is no net change over the period of a month in the amount of supply of the stablecoin, or when there is a decrease in supply of the stablecoin, this is when you should use the stablecoins you have accumulated to buy other more speculative cryptocurrencies
By taking this approach to investing in the crypto markets, you will have a much easier job judging when to do what and how to apportion what amount of capital in what types of cryptos. This will result in significantly better returns over time, as I have shown here by providing examples.
Don’t get lost in the hype and the stories. The utility of the coins and tokens is one part of the picture only, and not even the predominant part of the picture at that. Determining dollar inflation values and how those exist with the cryptodollar representation that interacts with the rest of the the digital asset market is by far the most key criteria to successful investing.
I hope this was helpful to you. If you liked it, don’t forget to subscribe if you haven’t already. Subscribing is free and means you won’t miss any of our updates here at Bitzur, the world of real digital asset intelligence from people who manage some of the most of the money in it!
Fantastic material Brad! The quality of Bitzur is showing through already ... brilliant stuff.
I really appreciated you shared all this
Brad!! Amazing 👏👏👏