A Quantitative Approach to Cryptocurrency Investing

Cryptocurrency x Multiples - Price on Last Traded Date divided by First Traded Date

In conventional financial markets, the large majority of start-up projects sink without trace. The occasional winner however can make up the losses and yield a profit on the portfolio.

Can this be done in the altcoin market?

To attempt to answer the question I took data from two sources.
From https://www.cryptocompare.com/ I downloaded daily closing prices (in US dollars) on all 1254 coins in their database.  Start dates varied form that of Bitcoin on 17th June 2010 to an end date of 22nd February 2018 for all coins.
To avoid survivorship bias I took a single figure from http://deadcoins.com/: 740. The number of coins initially offered which now have no residual value.

I then calculated how many coins “mooned” by dividing the last traded price by the first traded price.  The famous xMultiple.  Here is a scatter plot of the CryptoCompare data:

Cryptocurrency x Multiples - Price on Last Traded Date divided by First Traded Date
Cryptocurrency x Multiples – Price on Last Traded Date divided by First Traded Date

There are some obvious yet pertinent observations to be made.  The first is that there are indeed some incredible “moon shots”.

Bitcoin can be seen in the top left-hand corner: a first traded price of 0.0491 and a final closing price of 9771. No doubt the initial offer price of Bitcoin was even lower than the first price available on CryptoCompare but unfortunately there are no records available of issue prices.

However, it can also bee seen that the great majority of coins fared far less well: 60% of coins lost money or made no gains over the period.
Putting the xMultiples in ‘bins’ we can break down the statistics as follows (including the 740 “deadcoins”):

Cryptocurrency - Frequency of x Multiples (Profitability)
Cryptocurrency – Frequency of x Multiples (Profitability)

In the traditional financial markets, “stock picking” has a well-deserved reputation for being an expensive waste of time.  For many decades, armies of earnest but useless analysts and fund managers have overcharged their luckless clients for attempting to beat chosen benchmark indices.  With lamentable lack of success.  Most investment professionals fare no better than a monkey with a dart board.

This is the reason for the exponential growth in index tracking “passive” funds.  There is little or no reason to believe that a stock picker can outperform a market cap or equal weighted stock index.  An index like the S&P 500 is already an algorithmic or rule based systematic investment procedure: winning stocks enter the index as they gain in price and losing stocks are dropped as they decline.  Actually, it is the perfect way to invest – why gild the lily?

The less experienced investor will point to a few well-known names who appear to have outperformed the relevant index for a prolonged period.  The more experienced quantitative analyst will realise it is a question of random chance and survivorship.

So back to altcoins.

I have long advocated a systematic rule-based approach to financial markets and that approach is equally suited to the crypto-sphere.

If you manage to weed out the worst ICOs, perhaps you have a chance of generating extraordinary returns from this booming new area.  Even if you don’t manage to weed out the less successful deals perhaps the extraordinary returns from the moon-shots can compensate for the 60% no hopers?

To test out this theory I devised a set of random portfolios.  I took different sample sizes (the number of altcoins included in the portfolio) from 50 to 1,000 coins and ran 1,000,000 iterations on each sample size, selecting at random that number of coins out of the total available database of 1994 coins.  I used the “select without replacement” method.  I assumed an equally weighted investment of $1 per coin with a portfolio starting value of ($1 * the sample size) on 1st January 2010.

For each sample size I calculated a compound annual growth rate for each of the 1,000,000 iterations and then calculated a series of statistics for the entire array.  The holding period I used was 7.6 years.

Cryptocurrency - Profitability of investing in random cryptocurrencies
Cryptocurrency – Profitability of investing in random cryptocurrencies

Unfortunately, forecasting the future is impossible.

I can not tell you whether investing in a portfolio of altcoins over the next 7 years will reap the same sort of return as it has for the past 7.  I very much hope that may come to pass but refuse to make any prediction.

 

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