Cryptocurrencies have been the talk of the town and a rollercoaster ride of volatility over the last several months.
The total combined crypto market hit a high of $115 billion in June as Bitcoin, Ether, and Litecoin saw massive gains amid speculation. The market has seen roughly a 45% drawdown over the last several weeks - I would venture to guess that it’s mostly been due to uncertainty over the Bitcoin fork.
Source: coinmarketcap.com
Breaking it down more specifically, here’s the indexed performance of the three over the last three months (since April 18, 2017).
As you can see from this time horizon, Ether had quite the run in June. Litecoin has actually been more stable in its gains. Bitcoin, being the most established cryptocurrency, has seen the least volatility.
As I stated before, I’ve been holding onto Ether since October of last year because I believe in the long-term potential of cryptocurrency. I’m not a genius that saw it coming a month ahead of time, I’ve just been lucky. The severity of the pullback leaves one wondering if the bubble is in the process of popping. I’ve run head on against that conclusion and taken the opportunity to increase my position and add more.
Last week Ether was really moving down. Tuesday night, I was lying in bed and couldn’t sleep. I checked Ether’s price and saw it was down another 15% on the day (July 11, 2017), so I gobbled it up at $186.
It still fell some more over the weekend and could fall plenty more, but I’m comfortable sitting tight and getting it while I can. As I write this, it’s back to $230. Again, I’m just lucky. Obviously, that could disappear in no time, but it’s nice for the moment.
To show you I’m not one of these guys who says after the fact “I was saying buy Apple in 2002!” and never actually stuck my neck out and bought it, here’s my position:
I had some arguments for choosing Ether over others, but in the end I’ve just been lucky so far that Ether has performed better. I’ll leave it to the techno-geniuses to figure out what will be the best in the long run. In the meantime, the last one year’s performance shows just how crazy this ride has been.
Ripple and other smaller cryptocurrencies have seen even bigger gains, so let’s not forget them. The average daily returns have been nice too.
The thing is, when you’re considering investments you want to consider risk accordingly. There’s a strong relationship between returns and risk. Great gains necessitate great risk, lesser gains necessitate less risk.
Here’s where the heavy technical stuff comes in. The way sophisticated investors look at risk is through “volatility”. In statistical terms, volatility is measured by the standard deviation of an asset’s price movements. If you don’t mind “volatile” moves to the upside (you like making a profit on your investments), then you only care about the volatility of downside moves. As you can see here, the S&P 500 has been much less volatile than cryptocurrencies.
So what is better, high returns or low volatility? Can you have both at the same time? Well if you take it to the next level, you can standardize your comparison by taking the ratio of an asset’s return by its standard deviation to get a measure of what has performed the best relative to the amount of risk you endured. The higher the ratio, the better. In finance geek terms, I’m modifying the Sharpe ratio to create my custom assessment of what has performed the best over the last year.
Lastly, for those of you who really want to go deep: finance people love to talk about diversification. In Modern Portfolio Theory, it is suggested that you stand to increase your risk adjusted returns by diversifying your investments. But it doesn’t help to buy Exxon, Chevron, and Shell to say you are diversifying. They carry essentially the same risks and the stocks move together. In statistical terms, they are correlated. To increase your risk adjusted returns, you want to invest in uncorrelated assets. Well as it turns out, here are the correlations of these cryptocurrencies with each other and the S&P 500.
This shows you that Bitcoin and Litecoin have represented excellent diversification over the last year for people who are invested in the general stock market.
Until next time, happy hunting!
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