The highest Sharpe ratio shows that a pure cryptocurrency investment portfolio has the best risk-adjusted return. The research emphasizes that investors need to hold both of these cryptocurrencies simultaneously to maximize benefits. However, a simple allocation of 50% BTC and 50% ETH also demonstrates significant advantages, enhancing the diversification value of the cryptocurrency asset class.
Various BTC-ETH investment portfolio allocation comparison metrics
Source: According to VanEck Research, as of May 28, 2024, past performance does not guarantee future results. Volatility is measured by the standard deviation of asset or portfolio returns, where higher volatility indicates higher risk and potential higher returns, affecting the risk-adjusted return measured by the Sharpe ratio. The Compound Annual Growth Rate (CAGR) represents the annual growth rate of Ethereum (ETH) in a specific period, providing a smooth annual growth perspective to better understand long-term investment performance. The Sharpe ratio is a financial standard that measures the relative performance of an investment adjusted for risk compared to risk-free assets, calculated by subtracting risk-free returns from the portfolio’s return rate and then dividing by the standard deviation of returns. The ratio reveals how much additional volatile return investors receive due to taking on higher risk. A higher Sharpe ratio indicates superior risk-adjusted returns. The information, valuation scenarios, and price targets in this blog are not intended to provide financial advice or any specific action calls, buy or sell recommendations, and are not predictions of future performance of ETH and BTC. The actual future performance of ETH and BTC is uncertain and may differ significantly from the assumed results described here. The proposed scenarios may involve risks or other factors not considered, which may hinder performance. These are only based on simulated results from our research and are for illustration purposes only. Please conduct your own research and draw your own conclusions.
Effective frontier with cryptocurrency inclusion
To achieve the best configuration of cryptocurrencies without restrictions and maintain reasonable volatility, we studied the optimal weights of including the ideal cryptocurrency investment portfolio (28.6% ETH and 71.4% BTC) in a traditional 60/40 portfolio. The goal is to maximize returns while maintaining a specific volatility level (13%-25%), constructing effective frontier portfolios that match the volatility levels typically associated with broad investor portfolios. The resulting scatter plot shows that including the ideal cryptocurrency investment portfolio in a traditional 60/40 portfolio can significantly increase returns at different risk levels. Additional volatility from digital assets is beneficial to overall returns.
Data source: VanEck Research, as of May 28, 2024. Past performance does not guarantee future results. Volatility is measured by the standard deviation of asset or portfolio returns. Higher volatility implies higher risk and potential higher returns, influencing the risk-adjusted return measured by the Sharpe ratio. The Compound Annual Growth Rate (CAGR) represents the annual growth rate of Ethereum (ETH) value within a specified time period. This indicator aims to provide a smooth annual growth rate to eliminate volatility and present long-term investment performance more clearly. The information, valuation scenarios, and price targets in this blog should not be considered as financial advice or recommendations to take any action, buy or sell recommendations, and should not be seen as predictions of future performance for ETH and BTC. The actual future performance of ETH and BTC remains uncertain and may differ significantly from the assumed results described here. There may be risks or other factors not considered in the proposed scenarios that could hinder performance. These are based on simulated results from our research and are for reference only. Please conduct your own research and draw your own conclusions.
We analyzed that as volatility increases, there is a near-linear relationship between risk and return, which is rare when studying the efficient frontier. The conclusion is that increased exposure to cryptocurrencies leads to a very attractive risk/return balance. The Sharpe ratio of the mixed investment portfolio remains stable at a volatility of 22%.
Data source: VanEck Research, as of May 28, 2024. Past performance does not guarantee future results. The information, valuation scenarios, and price targets in this blog should not be considered as financial advice or recommendations to take any action, buy or sell recommendations, and should not be seen as predictions of future performance for ETH and BTC. The actual future performance of ETH and BTC remains uncertain and may differ significantly from the assumed results described here. There may be risks or other factors not considered in the proposed scenarios that could hinder performance. These are based on simulated results from our research and are for reference only. Please conduct your research and draw your conclusions.
The time dependency of the results of the effective frontier
To explore whether different starting points affect the risk/return situation of the ideal cryptocurrency and 60/40 portfolio investment portfolios, we repeated the analysis from the fourth section and continuously moved the starting point forward by one quarter. Our only limitation was that the analysis must include at least 3 years of return data. Therefore, we successfully generated 23 sets of results and eliminated time dependency as a variable through this method.
Our findings show that in all time periods, the optimal weight of the ideal cryptocurrency investment portfolio increases with increasing risk, regardless of the starting point, supporting the balanced allocation of BTC and ETH at 6% weight as per our research.
Ethereum investment risks:
Despite Ethereum (ETH) having a market cap exceeding $400 billion and being recognized as a mature smart contract platform, it is essential to acknowledge the significant risks associated with investing in ETH.
Dependency on speculation:
Currently, Ethereum’s ecosystem relies heavily on speculative activities to generate profits. If overall risk appetite decreases, ETH performance may show a significant negative correlation with the S&P 500 index or the Nasdaq Composite Index.
Regulatory risk:
Changes in regulatory policies regarding Ethereum cannot be ignored. Many assets in ETH or its ecosystem may be classified as securities, potentially requiring many Ethereum-related companies to register with the U.S. Securities and Exchange Commission (SEC) or face severe legal consequences. It is worth noting that the world’s largest financial companies not only have numerous lobbyists but also many former employees who have held high positions in various governments, who may set up regulatory barriers unfavorable to disruptive technologies like Ethereum.
Interest rate risk:
As a high-risk asset, Ethereum’s valuation may be significantly affected by interest rate hikes or other restrictive measures on global liquidity.
Competition:
Competition among smart contract platforms is fierce. Although Ethereum currently holds a leading position, high-performance blockchain technologies like Solana and Sui have certain advantages and have put significant effort into business development and user experience, which may challenge Ethereum’s dominant position in the long run.
Financial companies evolving:
One of Ethereum’s significant advantages is its ability to create low-cost financial systems by eliminating many high-cost factors in the current financial system. However, if financial companies start implementing cost-saving measures, they may retain their user base. Additionally, existing financial companies can create competitive blockchain smart contract platforms to tap into Ethereum’s long-term potential.
Geopolitics:
Currency control is a core aspect of government power. Geopolitical events, such as major regional conflicts or escalations in geopolitical tensions, may prompt governments worldwide to suppress non-sovereign financial systems and forms of currency.
Conclusion:
Analysis shows that appropriately increasing cryptocurrency allocation in a traditional 60/40 portfolio (up to 6%) can significantly enhance the portfolio’s Sharpe ratio while having a relatively minor impact on drawdowns. For a pure cryptocurrency investment portfolio, a near 70/30 allocation between Bitcoin and Ethereum provides the optimal risk-adjusted return. Investors should consider their risk tolerance, but the research results indicate that introducing BTC and ETH in a balanced manner can significantly enhance returns, highlighting the potential of cryptocurrencies to improve portfolio performance in a controlled and measurable way.
