Benjamin Cowen provides valuable insights on Modern Portfolio Theory as applied to cryptocurrencies. The CoinSpeech team has gathered the key points from his recent discussion. You can find Benjamin Cowen’s new video below.
Understanding Modern Portfolio Theory in Crypto
Benjamin Cowen delves into the applications of Modern Portfolio Theory to optimize risk-adjusted returns within crypto portfolios. He discusses the Sharpe Ratio and the Sortino Ratio, emphasizing their significance in assessing performance against volatility.
Monte Carlo Simulation and Portfolio Weightings
The presentation starts with a Monte Carlo simulation of 50,000 portfolio weightings consisting of just Bitcoin and Ethereum. Cowen notes, “Although historical data is useful, it doesn’t guarantee future results.” For simplicity, he talks about visualizing 5,000 simulations to illustrate pertinent trends and the concept of the efficient frontier.
Further, the simulation calculates an optimal portfolio balance of 76% Bitcoin and 24% Ethereum for maximizing the Sharpe Ratio and 80% Bitcoin and 20% Ethereum to maximize the Sortino Ratio.
Incorporating Additional Assets
Cowen adds depth to the analysis by including other assets like Litecoin, noting that “to maximize your Sharpe Ratio, it calls for a very heavy allocation in Bitcoin, much smaller in Ethereum, and practically zero in Litecoin.” This highlights the opportunity cost associated with diversifying into assets that have not consistently outperformed the primary cryptocurrencies, Bitcoin and Ethereum.
He also emphasizes the importance of adding USD for stability, particularly in risk-averse portfolios, “to maximize your Sortino Ratio with USD, it’s 66% Bitcoin, 17% Ethereum, and 17% USD.”
Historical Context and Market Cycles
Taking a historical perspective, Cowen reminds us, “Ethereum outperforms Bitcoin in a QE bull run, but not in a QT bull run.” This has significant implications for portfolio decisions based on current market conditions.
Conclusion on Risk Management Strategies
Benjamin sums up the discussion by stressing the value of classical portfolio theory, devoid of biases, in constructing an optimal crypto portfolio. “Approaching this from something developed decades ago that has worked out pretty well for others, and applying it to crypto, offers a balanced strategy free of any biases.”
Here’s Benjamin Cowen’s new video for more detailed insights: