There are two types of returns in the markets, Beta and Alpha. Beta returns will be equivalent to what the market returns. If the market returns 20%, then the beta return will be 20%. If the market loses half it’s value, then the beta return will be -50%. In the case of the crypto market, taking a rebalancing strategy such as the one implemented by Bitwise which exposes investors to the top 10 cryptocurrencies and weights based on market cap, the return over the past twelve months would be 916%.
Another viewpoint would be the investor who simple chose one high cap cryptocurrency and chose to hold it throughout 2017. The below table shows the returns. Investors who just held Bitcoin would have achieved 1390% on capital invested.
The case in point is that by even exposing just a fraction of capital to cryptocurrencies offers potential for extraordinarily high beta returns. On the other side of the things, greater risks are associated with greater returns and this is evident in the performance of cryptocurrency markets since early 2018 with many cryptocurrencies crashing 60%+. However, by applying portfolio theory and diversifying among different asset classes, cryptocurrencies still could be an attractive option. An investor who applies 2–5% of his overall portfolio to cryptocurrencies will only have a small relative impact on the overall portfolio if the capital portioned to cryptocurrencies is lost or significantly reduced but will have a potentially much bigger upside if cryptocurrency continues to show some of the returns they have in previous years. Considering that the market cap of cryptocurrencies is approximately 330 Billion USD whereas the marker cap of global equities is 80 Trillion USD, there is reason to believe it could have a lot of room to grow*. Furthermore the figure for global wealth is 280 Trillion meaning that the cryptocurrency market is still only representing 0.0011% of global wealth.
Other methods which can be applied to manage the risks associated with cryptocurrencies is applying dollar cost averaging into cryptocurrencies each month with some given amount of monthly cash which you can afford to lose. This serves to minimise the risk of buying when the price is really high, and also smoothes out the volatile price fluctuations. The downside to applying this method as opposed to putting a chunk of cash into the market all at once is that there is the risk that the price will continue to appreciate. In general, dollar cost averaging is a very good tool to employ when it comes to investing.
“Alpha is a zero sum game. In order to earn more than the market return, you have to take money from somebody else.” Ray Dalio
Alpha returns are a whole other ball game. Alpha returns are a zero-sum game and with alpha returns, you are not just exposing yourself to the overall market but you are actively positioning your portfolio to achieve extra. For you to achieve alpha and gain extra means you have to take away from somebody else. Hence the reason alpha returns are a zero-sum game. So, if you think about this, undertaking the great game which is chasing alpha has some connotations:
Firstly, it’s a general “fuck- you” to efficient markets hypothesis
Secondly, you are saying you are a better speculator than other market participants as a whole and this includes algorithms, institutional investors, insider trading shenanigans, and traders with years upon years of experience.
Your returns achieved through chasing alpha will have to be profitable to the extent that they outperform the extra fees, the time value put in and other costs associated. As noted by the below cited macro-ops blogpost, there are three edges you can have to achieve alpha returns:
-Informational
-Analytical
-Behavioural
Alpha returns will be further discussed in a future blogpost as this area can go deep. Alpha returns in relation to the crypto market are particularly interesting as these markets are so nascent and are largely comprised of retail investors/speculators.
*Figure for cryptocurrency market cap taken from coinmarketcap.com on publishing date 25th March 2018.
(1) https://macro-ops.com/high-quality-trading-episodic-not-continuous/
(2) https://www.bitwiseinvestments.com/fund
(3) https://cointelegraph.com/news/2017-market-performance-crypto-vs-stocks
(4) http://uk.businessinsider.com/global-market-cap-is-about-to-hit-100-trillion-2017-12
(5) https://www.credit-suisse.com/corporate/en/research/research-institute/global-wealth-report.html
