Qidax is soon bringing more people into the world of crypto, one of the first things to ask is, Bitcoin or Ethereum. While this could be a baffling question among investor, this post might reveal some investment tips in these crypto assets.
Bitcoin vs Ethereum: The Difference
Bitcoin’s market capitalisation is $147.3b while Ethereum’s market capitalisation is $84.2b. Bitcoin is limited to 21,000,000 coins. This creates supply and demand, which is healthy for a store of value. Ethereum, however, is not limited. The production of Ether is continuous. The supply of Ethereum will slow down a lot over time though.
Bitcoin serves as a decentralized store of value — a peer-to-peer digital currency, used for financial transactions. It eliminates the need for third parties in payment technology.
Ethereum’s purpose is to offer and run decentralized smart-contract applications powered by blockchain technology that do not go offline and cannot be altered. It provides users with a platform and programming language to build the applications on.
In short, Ethereum’s blockchain runs smart contracts Bitcoin doesn’t and instead only focuses on manual payment technology.
The question is: which crypto(s) should I invest on? Bitcoin, Ethereum or both?
Methodology
As we are approaching a new financial year, Qidax has conducted a portfolio management analysis between Bitcoin and Ethereum based on their prices from last financial year, i.e. starting Jul.1,2019.
Portfolio optimization is a process of selecting the best portfolio out of the set of all portfolios being considered; in this case Qidax has offered the two best crypto assets in the about-to-launch platform, i.e. Bitcoin and Ethereum.
Optimization of crypto assets of Bitcoin and Ethereum is done using efficient frontier. In modern portfolio theory, the efficient frontier is an investment portfolio which occupies the ‘efficient’ parts of the risk-return spectrum. Formally, it is the set of portfolios which satisfy the condition that no other portfolio exists with a higher expected return but with the same standard deviation of return.
The Sharpe ratio describes how much excess return received for the extra volatility endured in holding a riskier asset. It is defined as the difference between the returns of the investment and the risk-free return, divided by the standard deviation of the investment. Any Sharpe ratio greater than 1.0 is considered good by investors. A ratio higher than 2.0 is rated as very good. A ratio of 3.0 or higher is considered excellent. A ratio under 1.0 is considered sub-optimal.
Price & Daily simple returns
The close prices of Bitcoin and Ethereum are first extracted from historical data from starting date of this financial year Jul.1, 2019 to the current date (today). Price of the above two crypto assets are taken to be of equal amount in terms of market values, then normalised and compared.
Daily simple returns: (new_price + -old_price)/ old_price or (new_price / old_price)-1 are calculated.
Co-variance matrix
Next, annualized co-variance matrix is created. The co-variance matrix is a mathematical concept which is commonly used in statistics when comparing data samples from different populations and is used to determine how much two random variables vary or move together. Variance is a measure of how much a set of observations differs from each other. Taking square root of variance gives volatility also known as the standard deviation.
The expected portfolio variance is calculated using:
Expected portfolio variance= WT * (Covariance Matrix) * W
Followed by portfolio volatility calculation using the formula :
Expected portfolio volatility= SQRT (WT * (Covariance Matrix) * W)
Volatility (standard deviation) can be calculated by square rooting the variance.
Results show that annual return on the investments is 22% and the amount of risk for this portfolio is 83%.
Question: Can I do better with these Crypto Assets and how?
Portfolio Optimization
Optimization is conducted to give maximum return with the least amount of risk through calculation of expected returns and the annualised sample covariance matrix of daily asset returns. Through optimization, investment on Bitcoin and Ethereum is found to be at 77% and 23%, respectively.
The annual return on the investments is increased to 30% and the annual volatility / risk is reduced to 36%. This optimized portfolio has a Sharpe ratio of 1.21 which is good.
Discrete allocation of Bitcoin and Ethereum is performed. For example I have a spare fund to be invested in Crypto assets of $50,000 USD, and need to know how much of each crypto I can purchase in the portfolio to give me the optimal results.
4 units of Bitcoin and 48 units of Ethereum are found to be the best portfolio allocation of Crypto asset with $50,000 fund and a leftover of approximately $1040.
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