Bitcoin & Ethereum: Modern Portfolio Theory

Hey everyone and thanks for jumping back Into the cryptoverse today we're going To talk about Bitcoin as well as some Other cryptocurrencies and go through an Exercise something we've done a few Times before on Modern portfolio Theory We're going to talk about the sharp Ratio the sortino ratio how do you Maximize your risk adjusted returns just Simply based on historical data if you Guys like the content make sure you Subscribe to the channel give the video A thumbs up and also check out into the Cryptoverse premium at intothe where you can of course get Access to this Tool uh and um plenty of Other charts and and tools as well so We've done this video before but it has Been a while and and some of the Percentages have slightly changed in the Direction that if you go back and watch The prior videos that we suggested they Were likely going to change into and What we're doing here is we're first Running a a Monte Carlo simulation right So we're taking 50,000 different portfolio weights Between just Bitcoin and ethereum and We're calculating out unexpected return Based on historical returns now a lot of Hedge funds use this sort of stuff but In a slightly different way for instance They might use something different for The expected return rather than just

Simply looking at his hisorical returns Right just because something played out Certain way in the past doesn't mean It's going to continue to play out like That but it has been fairly useful Through the years and and this is Something we've talked about over the Last few years so if you know if you're A hedge fund or something your expected Return might be something you know your Your Alpha right your you're something That you've decided it's actually worth This this is what I think's going to Happen and based on where I think it's Going to go how do I maximize my risk Adjusted returns because even if you Think it's going to go to a certain Level you also want to look at its Volatility and say all right well I Think it's going to go here but there is Still some level of risk involved and in This way we're sort of defining risk as The amount of volatility and so here What we're doing is we're displaying 5,000 of 50,000 portfolio simulations Because it's just a lot to to you know To to visually show 50,000 but when You're only using two different assets You just get a you know you get a simple Curve that looks like this now if you Were to add in a third asset and Recalculate it then obviously it's it's A little bit more complex we'll talk About that in a little bit but when

You're just talking about two Assets Bitcoin and ethereum you get this Line now this line is known as the Efficient Frontier so again when you Have three assets you want to be on that Efficient Frontier when you have two Assets it OB there's no depth to it Right you're either you know if you're 20% Bitcoin that means you're 80% eth or If you're 80% Bitcoin that means you're 20% eth if you're looking at a portfolio Of Simply only consisting of Bitcoin and Ethereum and so the way to interpret This is to say all right well if your Expected if your expected return is say 7 and the volatility is point and you're Okay with say volatility of of 75% then your annual expected return Would be 70% plus or minus 75% and then That would lead you to a portfolio Consisting of approximately 61% Bitcoin And 39% eth now that portfolio is not The portfolio that maximizes your risk Adjust returns in fact the one that Maximizes your sharp ratio is 76% Bitcoin and 24% e however I think the Sortino ratio might actually be a Littleit more useful because the sharp Ratio actually punishes positive Volatility if you remember earlier we Talked about volatility we're thinking About volatility in terms of risk right Now you might think well if if if the Asset that I'm holding goes up 100%

That's not a bad thing but if you're Calculating out your sharp ratio it'll Just punish any type of volatility right And treat it as as bad right or treat it As risk but if you want to only punish Negative volatility right where you get Volatility to the down side then you can Actually stick to your sortino ratio and The sortino ratio is maximized with a Portfolio consisting of 80% Bitcoin and Only 20% eth now this is something that I'm sure would be very controversial but If you go back and look at these videos That I did on Modern portfolio Theory Say two years ago the numbers were Actually closer together I don't Remember exactly what it was it might Have been like 65% Bitcoin 35% e but Back then if you go watch all those Videos what I said was that I think it's Actually going to be going more towards Bitcoin over the next few years and so It's better to anticipate that rather Than to wait for it to say 80% right or 90% or whatever it's going to say and The reason I said that back then I got To work it in is of course because of The view that we've expressed time and Time again regarding the dominance of Bitcoin going up and and we we've seen That happen and and so because that has Continued to to to play out what Essentially has happened is that the you Know the the the allocation towards

Bitcoin by percent has actually gone up And ethereum has gone down and if you Think back a couple years ago a lot of People were saying well eth outperforms Bitcoin in a bull run I've been very Clear that eth outperforms Bitcoin in a QE bull run but not in a qt Bull Run in A qt Bull Run just like 2019 Bitcoin Outperforms ethereum and so that's why That's why you get this so I mean I Think a lot of people they only remember That one year of QE you know from like 2020 to 2021 and they saw eth outperform Bitcoin so then they always think it's Going to outperform it when in reality That's just simply not the case and While it has been putting in higher lows For a while it's also been putting in Lower highs perhaps it's converging to Whatever the fair value is um but again The sortino ratio is maximized by 80% Bitcoin 20% eth the sharp ratio is Maximized by 7 6% Bitcoin 24% eth and Your sharp ratio your your stina ratio Max is 1.19 your sharp ratio Max is 0925 you Want it to be as high as possible okay And and this is just something going Back to 2015 because you can only go Back as far as the youngest asset right You can't use bitcoin price history from 2011 because ethereum didn't exist back Then um so then what we're going to do Is we're going to say what what if

You're super risk averse right what if You're like you don't want hardly any Volatility but you still want to hold Bitcoin and eath then you want to look At how do you minimize your volatility Right so rather than maximize your sharp Ratio or your sortino ratio maybe you're Super risk averse and you'd rather Minimize your volatility so that you can Sleep better at night and in that case It would call for 93% Bitcoin and 7% eth Right now for me I've obviously been Even more weighted towards Bitcoin over The last couple years just simply Because I thought Bitcoin dominance Would go up and that the valuation of Eth would bleed against Bitcoin until we Get back to looser monetary policy and I Am very happy with that decision Obviously if you bought eth at $1,000 It's not like you're hurting let's be Real but I do think it it goes to show Why Bitcoin has in fact been the better Play now what we can do though is we can Add a little bit more depth to this Chart one thing that I'm sure is on Everyone's mind right now before we get To that is how do we know that this is The actual Max tortino ratio and sharp Ratio because we only ran 50,000 Simulations is it not possible that if We had run 50,000 And1 simulations maybe We would have found a portfolio with a Higher expected return we've we've

Accounted for that right and so there's Actually this cool thing you can do um With with this I mean you can run the Money Carlo simulation and try to brute Force it or you can resort to quadratic Programming and if you do that you can Identically solve for the portfolio that Maximizes your sharp ratio and your Soro Ratio so you don't even have to rely on A Brute Force money Carlo approach if we Add in an asset let's say Litecoin I Always like to pick on Litecoin because It it just keeps on bleeding back to Bitcoin it's what it does best now There's depth right and as you hover Over these different portfolios you can See how the portfolio percentages change And when you're down here at your max Tina ratio and sharp ratios you can see How it calls for a very heavy allocation In Bitcoin coin much smaller in eth and Practically zero in Litecoin as you go Up the efficient Frontier you can see How it goes from less it goes from a lot Of Bitcoin to less Bitcoin and more eth And the reason for that is because you Know eth while it has been Underperforming Bitcoin when it does Move especially when QE returns it Actually does tend to outperform bitcoin And so you know you could get a higher Return with eth but you're also paying For it with a lot more volatility Especially over like the last three

Years where you've actually seen eth Underperform Bitcoin so in that case the People that were 100% eth took on more Risk than Bitcoin and they got a lower Return which is what you really want to Avoid now you also can go down here at Sort of the red line and you might think Of that even as the inefficient Frontier And that's where you really don't want To be right you're taking on a ton of Risk and you're getting a you're Expecting a lower return for instance up Here at say volatility at 08 on the Efficient Frontier your expected return Is about 70% and that's you're there There you're about 52% Bitcoin 48% e but If you go all the way down here to the Inefficient front it's inefficient FRS Here is not really a thing I'm just sort Of making it up I believe um maybe Someone's used that before there it Calls for say 43% Bitcoin 3% eth and Like 54% Litecoin but 54% Litecoin is Really going to get you anywhere in in The crypto and you can see that in this Case you're taking on the same amount of Risk as you were up here but your return Is you know 30 to 40% less theoretically Just based on historical returns and so In this case to maximize your sortino Ratio it calls for 78% Bitcoin and and 22% e right and and again for your sharp Ratio it's about 76% Bitcoin and 24% eth Um so it it is interesting how these how

How sort of the numbers subtly change Right especially when you're talking About your your sortino ratio right so If go back to just your Bitcoin and eth Chart um you can see it it really Doesn't change right it's still 76% 24% For the sharp ratio and the reason it Doesn't change is because we're just Using quadratic programming to Identically solve for the the the Valuation or the the portfolio weights That maximize your risk adjusted return Which is the sharp ratio okay so you can Add on Litecoin and and see that it it It really doesn't it doesn't make a Difference because it's saying you know What you can add Litecoin all you want It's not that Litecoin can't go up right But guess what even if it does go up Bitcoin and ethereum likely outperformed It right there's not many if you think About you know if we live in a Multiverse and there's like thousands of Other universes like how many of those Do you have an example where Litecoin Goes up a lot and Bitcoin and ethereum Aren't also doing well right so it's It's not to say that Litecoin can't do Well it's just that there's some Opportunity cost there's a lot of Opp Opportunity cost associated with it now You can also add on some other altcoins As well let's add in xrp and Monero and I know what a lot of you guys are

Thinking you're like well why is he Using all these relics you know why is He using all these coins from prior Cycles that no one cares about right the Reality is is that you you really can't Use assets that have only been around For like one market cycle because they Just skew the results and the reality is In the First Market cycle an altcoin can Do quite well in the second and third it Often times a lot of them underperforms Some of them will continue to do well in Later Cycles but there's just so many of Them that underperform later on and and You just have to be aware of that so in This case you can still see that to Maximize your sharp ratio it's still Just 76% Bitcoin 24% eth and it's 0% Everything else right and it's not to Say that other stuff that other stuff Can't go up it's just to say look if it Goes up it's only because Bitcoin went Up right uh so it really does go to show That that that you know sort of an Interesting View of the market now we've Added something to this that we haven't Shown before and that's we're going to Add in USD right so if you're if you're Someone like me who likes to have some Cash on hand in case you get dips in Case in case this does play out like a Mid 2019 style thing where all Bitcoin Pairs are breaking down and the Bitcoin Dominance is breaking out if it does

Play out like that then you know it Makes sense right to have some cash on Hand right especially you know when you Do see the market sort of fall back in For a while for whatever reason it might Be and in this case to maximize your Sortino ratio it's 66% Bitcoin 17% e 177% USD right to maximize your sharp Ratio it's 51% Bitcoin 16% e 33% USD and by the way the USD I'm not we're Not even including you know your 5% Returns on USD I mean if if you threw in If you threw in the risk-free rate you Know you threw in something like the 2-year yields and said well I can at Least get 5% risk- free on that then it Then it might actually change the Calculation right um but in this case We're not doing that we're just saying You know it just is one right and it Just doesn't move and in that case You're still looking at about 33% but in Order to minimize your volatility Obviously it would just be 100% USD Because there's like there's no Volatility in the sense that everything Is being denominated in US Dollars now We know if you're in crypto you know That's not entirely true Right well it might be true that1 us Equals $1 us we know that the dollar is Being devalued right is there's no such Thing as like the sort of the perfect Reference point even if you're measuring

Like you know speed or like velocity Right it's it's always relative to what Right I mean like like I'm sitting here And I'm not moving but relative to the Sun I'm moving and relative to the Milky Way the you know our solar system is Moving and relative to the Milky Way Right everything's moving with respect To something something else and so you Can't just look at USD in the vacuum and Say that it's always just I mean yes It's true that $1 equals but the Purchasing power goes down um so of Course if you wanted to minimize your Volatility that's what you would go with But you're you're going to lose Purchasing power over a long period of Time and so this is a really interesting Way I think to look at at this stuff and To try to figure out you know what makes The most amount of sense how much risk Do you want to take on at various parts In the cycle and the thing I love about This this type of chart is there's no Bias in it right it just it's something That dates back dates back several Decades classical portfolio Theory right There's papers on it you can read them Go to Google Scholar and just type in Modern portfolio Theory and there's no Bias to it it's just like you know I'm Just we're just plugging in historical Returns as the expected return which I Mean it's a bit dubious right but that's

What we do here you know we're looking At prior volatility plugging that in and Just saying you know what based on Historical results this is what we Expect we would expect annually that Doesn't mean that years you're not going To have a bad return again even when You're maximizing your sharp ratio your Expected return between these three Things is about 50% plus or minus 50% Right I mean so some years within one Standard deviation you're not going to Get a return at all and then some years You you might lose money Right but this is modern portfolio Theory I thought this would be a good Way to just sort of show people the Different strategies cuz you know There's a lot of people out there That'll that'll just say you know this Is how you manage your risk right They'll you know they'll they'll St They'll they'll talk about um like sort Of the technical analysis levels which I'm not saying there's no validity to That but there's another way to to Approach the markets right than than the TA way and it's just to say look what if We approach this from something that was Developed decades ago that has worked Out pretty well for other people and we Just apply it to crypto right it's as Simple as that and this is a way that You can go about doing that and and

Leaving the bias at the door now you can Add a bias to it right and the way you Could do that is you could you know Program in instead of using the expected Return based on historical returns you Could make your expected return based on What you think the return is going to be So like if you think bitcoin's going to Go up say 30% or something then you Could plug that in and then it would Tell well I mean not on this right now Like we don't have that capability right Now but theoretically if you just Programmed it yourself Ian you can do All this in in in Python the first time I I did all this I just coded it up in Anaconda my point is is that is Something you could theoretically do Plug it in what you think bitcoin's Going to do what you think eth is going To do and then based on historical Volatility you could then figure out What weights would make the most amount Of sense and you could also be the Person that says you know what I don't Want to maximize my risk adjusted return Maybe you want to minimize volatility um With these two assets or something right I so there's different ways right and There's no there's no WR wrong answer It's just what is the risk you're Willing to take on the you know the the The More DJ friends Among Us they might Want to be all the way out here on the

Risk on the on the risk curve at at Really high volatility you know over 100% annualized volatility and they Barely have any Bitcoin and they're just Loaded up on eth now that strategy has Not been working out for them in the way That they might have hoped over the last Few years they would have been better Off with 100 they would have been better Off over here right with 100% Bitcoin And 0% eth over the last few years Because the eth Bitcoin valuation has Bled quite a lot but look they knew the Risk they took on the risk it didn't pay Off it might pay off next year maybe It'll pay off at some point but again With investing timing is everything if You guys like the content make sure you Subscribe to the channel give the video A thumbs up and also check out into the Cryptoverse premium at intothe where you can of course get Access to this tool that'll wrap it up And I will see you guys next time bye


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