Cryptocurrency Portfolio Management

The theory of financial portfolio management emerged in the 1950s based on the work of Nobel Laureate economist Harry Markowitz. Markowitz established ideas that have since become fundamental to investing, such as the concept that investors should select instruments that offer an acceptable level of risk, and that the risk is intrinsically linked to the level of returns an investment delivers.  

The ideas of portfolio investing have carried through into the digital asset markets, where specific tokens, derivatives, or decentralized finance (DeFi) activities are selected and managed according to the risk tolerance and the financial goals of participants.

Along with the transactional activities of buying and selling assets, portfolio management also involves:

• Setting investment goals and risk tolerance

• Asset allocation – which may be based on various  strategies, like asset diversification

• Measuring and monitoring portfolio performance

• Rebalancing and adjusting the portfolio

Setting Investment Goals and Risk Tolerance

Setting investing goals and determining risk tolerance are two sides of the same coin. On the one hand, the question is about how much can be earned in returns in the best case: on the other, what level of losses can be borne if the worst case were to happen?

However, there can often be other factors at play that will determine how realistically a goal can be achieved, such as the time horizon for the investment or the level of active involvement required. For example, a longer time frame may mean an investor can afford to take more risks since they have time to recover losses, whereas a short-term time frame, where invested funds will need to be recovered sooner, could prove too risky to take such an approach.

Asset allocation and diversification strategies for crypto portfolios

Asset allocation is the process of determining how much of the portfolio should be invested in which assets or asset types are based on the chosen investment goals and risk tolerance. Diversification describes how funds are invested within those asset classes and is used as a way of attempting to reduce risk by spreading it across the portfolio. The rationale is that if a particular market segment suffers a downturn in one set of assets, other assets will be protected.

Diversification can involve many different types of strategies for spreading and hedging risk. Diversifying across different tokens and types of cryptocurrencies is one method; however, there are many diverse asset classes and opportunities in crypto that allow for more sophisticated investing strategies.

For example, generating staking returns through proof of stake crypto is one way of offsetting the risk of losses through market volatility. Some investors also use short positions to offset the risk of a downturn that would negatively impact growth investments. A more advanced strategy could involve using combinations of derivatives instruments such as options and futures to hedge against market movements in either direction. However, it’s worth noting that not all instruments are available to trade on a legal basis in all jurisdictions.

Diversification strategies in crypto don’t always need to focus on generating returns. For example, some users choose to split their holdings between wallets or custody providers as a way of protecting against hacks or the risk of a provider going out of business since not all funds will be exposed to the same risk.

Measuring Portfolio Performance and Evaluating Investments

Measuring and monitoring the performance of the portfolio is necessary to ensure that it continues to perform and align with the investment goals. In crypto, this is particularly important since market conditions can change quite rapidly. Even among the large-cap tokens, with the exception of Bitcoin and Ethereum, the landscape can change relatively frequently and more dramatically compared to traditional markets.

The easiest and most commonly-used way to measure crypto portfolio performance is to use dedicated portfolio management software. There are a huge variety of tools on the market, ranging from relatively straightforward free tools such as CoinGecko or CoinMarketCap all the way up to institutional-grade systems with more sophisticated tracking and analytical capabilities.  

Depending on the features available, users can operate multiple portfolios, track historical performance, set market alerts for price movements, and even integrate with exchanges or trading bots to execute orders automatically based on particular conditions.

However, even with automation in place, it’s still necessary to review performance regularly to ensure that a cryptocurrency portfolio is delivering on investment goals and nothing has gone awry.

Rebalancing and adjusting a crypto portfolio

Rebalancing is a way of ensuring that the portfolio remains aligned to its initial asset allocation and investment goals, and also ensures that the portfolio delivers gains and readjusts in line with market performance. Consider a scenario where a portfolio manager foresees growth in the decentralized physical infrastructure (DePIN) segment, and so defines a percentage of the portfolio to be invested in DePIN tokens.  

After some months, if the DePIN tokens have risen in value faster than some of the other segments, they will account for a greater percentage of the portfolio than was initially defined. At this point, the portfolio manager should liquidate some of the DePIN tokens and rebalance the portfolio to the initially defined allocation of assets.  

Rebalancing ensures that the portfolio is delivering on a strategy of buying low and selling high. On the other hand, simply holding onto the tokens in the hope of ongoing gains is a more risky approach since there is no way of knowing exactly when the market will reach a top.

Crypto portfolio management essentials

• Crypto portfolio management involves managing a set of digital assets to ensure they are delivering in accordance with defined investment goals and risk tolerance

• Portfolio management theory only emerged in traditional finance in the 1950s and has since carried over into crypto asset management

• Some of the activities involved in crypto portfolio management are asset allocation and diversification, monitoring performance, and rebalancing.