
Ask HN: Thoughts on Cryptocurrency Indices? - haggenballs
Cryptocurrency indices typically take the top 20-30 cryptocurrencies by market cap and apply one of these 3 different methods.<p><pre><code>  1. Weighted proportionally by market capitalization 
  2. Weighted proportionally by market capitalization but capped at a certain % 
  3. Weighted by square root of market capitalization
</code></pre>
Proportionally weighting makes the index vulnerable to a s single large constituent.<p>Capped and other weighting methodologies theoretically should diversify risk and reduce volatility. But if there is strong positive covariance between coins, then volatility is not necessarily being reduced in the index as a whole.<p>What do you guys think? I gave it my best shot and blogged about it here:<p>https:&#x2F;&#x2F;medium.com&#x2F;hodlblog&#x2F;hodlbot-cryptocurrency-investing-on-autopilot-dce2e4c9a7f7
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cimmanom
Frankly, the same thing happens to a slightly lesser degree with stock and
bond markets. Cryptocurrency is more extreme in this regard because most
cryptocurrency "investment" is still essentially speculation on the concept of
cryptocurrency in general.

Another poster mentioned diversifying your portfolio. There are at least two
dimensions to diversification.

One is diversifying among types of assets. That is, stocks vs bonds vs money
market vs real estate vs crypto, etc.

Another is diversification with an asset type, which is what an index helps
with. You could have a portfolio with a healthy mix of stocks vs bonds vs
other assets. But if all the stock holdings were in IBM, that's not actually a
diverse portfolio.

So: if you're investing in crypto as part of an otherwise healthily balanced
portfolio, a crypto index fund is a good idea. But that doesn't replace having
other investments spread across stocks and bonds et al.

Now, take a look at how stock or bond index funds work. Each one has different
strategies for balancing how much of which individual securities (individual
stocks/bonds) it includes.

Those strategies are mostly intended to protect you from volatility in one
stock or bond that doesn't match the market. That is, to make sure that your
portfolio goes up in a bull market regardless of whether Enron just crashed,
because on _average_ stocks are rising.

However, _every_ index fund moves with the market. When there's a bull stock
market, stock index funds will go up and bonds will go down. In a bear market,
stock funds will go down and bond funds will go up. The performance of assets
in the same class is always correlated.

An index fund will never protect you against the volatility of the market as a
whole. It only protects you against the volatility of an individual asset.

I'm sure books have already been written about the tradeoffs between various
portfolio weighting strategies within a single asset class. Maybe that would
be a good place to start.

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ecesena
I don't think that "diversify" is used with the correct economic meaning,
because to diversify you need independent assets, and cryptocurrencies are
not. Let me try to explain my thoughts.

To diversify you typically want to invest in assets that are _independent_ and
with a similar expected return. Only if they are independent you're really
reducing your risk or, said in another way, the more independent they are, the
more you're reducing your risk.

Cryptocurrencies are far from being independent, you can easily tell by
charting them together, e.g.
[https://priceeth.github.io](https://priceeth.github.io), so I don't think
you're really reducing any risk.

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haggenballs
Yeah exactly. Although there are some pairs that have low and negative
covariances.

Check out this: [https://blog.enigma.co/markowitz-portfolio-optimization-
for-...](https://blog.enigma.co/markowitz-portfolio-optimization-for-
cryptocurrencies-in-catalyst-b23c38652556)

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ecesena
Mmm... I'm not sure I'm reading this correctly, but it seems that these
portfolios only win against BTC. So if you just invested in ETH, you'd have
done much better.

I guess what I'm saying is that you're not reducing risk by keeping the same
expected return (well, unless you arbitrarily claim that all cryptocurrencies
have the same expected return, for which there's no data evidence). You're
just averaging your returns.

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jxub
"Ask HN:" prefix please

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haggenballs
Thanks !

