How to become a cryptocurrency “Samurai”

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Contrary to the Hollywood description, not all “models and bottles” are for portfolio managers, unless these bottles only contain aspirin, and the model they are chasing can be found in a spreadsheet.

At the end of the day (or more likely the end of the quarter), portfolio managers must show that they can add value, otherwise clients will find people who can even just buy index funds.

Those institutions that measure themselves against such benchmarks are now turning to Bitcoin. What followed was an interest in alternative cryptocurrencies (altcoins).

Five years ago, there may be more than a few cryptocurrencies, but Bitcoin accounted for about 95% of the total market value of all cryptocurrencies. At the beginning of 2018, due to the initial coin offering (ICO) boom that led to a large number of new entrants, it only accounted for about one-third of the market value of cryptocurrencies. Many early replacements have disappeared, but others have not (hello, ether). Just a year ago, Bitcoin accounted for 70% of the total market value. Today, Bitcoin is only slightly above 40%.

What DACS?

New entrants once again attracted the attention of the market. Some seem to be more than just a flash in the pan. Many people will never catch fire. According to CoinMarketCap’s statistics, as of Friday morning, there are 15,765 cryptocurrencies in New York, and this number seems to be increasing every day. Many of the listed cryptocurrencies are not traded in any market at all.

Last week, CoinDesk announced the launch of Digital Asset Classification Standard (DACS)It covers the top 500 cryptocurrencies by market capitalization, which is a reasonable limit on the scope of related currencies. The goal is to let investors understand where the coin is in this universe. It answers questions such as “What is its counterpart?” And “What are its main competitors?”

The six sectors identified are currency, smart contract platform, DeFi, entertainment, computing, and digitization. In turn, these are subdivided into industry groups, which in turn are composed of industries.

Already given an example

DACS is the basis for constructing indexes, such as CoinDesk DeFi Index (DFX) and CoinDesk Large Cap Index (DLCX)Both are weighted by market capitalization, the former includes 10 decentralized finance (DeFi) tokens, while the latter consists of eight cryptocurrencies, accounting for at least 70% of the total market capitalization of all cryptocurrencies.

Let us take a simple example to illustrate how the right index can help evaluate the performance of a fund.

Imagine a high-net-worth banker named Bob. He heard about the entire DeFi story and decided to invest funds to better hedge his wealth. After all, if it is really the wave of the future, he might be unemployed in a few years.

Bob called his daughter’s friend Alice, who is a portfolio manager in the crypto space. Alice has a fund in DeFi that consists of only two assets, Uniswap’s UNI token and Yearn Finance’s YFI. Bob wrote a seven-figure check to Alice, and she started trading on July 1, 2021, when UNI and YFI each had a portfolio weight of 50%.

At the end of the quarter, Alice called Bob, and Bob completely forgot the fat check.

“Congratulations, Bob! Your DeFi portfolio has risen by 9.24% in the last quarter. This is the weighted average of the two assets in your portfolio. It completely depressed the S&P 500, which fell 0.29%. Am I not a genius?” She smiled.

On the surface, Alice is indeed an excellent asset manager. But does she really add value? Yes, but not as much as she thought.

Become a crypto warrior

When trying to find the right benchmark for your portfolio, it helps to remember the acronym SAMURAI. This means that the index should be:

  • Pre-designated
  • suitable
  • measurable
  • clearly
  • Reflect current investment views
  • Responsible, and
  • Can be invested.

These are the seven characteristics of a proper benchmark.

(For a good discussion of all of these, check out This paper from the British CFA Institute.)

In the example above, the S&P 500 index is not a suitable benchmark. This is an index of US large-cap stocks and has nothing to do with DeFi.

Bob said to Alice: “What are you talking about? You are overwhelmed by Bitcoin. Its return in the third quarter was 30.58%. This is 21.34 percentage points higher than your DeFi portfolio.”

However, Bitcoin is also inappropriate. Although it is a cryptocurrency-and it is the first and largest-but as DACS shows, it belongs to the currency field. This is not necessarily a DeFi game.

Alice protested against Bob’s use of Bitcoin. “Okay, okay, you are doing worse against Ethereum, everyone knows that Ethereum is a big DeFi bet,” he shot back. “ETH’s return for the quarter was 42.21%.”

Again, this is another inappropriate benchmark. Ether may be a very popular asset that can be “locked in” or invested in DeFi, but it belongs to the field of smart contract platforms.

In fact, there is an index suitable for Alice to use, and that is the CoinDesk DeFi Index (DFX). Uniswap and Yearn Finance are among them.

In the third quarter, DFX’s return rate was 8.87%. This means that Alice’s fund gave Bob an extra 0.37% in the quarter compared to the fund that just invested in the DeFi index. This was a victory, albeit smaller than Alice claimed. Its return may be different from Bitcoin or Ethereum, but the goal of Bob and Alice’s investment is to contact DeFi, not other types of cryptocurrencies.

Win some, lose some

Fast forward to December 16, and Bob’s investment in him feels complicated. Since July 1, his and Alice’s DeFi holdings have fallen by 20.40%, which is slightly better than DFX’s loss of 20.79%-although still negative.

Remember, he wants to: 1) get in touch with DeFi and 2) hire people who can add value. Given that Alice is only slightly above the index due to Friday’s YFI rise, he may want to reconsider investing in her. In the long run, together with Alice investing in a volatile two-asset portfolio, he may be better able to invest in something that replicates a more diversified DeFi index.

Of course, if Alice’s goal is to propose a DeFi portfolio, she can invest in any or all ten assets in DFX (even assets outside of it). How she weighs these assets in her fund is the result of her research and skills.

For investors, only the right benchmark can be easily measured.

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About the Author: AZ