Let’s Co-invest in my Crypto Portfolio

Approximately one year ago I flirted with the idea of managing a crypto portfolio on eToro. I had previously created an algorithm that suggested a long or short position on Bitcoin taking its momentum, trend, and volatility into consideration. The results were unbelievable profitable, but I refrained from promoting it, fearing it was all just an algorithm based on hindsight – or, to use a more common phrase – knowledge about the future.

I will return to the problem of detecting hindsight bias from the algorithm. First, let me explain what the Bitcoin algorithm does and what it has accomplished.

The Bitcoin-algorithm

The algorithm suggests long (white background) or short (grey background) based on a composite of various technical indicators. The yellow line is the Bitcoin – the underlying asset and benchmark for this algorithm. The purple line is the bitcoin algorithm itself. The outperformance of the algorithm seems rather trivial plotted on a logarithmic chart, but it has returned 3.1 times that of the benchmark itself – and with much less volatility!

I worked a lot on this during the first months of 2020 and did in fact invest a few thousand dollars, but as you are all aware, the Covid-pandemic happened – and I had to change my priorities from creating and documenting the algorithm to preserving my capital on my other portfolios.

The market volatility that followed provided me with a short signal. I did as the algorithm advised and shorted bitcoin at 8874 USD and went back long at 5588 gaining about 41 % on the trade. The fact that the algorithm worked in real time and outside the domain of hindsight was for me a great relief.

The Ethereum algorithm

The same applies for Ethereum. It is suggesting long or short based on price momentum, volatility, and trend. The best assets to trade with such an algorithm are those who follow a clear trend. Zigzagging sideways and sharp non-trending moves are truly the Achilles-heel. The Ethereum-algorithm have historically held a steady direction thus providing an amazing return of 46.4 times that of the Ethereum itself. Most of this alpha were created during the bearmarket of 2018.

The Litecoin algorithm

Litecoin is not an exception. It does the same thing providing a return of 30.1 times that of Litecoin itself.

The crypto algorithms combined

Even though all three algorithms are based on price momentum, volatility, and trend, they differ in many ways. The problem with all three crypto assets, is that they are quite correlated. I have tried to make the algorithms as differently as possible, optimizing them for cooperation. The chart below shows all three algorithms separately and combined in addition to the Bitcoin long-only benchmark.

In those charts, the algorithms start at (1/3) of the capital and is never rebalanced. In the real fund they will rebalance, and that process is expected to reduce volatility overall. The chart starts at the end of august 2017, about four months prior to the peak before the bear market of 2018. If I had invested 1 USD at that august day in 2017, I would have had 65.2 USD today! This return is insane and is not to be expected for the future.

Hindsight bias

Technical analysis (TA) is the “science” of price-data and the backbone of my algorithms. Its proponents would argue the method is well documented, its critics compares it to astrology and witchery. Some people may call it the momentum factor, others the castle in the air method. Whatever one may call it, the method assumes the future based on the momentum of the past. That is of course a backward-looking strategy, but the same can be said about “buy the dip” strategies on equities, systematic value investing, gold to M2/GDP/silver ratios etc. No systematic approach is to my knowledge deprived of the bias of backward-looking. Even our very sciences are derived of experience. One would not expect Sir Isaac himself to assume Newtons second law prior to experiencing an object falling or otherwise being accelerated. Objects tend to fall every time you drop them. The algorithms is by no means that deterministic. It makes mistakes, but thus far the overall performance has fared well – and then some.

The portfolio

The growth part of the portfolio is expected to be delivered by the crypto algorithms. Come bull or bear, we will ride them both! Yet, the algorithms do somewhat correlate, so does the underlying asset – and there are limitations to how focused one portfolio should be. I have decided upon this main structure for the portfolio as a whole:

Bitcoin algorithm	16,7 %
Ethereum algorithm	16,7 %
Litecoin algorithm	16,7 %
Gold/silver/mining	25,0 %
Equities/indexes	20,0 %
USD (for rebalancing purposes)	5 %

I will systematically rebalance to this allocation when the assets deviate notable from this setup. If the crypto algorithms continue to perform as they have previously, I will continually sell some crypto assets and buy gold and equities.

The Achilles heel of the algorithms is a zigzagging sideways market with no clear trend. In such an environment the buy and sell spread will result in great losses. That very environment is the reason why I use the phrase “the algorithm suggests” rather then “the algorithm demands”. I will not always follow the suggestion. I will take both the macro environment and the halving cycle into account prior to transacting with the crypto assets. If the zigzagging between long and short is too aggravating, I will hold USD until the trend is clearer.

The process of rebalancing, buy the dip and sell the spikes, is assumed to lower risk and volatility for the portfolio.

The gold and silver assets

Gold and silver have been money for thousands of years. I do not expect that to change any time soon even though most crypto bull investors presumably do. Gold is indeed what I consider a perfect partner to crypto assets in general. Both camps tend to believe that money printing, massive debt, and lack of discipline to handle it eventually will cause a catastrophe. I will not go too much into that, but it is obvious from looking at the charts that gold correlate with M2 money supply in the long term and real yields in the medium term. Crypto assets are more of a risk-on speculative inflation bet with optionality on the future of finance. Gold I presume as a risk-off asset, only to be truly hit if massive liquidation of assets to meet margin calls were to happen. Of course, we have had massive gold bear markets too, but those have historically happened when gold overshoots M2 money supply and real rates is increasing. I believe that eventuality may happen several years into the future. I am bullish on gold at this price levels. M2 is expanding and is expected to continue to expand. Real yields will stay depressed for longer due to massive debt and recuring FED interventions to protect the economy from collapsing on its debt obligations.

I will trade gold and gold-equities using my gold algorithm together with charts of M2 and real yields. This is a conservative macro play to manage risk and store wealth. This is the defence player of the portfolio.

Equities and indexes

Since crypto assets historically have gained the most during speculative times, holding speculative stocks makes little sense. I will tend to hold stocks and indexes that one may describe using the value factor. As of this writing, I find a lot of value in the material and energy sector. The valuation is very cheap for the energy space, possibly due to ESG mania and anti-carbon portfolios, but also the recent OPEC debacle, reduced demand due to the shut down and the one-off craze of negative oil price. Big oil companies are priced at generational lows, and that opportunity in the space are in my estimation remarkable. Remember that tobacco companies have been hated and regulated worldwide for several decades now. Yet they have returned great appreciation on the invested capital. Being hated and regulated is not necessary a bad thing in finance. Regulation may result in less capital being invested thus fewer projects realized with the result of increased energy prices.

The portfolio history

The portfolio started out as a pure Bitcoin long short play but has evolved gradually towards what I have just explained.

• I started adding Bitcoin in 2019, but added most of the position the 17^th of January 2020
• I added gold 21st of January 2020
• Ethereum was added 19^th of February 2020
• Litecoin was added 25^th of November 2020
• Most stocks and ETFs were added in December of 2020
• I rebalanced the portfolio in relation to the rules described in this document during the Christmas holidays of 2020.

The history and stats of the real portfolio (no back test) is shown below.

Future expectations and risk

I expect the algorithms underlying asset to continue to trend either up or down and that the algorithm will manage to suggest the trading action based on price momentum, trend, and volatility. I do however not expect it to perform as well as the back tests in the charts suggest. Even though the short Bitcoin signal in March was a real money success, one must realize that the algorithm is based on past price action. History may rhyme, but never repeat exactly – and that will most probably manifest in somewhat less of an alpha compared to the benchmark in the future.

When I modelled the algorithms, I realized the greatest risk is sharp drops in the underlying asset. The algorithm does not protect us from such events, and I have as a result refrained from investing in alt-coins where such price action is more common.

Trading on eToro is without normal commission, but you do pay indirectly in spreads. Those spreads are quite huge for crypto assets and may become an Achilles heel if the trend is unclear. The spreads are incorporated in the back test.

The algorithm may fail to deliver its signal due to bugs in the algorithm, issue with the data provider or human error. I will keep a close look at both the underlaying assets and its algorithms in order to prevent such circumstances. Yet it is a risk.

All normal equity and trading risk do of course apply. I am not a professional money manager, but I have managed my own investor portfolio of diversified assets since 2015. I consider that portfolio a conservative hedge fund with both long and short equities, long commodities, gold, crypto, and sometimes even bonds. I intend to run the 50 % non-crypto part of the portfolio in a somewhat similar way.

Who should consider investing in this portfolio?

This is not a portfolio for the faint of heart! It will be volatile and that is the whole point. The goal is to harvest that volatility to our benefit using a systematic approach. Considering the volatility, the unique long and short crypto algorithms and the constant rebalance to value and gold, I believe the portfolio could act as an interesting hedge in symphony with a more common and broad portfolio. I do not consider this portfolio a stand-alone vehicle for capital appreciation or conservation, but rather a spicy addition.

Many people believe crypto is just another tulip mania. I believe that view may be compatible with investing in this portfolio due to its long and short nature. Nevertheless, the algorithms do have a long bias. Please consider the grey area of each algorithm carefully to evaluate whether the long bias is appropriate for your investor needs.

If you believe crypto is the future of finance, and that the Bitcoin price eventually will hit 400k or even 1M, you still have to cope with massive volatility and yearlong bear markets. This portfolio offers a way to trade the ups and downs of the asset class and could supplement a long only position held in cold storage or another platform.

If you choose to invest or trade on eToro, please consider clicking the banners, or this link when setting up your account. If you do so, I will earn some commission from eToro.

67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.

After setting up your account and deposit some funds, you may search for “AliasCryptus” (or follow this link), and you will find my portfolio. After that, you may automatically copy all my trades and thus invest with me on this social trading platform.

I would suggest you set up a portfolio of favourable traders. There are several great traders on the platform and copying a few of them will help diversify both equity and manager risk.

eToro is a multi-asset platform which offers both investing in stocks and cryptoassets, as well as trading CFD assets. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 67 % of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work, and whether you can afford to take the high risk of losing your money.

Good luck and happy trading!