Cryptocoin investment is extremely risky. I want to be absolutely clear: I can not, and will not, provide you with investment or financial advice. You can read more about this in our Terms of Use found at the bottom of every page.
Having said that, the following is a summary of how I approach cryptocoin investment. The majority of this information has been sourced from Reddit. It aligns closely with my own investment approach. I have modified it to reflect my personal preference in parts.
Set your target early. Ideally, relate this back to a standard investment base. For example, given the significant risk, you may want to target twice the current high-interest-savings-account rate. Or perhaps you might want to double an index on the stock market over the same time period. You may end up with a target of 5% to 10% with this method.
A lot of young investors who are in crypto have unrealistic expectations about returns and risk. A lot of them have never invested in any other type of financial asset and many seem to consider a 5-10% ROI in a month to be ‘unexciting’. It’s important to temper your hype and learn why we have had this exponential growth in the last year. Also, to realise how unlikely it will be to see 10x returns in the next year. What we saw recently was Greater Fool Theory in action. Those unexciting returns of 5-10% a month are much more of the norm and much more healthy for an alternative investment class.
You can think about setting a target in terms of the market ROI over a relevant holding period and then add or decrease based on your own risk profile.
Lets say you want to hold for 2 years now, how could you set a realistic target to strive for? You could look at a historical 2 year return as a base, preferably during a period similar to what we’re facing now. Now that we had a major correction, I think we can look at the two year period starting in 2015 after we had the 2014 crash. To calculate a 2 year Compound Annual Growth Rate (CAGR) in 2014, 2015 and 2016:
2014-2016 | Total Crypto Market Cap |
---|---|
Jan 1, 2014 | $10.5 billion |
Jan 1, 2016 | $7.1 billion |
2015-2017 | Total Crypto Market Cap |
---|---|
Jan 1, 2015 | $5.5 billion |
Jan 1, 2017 | $18 billion |
2016-2018 | Total Crypto Market Cap |
---|---|
Jan 1, 2016 | $7.1 billion |
Jan 1, 2018 | $33.9 billion |
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CAGR for:
Taking the median, this annual return rate of 81% comes out to about 4.9% compounded monthly. This may not sound exciting to the lambo-moon crowd, but it will keep your goals in cryptocoin investment grounded. You could aim for a higher return (say 2x of that 81% rate) if you choose to take on more risky propositions. I can’t tell you what return target you should set for yourself. Just make sure it’s not dependent on you needing to achieve continual-near-vertical-parabolic-price-action-in-small-cap-shillcoins because that isn’t sustainable.
Once you have a target, you can construct your risk profile (low risk vs. high risk category coins) in your portfolio based on your target.
All cryptocoin investment is extremely risky, however it still helps to break the level of risk down into these three categories:
How much risk should you take on? That depends on your own life situation. It also should be proportional to how much expertise you have in both financial analysis and technology.
The general starting point I like to begin with is:
Some more core principles on risk management to consider:
Along with thinking about your portfolio in terms of risk categories described above, I really find it helpful to think about the segments you are in. OnChainFX has some segment categorization but I generally like to bring it down to:
Think about your “Circle of Competence”: your body of knowledge that allows you to evaluate an investment. Your ability to properly judge risk and potential is going to largely be correlated to your understanding of the subject matter. If you don’t know anything about how supply chains functions, how can you competently judge whether VeChain or WaltonChain will achieve adoption? If you don’t understand anything about the tech when you read the Cardano paper, are you really able to determine how likely it is to be adopted?
Consider the historic correlations between your holdings. Generally when Bitcoin pumps, altcoins dump but at what rate depends on the coin. When Bitcoin goes sideways we tend to see pumping in altcoins. When Bitcoin goes down, everything goes down.
You should diversify but you really shouldn’t be in much more than a dozen cryptocoins. You simply don’t have enough competency to accurately access the risk across every segment and for every type of crypto you come across. If you have over 20 different cryptos in your portfolio you should probably think about consolidating to a few sectors you understand well.
Do you struggle on how to fundamentally analyse cryptocoins? Here is a 3-step methodology to follow to perform your due diligence for cryptocoin investment:
There is so much out there that you can get overwhelmed. The best way to start is to think back to your own portfolio allocation strategy and what you would like to get more off. For example, in my view, enterprise-focused blockchain solutions will be important in the next few years. So I look to create a list of various cryptocoins that are in that segment.
Upfolio has brief descriptions of the top 100 cryptos and is filterable by categories. For example you can click the “Enterprise” category and you have a neat list of VEN, FCT, WTC…etc.
Once you have a list of potential cryptocoin investment candidates, it’s time to read about them:
You can actually filter out a lot of scams and bad investments by simply keeping your eye out on the following red flags:
It is rare to find a person who spends so much time and energy reviewing potential cryptocoin investment options. Also, who has the time to present their findings? It is even more rarer that a person who is genuinely successful in cryptocoin investment strategies wants to share their recipe for success. Many of the big name ‘reviewers’ are receiving a lot of money to promote the cryptocoin in question, regardless of its actual quality. They are also able to benefit by buying in early, giving a small group of insiders the time to buy in, before promoting it to the public. Not only does the reviewer get paid to do this, but they are able to flip the coin for an inflated price as the public swarms in to buy, Rene Rivkin style.
There are lists available on Reddit (example showing the Youtubers) who the community suspect of promoting cryptocoins for payment. Always research where your source of information is coming from.
Some of the social media people suggested by the community (and myself) include:
Once you feel fairly confident that a pick is worth analysing further, run them through a standardised checklist of questions.
This is one I use for myself and on which I base this website’s reports on. Feel free to add other questions yourself:
You don’t need to get into full modeling or have a financial background. Just start with a simple model that tries to derive a valuation through relative terms. This will put you above most cryptocoin investment groups. Some simple valuation methods that anyone can do:
This is all about thinking of scenarios and probability, a helpful exercise in itself. For example: Bill Miller, a prominent value investor, wrote a probabilistic valuation case for Bitcoin in 2015. He looked at two possible scenarios for probabalistic valuation:
Combining those scenarios would give you the total expected market cap:
(0.25% x 6.4 trillion) + (2.5% x 350 million). Divide this by the outstanding supply and you have your valuation.
Metcalfe’s Law which states that the value of a network is proportional to the square of the number of connected users of the system (n^2).^ So you can compare various currencies based on their market cap and square of active users or traffic. We can alter this to crypto by thinking about it in terms of both users and transactions:
For example, compare the Coinbase pairs:
Metric | Bitoin | Ethereum | Litecoin |
---|---|---|---|
Market Cap | $152 Billion | $93 Billion | $7.3 Billion |
Daily Transactions (last 24hrs) | 249,851 | 1,051,427 | 70,397 |
Active Addresses (Peak 1Yr) | 1,132,000 | 1,035,000 | 514,000 |
Metcalfe Ratio (Transactions Based) | 2.43 | 0.08 | 1.47 |
Metcalfe Ratio (Address Based) | 0.12 | 0.09 | 0.03 |
Generally the higher the ratio, the higher the valuation given for each address/transaction.
Another easy one is to look at the total market for the industry that the coin is targeting, and compare it to the market cap of the coin. Think of the market cap not only as circulating supply, such as that shown on CMC, but also including total supply. For example, the total supply for Dentacoin is 1,841,395,638,392. When multiplied by its price in early January, we get a market cap that is actually higher than the entire industry it aims to disrupt: Dentistry.
If you would like to get into more fleshed out models with Excel, I highly recommend Chris Burniske’s blog about using Quantity Theory of Money to build an equivalent of a DCF analysis for crypto.
Here is an Excel file example of OMG done by Nodar Janashia using Chris’ model.
You should create multiple scenarios with multiple assumptions, both positive and negative. Have a base scenario and then moderately optimistic/pessimistic and highly optimistic/pessimistic scenario.
Personally, I like to see at least a 50% upward potential before investing from my moderately pessimistic scenario, but set your own safety margin.
The truly beneficial thing about modelling isn’t even the price or valuation comparisons it spits out, but that it forces you to think about why the coin has value and what your own assumptions about the future are. For example, the discount rate you apply to the net present utility formula drastically affects the valuation and reflects your own assumptions of how risky the crypto is. What exactly would be a reasonable discount rate? Consider the digital economy you are assuming for the coin. What levers affect its size and adoption and how likely is it that your assumptions will come true? You’ll be a drastically more intelligent investor if you think about the fundamental variables that give your coin the market cap you think it should hold.
This post is my attempt at documenting how I approach investing into cryptos. How I construct a portfolio allocation, taking into consideration risk and return targets. What my systematic crypto picking method is. I won’t tell you what to buy, you should always decide that for yourself and do your own research. But as long as you follow a rational and thorough methodology, you will feel pretty good about your cryptocoin investment even when times get tough.
While there is money being made simply flipping coins, I look for the coins I would be happy to hold onto for a year or two. This forces me to conduct proper research into the project team and the actual product before contributing to it.
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