This one simple crypto-hack could substantially reduce your losses during the next bear market.
DISCLAIMER: I am not a financial advisor. Past performance is not an indicator of future outcomes. Please do your own research.
What is rebalancing?
Rebalancing assets is a time-proven strategy that investors have been using in traditional markets for decades. After assigning target percentages to each of the assets in your portfolio, periodic automated rebalancing can execute the necessary trades on exchanges to keep your initial target percentages consistent. By automatically applying a buy-low/sell-high methodology, you can repeatedly send the short-term gains of your assets into your wallet. Otherwise, you can have those gains redistributed amongst your other assets.
Data shows that auto-rebalancing cryptocurrency portfolios typically leads to better performance. While you do pay more in trading fees, on the whole, you can make more money during the good times and lose less money during the crashes, provided that you choose the right mix of assets to compliment your rebalancing strategy.
I’ve personally come to see the rebalancing strategy as a kind of free insurance policy and dividend reinvestment plan that I’m regularly collecting on regardless of what the markets are doing.
My returns come from frequently netting gains between the non-correlated and best performing assets in my portfolio and then distributing them across my other assets. I’m not reliant on a few outliers (like an AAPL, AMZN or their crypto analogs,) which can take a long time to pay off. Instead, my returns are streamlined over time, which gives me more freedom to exit the market at will. Not only that, I don’t get much joy out of analyzing the markets and making my own trades. The maximum amount of time I enjoy spending each day reviewing or managing my own investment portfolio is around ten minutes. Auto-rebalancing makes that possible.
Using historical price data, let’s run some experiments to understand how rebalancing has performed under different market conditions with different bundles of assets. Note that for all proceeding examples, my calculations have included a 0.25% commission payable to exchanges on all necessary trades.
Also note that the most important factor in the performance of a rebalancing strategy (apart from choosing reliable assets) is the degree to which non-correlating volatility exists between those assets.
i. Let’s assume that between February 6th to August 6th of 2018, your portfolio was worth $10,000 and was split between Bitcoin (50%) and Tether (50%). By August 6th, a daily rebalancing strategy would help you secure a portfolio now worth $10,326. Had you NOT rebalanced during this period, you would have lost money — Your portfolio would have been worth $9838, leaving on the table around $500 — That’s 4.88% of your portfolio value over the six months, and almost 10% annualised after all trading fees have been paid. In a period that was mostly bearish, a Bitcoin versus Tether portfolio would have been profitable.
ii. As another example for the same period, imagine that your ‘Feb-6’ $10,000 portfolio was slightly more diverse including Bitcoin (25%), Ethereum (25%), Ripple (25%) and Tether (25%) — and was also on a daily rebalancing schedule. Six months later, by August 6th, your daily rebalanced portfolio would now be worth $8259, compared to $7981 without rebalancing. That’s a 2.77% save during the period, equivalent to 5.54% annualised. Nothing to sneeze at!
At Portfolio.io we’ve backtested 100s of differing portfolio configurations (coin combinations plus rebalancing frequencies and thresholds etc) across the top 50 coins, during the 6 month period between February and August 2018. What we’ve found is that through using automated rebalancing, some portfolios would have provided up to 200%+ better annualized PnL percentage (%).
Importance of stablecoins in an auto-rebalancing strategy
Putting some Tether (USDT) in your portfolio, or any other stablecoin that trades at $1 as intended, can act the same way as having cash in your bank account.
When held alone, cash or USDT is not doing much for you — It’s forever losing its purchasing power due to inflation and opportunity cost, but if used as part of an auto-rebalancing investment portfolio, it can help to protect against market-downturn and capture the upswing price fluctuations of your other assets. It can also ensure that 1-step trading pairs and capital are available to you or your broker when buying up certain assets when they experience a dip in prices.
Put another way, a rebalancing investment strategy for crypto assets has been found to be more productive when your portfolio includes a stable coin. Since we know that the value of stable coins like USDT don’t tend to fluctuate all that much, value can be transferred seamlessly between the highs and lows of your Bitcoin and alt-coins to the safe haven of USDT, where profits can be locked in.
Tools for rebalancing
If you want to start rebalancing your crypto portfolio, there are several tools already available and working, such as Shrimpy. However, my understanding of these existing tools is that they do not trade on your behalf or offer custodial solutions. They rely on you independently opening up accounts on crypto exchanges such as Binance and Kraken, and linking up your accounts on those exchanges to your chosen rebalancing tool through personal API keys. For that reason, they are time-intensive, prone to error, and do not cater to the average, non-technical investor. Such rebalancing tools also lack other value-added services that can further automate and enhance the crypto investment experience, such as easy diversification and smart order routing (i.e. seeking out the cheapest asset prices across multiple exchanges).
Rebalancing Strategy Key Takeaways
- As a strategy that can protect and benefit from market volatility, auto-rebalancing is useful to people investing in cryptocurrencies.
- While day traders may already leverage the volatility of crypto markets to optimize their performance, they waste too much time on manually buying and selling the swings.
- With the right auto-rebalancing tool, you can effortlessly generate value from the ups and downs of the market. Even though you pay more in trading fees, you can still come out on top.
- Holding a stable coin alongside non-correlated volatile assets in an auto-rebalancing portfolio, will likely give you the best results.