How to Construct and Optimize a Portfolio

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We are reviving our Technical blogs, and today, we’re going to share with you how to construct and optimize a crypto portfolio.

In case you missed it, here’s a recap of our past editions:

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Introduction

There are many opportunities to be had in crypto, and constructing your portfolio by no means is an easy task.

As an investor, your time horizon span from months to years, and as a trader, you may be flipping coins from months to mere seconds.

You’ll be screening thousands of coins, of which only a handful of blue-chip tokens and a few promising projects survive during bear markets.

On themes, you’ll be scanning projects with high beta on sectors and themes like DeFi and Bridges, ReFi, Blockchains (L1, L2), DAOs, NFT, Metaverse, PlayToEarn, File Storage, and many more.

On market sentiment, you’ll often hear about opposing news from prominent VCs and speculators sharing their crypto bags in the news and social media, which may impact your perception. Familiarizing yourself with cognitive biases that may affect your behavior lessens the outside influence on making your personal or financial decisions.

In a flash, here are four concepts that we’ll share on how to construct an optimal portfolio.

Volatility

Since crypto is still an emerging tech, projects are notoriously volatile among asset classes like Stocks, Bonds, and Commodities.

Volatility is the rate at which the token’s price may increase or decrease in a given time.

A volatile project may have a huge return but often comes with the highest risk to the downside, while a project with little volatility may offer little to no return.

Return

We are often drawn to assets with the highest returns in the least possible time. While some investors get lucky, many of us get rugged by trying to hit the next big thing.

A healthy portfolio will have steady returns and a few drawdowns in a long time.

As an investor and a hodler, you’re more of an asset allocator; picking projects with a team that constantly delivers at any market cycle will give you peace of mind and a healthy portfolio, rather than the projects that are one-off and overhyped.

As a trader, you’re a speculator — inclined on price and technicals, capitalizing on short-term trends and volatility of a given project, no matter the market cycle.

As a DeFi farmer, you’re providing liquidity to both investors and traders, earning tokens with interest in the process. Usually, you care most about the APY rather than the project’s direction.

Source: Defillama Yield Rankings

APY is an important metric when browsing which pools to farm, lend tokens, or which project to stake. APY or Annual Percentage Yield is an annualized rate of return of an asset that considers the compounding interest.

Correlation

It is no secret that cryptocurrencies are a highly correlated market and rotate to different sectors and may have small bullish cycles like the alt seasons and DeFi summer.

Correlation — a measure of how two assets are related to each other — is a double-edged sword that is beneficial when the market cycle is bullish and has a significant potential loss when the market is bearish.

Source: Blockchain Center

There’s a positive correlation when the assets move in tandem and a negative correlation when the assets compare move in different directions (up and down).

A good investor practices diversification, including assets like stablecoins (low volatility) to serve as a dry powder for the next uptrend, derivatives to weather market downturns, or farming to increase your tokens by lending while the market is going sideways.

You’ll rebalance your portfolio from time to time — adjusting the percentage weight of assets within your portfolio, from your blue-chip coins, NFTs, derivatives, memecoins, and stablecoins.

Journaling

Crypto is a fast-moving industry, and tracking your decisions with a thousand data points can be tricky and needs an effective tool. Journaling is both a way and a means to track the performance of your portfolio and manage your risks, whatever is your chosen investing profile (investor, trader, farmer).

Journaling lets you record the trades you’ve done from what emotions and behavior you’re in when you made the call and what rationale behind the decisions you’ve chosen that made the outcome.

To effectively journal your assets, you need to track the following metrics:

  • Period — Date and time of entry
  • Chart — A price chart of the asset
  • Price — Prices at which you initially entered will take a profit and will cut your losses
  • Position — the number of coins or the value of an asset (denominated in USD) you bought or sold.
  • Reasons for buying/selling the asset.

To sum it up: an optimal portfolio will have a mix of crypto assets diversified with uncorrelated assets, which you’ll rebalance from time to time to get a steady return of investment with the lowest volatility.

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Defy Trends provides advanced analytics and actionable insights for cryptocurrencies and NFTs. Created by a female-led team of data scientists and global markets experts, Defy Trends brings together crypto, NFT trading, and research operations. The goal is to empower everyday individual investors and institutions ranging from exchanges and marketplaces to research firms. Defy Trends is committed to making crypto accessible to all. Dare to Defy.

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Disclaimer: This article is for educational purposes only and must not be treated as financial advice.

As always, please conduct due diligence and manage your risks accordingly.