370️⃣° : Spreadsheet Wins Above Ape
Investing in wins, not players
Hello and welcome to this new edition of 36⭕️° !
Crafted with ❤️ by Cercle ⭕️ DAO.
Dear Cerclers,
Over the past few weeks, all sorts of weird feelings have started taking over my mind and my body. A strange tingling sensation has progressively gained my fingers. I couldn’t resist frantically typing lines and lines of macro again, like in the good old days of unravelling race car data to extract the last bit of performance.
The only moment I’ve been able to finally get some relief was after pressing “Play ▶️” again, and watching my crypto spreadsheets magically updating themselves with a fresh horde of graphs and numbers. That’s the result of this work that we’re going to touch on today.
First off, don’t worry : I’m an analytics nerd, but I’ve learned the last couple of years that formulas and spreadsheets are not to everyone’s delight. That’s why we’re going to keep the maths part of it pretty light.
I just thought you might be interested to know that very few people ever talk about this quantitative approach to portfolio diversification, inspired by sabermetrics (the science of baseball statistics) and modern portfolio theory.
Who knows ? Maybe that’s because, if you’re in crypto, it won’t help you find THE life-changing opportunity among the 13260 coins listed out there. Period. You can now close this email and resume your normal activity …
Unless you’d like to learn more about diversifying a portfolio in the most efficient way, based on a spreadsheet and freely available data ?
But, hang on : aren’t we supposed to talk about crypto Venture Capital and early-stage investing in this newsletter ? If a token is already on the secondary market, where is the early-stage opportunity then ?
Well, if you’re an avid reader of 36⭕️°, you will remember 366️⃣° . Our first edition after the summer break, in which we explored why crypto is still evolving at the frontier of innovation : small, disruptive and fast growing.
Crypto’s global user base is in the process of reaching critical mass. Both institutional investors and regulators are still adapting to the paradigm shift. All this makes the range of possible outcomes extremely wide for the industry as a whole.
That’s why investing in small cap projects carries so much potential reward, but also so much implied volatility. While some of them will become the dominant businesses of tomorrow’s online economy, most might not survive the financial and administrative environment that is taking shape.
Nevertheless, unlike private equity, liquid tokens transactions leave plentiful of data behind them. Historical returns & drawdowns, for example, can allow investors to assess a new course for their portfolio in the face of rapidly evolving landscapes.
Just like the Oakland Athletics baseball team did in 2002 : a story that was put onscreen with Moneyball.
Before we dive into the Moneyball story, don’t forget to subscribe below & add 36⭕️° to your newsletter line-up ! ⚾️🏆 Now onto the game …
In the 2001 American League Division Series finale, the Oakland Athletics lost to the NY Yankees in a devastating blow for Manager Billy Beane. To conjure this demise, Beane had to find a way back to victory for his team.
But he was now constrained by its limited budget, following the departure of major star players to free agency. To the point that Beane and his assistant Paul DePodesta, also known as Peter Brand, decided to follow a pretty unusual strategy : selecting undervalued players based on widely overlooked statistics, that were mostly correlated to actually winning games - as opposed to only highlighting each players individual qualities.
In 2002, the Oakland Athletics achieved a record-breaking streak of 20 consecutive wins against the most powerful clubs of the ALDS.
While all-star teams were giving away exorbitant amounts of money to line-up with the best players in the series, it had been cheaper and more efficient to acquire those who excelled in the overlooked metrics - who turned out to help the team win again.
While the Oakland team lost to the Minnesota Twins in the 2002 ALDS finale, in 2004 the notorious Red Sox went on to break an 86-year drought & win the World Series … using that exact same model that Beane and DePodesta had pioneered a few years before.
Professional baseball had entered the era of sabermetrics. This story actually ties up quite well with our environment as investors : taking one finite resource, and trying to allocate it to maximize for an ideal outcome.
What matters is whether or not a new token helps a portfolio grow by improving its total risk-adjusted returns - not if it’s Crypto Twitter’s or other VC’s shiny new darling.
For the sake of your mental health (and your Sunday night), I’ll save you both time and effort by acknowledging that :
1/ The methodology exposed here is widely based on Artemis Capital’s research work about the resilience of various portfolio management techniques, and more particularly Christoper Cole’s CWARP.
2/ You can refer to Artemis research, or get in touch with me directly via the channels listed at the end of this post, should you look for more in-depth explanations about the tools and formulas involved.
3/ We’re going to cover the shortest possible list of things needed to calculate our very own SWAAP (Spreadsheet Wins Above Ape Portfolio) :
An internet connection.
Coingecko’s API.
An arbitrary assumption about a baseline portfolio that one wishes to diversify (example : a 60% Bitcoin / 40% Ethereum allocation).
An arbitrary assumption about a future portfolio, built on top of the baseline (example : a 25% allocation to a new token, on top of 60% Bitcoin & 40% Ethereum).
A sensible evaluation of a risk-free rate of return (example : the least risky yield one can get on a stablecoin, in our demo 5% APY).
A sensible evaluation of the rate at which one can borrow fresh cash to buy into the new token (in our demo also 5% APY).
The math.
Yes : I’ve run some numbers, and I’m going to show you some results. But, before we go through some concrete examples, I’d like you to remember one thing : the SWAAP is meant to complement a thorough diligence process that no macro can execute for you.
It’s the kind of cheat code that can reveal pretty handy once you’ve completed every single level of the game, and need to prepare for the final fight against big boss Donkey Kong.
It gauges if a new token, once incorporated to an existing selection of crypto projects, is likely to give the portfolio an unfair advantage, or add another layer of risk & correlation over the long run.
If the SWAAP is negative, it means the new token considered will likely hurt the existing portfolio, by replicating existing exposures (aka being closely correlated to Bitcoin & Ethereum) and/or increasing drawdowns & volatility.
If the SWAAP is positive, it means the new token considered will likely improve the existing portfolio, either because it has a better history of return to downside volatility or return to maximum drawdown than Bitcoin & Ethereum (or both).
Right, so here we go : you might recognize some of the coins listed in the graph below, because they’ve made the headlines this year. Some others have been less exposed to the usual frenzy :
The main point of interest in this graph is how 2 of the most hyped projects in 2022 (GMX and Stepn) have actually hurt the baseline portfolio on a multi-month timescale. Of course, it doesn’t mean some people haven’t been successful trading these 2 coins. But a majority of participants out there aren’t in a position to anticipate 50 to 65% drawdowns on such a regular basis :
Meanwhile, some crypto market veterans (see Synthetix & Polygon aka Matic) have historically done pretty well in terms of price action resilience against $BTC & $ETH.
Of course, because of crypto’s level of maturity as an asset class, a majority of the tokens on the secondary market haven’t gone through a complete bull & bear cycle yet. Some even have less than a year of price history, in which case the SWAAP relies on a projection of the data that’s available.
These are important limitations to bear in mind. But one thing is for sure : like Billy Beane and Paul DePodesta, we at Cercle ⭕️ DAO believe in the power of data to separate the signal from the crypto noise. As an education-centric community, we’re going to dig deeper and deeper into such tools that will shape the investor of tomorrow.
Welcome aboard, the macro party has only got started !
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⚠️ Disclaimer : the content of this newsletter is for educational & entertainment purpose only. In no situation should it be considered investment, tax or legal advice. The reader is invited to build his/her own opinion about the views expressed, and take appropriate decisions for his/her specific situation or objectives. Cryptocurrency is a highly volatile asset class and the risk of capital loss must never be underestimated : do your own research, and only invest what you can afford to lose.