Correlated Cryptos: How Market Capitalization Affects Portfolio Weighting

Building a cryptocurrency portfolio comes down to one key decision: determining the weight of each holding. A recent analysis of the four largest cryptocurrencies, Bitcoin, Ethereum, Solana, and XRP, shows that their daily moves are highly correlated, with a correlation coefficient of 0.82 to 0.90 over the past 12 months. This means that when one of these coins moves up or down, the others tend to follow.

Market capitalization is often used as a yardstick to determine the weight of each holding. However, when applied to the four largest coins, it results in a very lopsided split, with Bitcoin accounting for over 77% of the total weight. Many investors opt for equal weighting instead, giving each coin 25% of the portfolio. However, this approach can increase the volatility of the portfolio, as seen in the 52% to 73% drawdowns experienced by each coin over the past 12 months.

The analysis also highlights the importance of considering the role of each holding in the portfolio. The core holding is the one that sets the character of the portfolio and stays put the longest, while the satellite holding is the smaller part that can be trimmed without significantly affecting the overall portfolio.

Ultimately, the decision on how to weight a portfolio depends on individual investment horizons, income, and risk tolerance. Spreading assets within one class can protect against bad luck in selection, but it does not guarantee a return and does not lower the risk of a market slump.