Building a Diversified Stablecoin Portfolio
Although we’re not huge fans of stablecoins here at HodlBot, we do realize that they play an important role for cryptocurrency investors.
On crypto-to-crypto exchanges like Binance, traders rely on stablecoins as a quick way to exit the market. It’s an asset they can flee to when the market goes red. If timed correctly, switching to stablecoins can significantly shield your losses.
Betting on a Single Stablecoin?
Despite what their names suggest, stablecoins are not entirely risk-free. Many stablecoins have a history of falling beneath their peg (< $1USD).
For example, Dai has had a hard time maintaining its peg to $1. As the price of ETH was rising, more people wanted to open CDPs to increase their long exposure to ETH. New CDPs increased the supply of Dai in the market. But because the demand for Dai hadn’t risen at all, the new supply pushed the price downwards.
USDT is another example of a stablecoin gone awry. The SEC is currently investigating Tether for fraud. So far Tether has confessed that they do not, in fact, hold a dollar for every USDT as advertised. Instead, a large chunk of the reserve was used to invest in volatile assets. At some point, reserves were even used as a loan for Bitfinex when they were short on cash.
Apart from hidden risks, financial risk is typically a measure of price volatility. In the following two tables, we’re going to look at the daily standard deviation and the max drawdown of the top 10 stablecoins pegged to the USD.
As you can see, some stablecoins are a lot more volatile than you would imagine. In a market that is as opaque and unpredictable as the cryptocurrency market, putting all your eggs in one stablecoin can be quite scary.
What’s the Alternative?
If you’re dead set on converting your portfolio into stablecoins, then it may be prudent to diversify across an entire portfolio of stablecoins, rather than banking on a single one.
How Portfolio Diversification Reduces Risk
Harry Markowitz, the father of modern portfolio theory, postulated that the most important aspect of risk to consider is an asset’s contribution to the overall risk of the portfolio, rather than the risk of the asset in isolation.
This means that by including assets with low or negative correlation in your portfolio, you can reduce the overall variance and therefore reduce the risk of your portfolio.
Stablecoins Are Generally Uncorrelated to One Another
After calculating the correlations between stablecoins, we see that they are actually quite low. That means a combined stablecoin portfolio is likely to be more “stable” than any individual coin since the volatility of individual coins can be cancelled out by other ones.
A Diversified Stablecoin Portfolio vs. Individual Stablecoins
As a real life examplee, I’ve created 5 coin stablecoin portfolio based on the stablecoins that are available on Binance.
It is an evenly weighted portfolio consisting of:
- USD Tether (20%)
- PAXOS (20%)
- USDCoin (20%)
- StableUSD (20%)
- True USD (20%)
Standard deviation of a stablecoin portfolio
Max drawdown of a stablecoin portfolio
Compared to individual coins, our diversified stablecoin portfolio has the 2nd lowest standard deviation as well as the 2nd lowest max drawdown.
The more important aspect to consider is that our portfolio is significantly more resilient to black-swan-like catastrophes. It is not difficult to imagine a single stablecoin getting completely wiped out due to some unforseen circumstance. But the annihilation of all 5 is a lot less likely.
The portfolio looks good, but sounds like a lot of work…
If you’re trying to get out of the market in a rush, chances are you’ll probably won’t want to execute the trades required to create a 5 coin, evenly-weighted, stablecoin portfolio. It’s not worth the time nor the effort.
But luckily with HodlBot, you can do this with a click of a button.
Here’s how it works:
- Connect your exchange account to HodlBot
- Create a stablecoin portfolio
- Execute the portfolio — it will trade all your exchange assets into your portfolio of choice.
- Switch back between a stablecoin portfolio and a normal cryptocurrency portfolio anytime.
If you would like to read more information about HodlBot, check out our wiki.
About the Author
I quit my job recently to start HodlBot.
We created HODL10, HODL20, HODL30 indices and the first ever application that allows you to create your own personalized cryptocurrency index fund. You can also create other kinds of custom portfolios.
To get started all you need is a
- Cryptocurrency Exchange Account
- $200 in any cryptocurrency