The Search for the Methodology of Evaluating Investments into Cryptocurrencies – Sharpe Coefficient

We offer a look at crypto assets through a coefficient traditionally used to assess the risks and profitability in classic markets – the Sharpe index.

By Prosphero Team

In order to be successful in the cryptocurrency market, a trader has to analyze the risks and profitability of the upcoming transaction. There are various indirect ways to evaluate profitability and riskiness. Unfortunately, there is no common, established methodology specifically for the cryptocurrency market.

If we talk about similar tasks in the classic markets, such as stock market, the Sharpe coefficient (aka the ‘Sharpe measure’ or ‘reward-to-variability ratio’) is obviously the best tool; in fact, it has become widely popular in portfolio investments. The special feature that has made it so successful is the accountancy of the investor’s potential profitability (percentage), as well as the risks, ie the possibility that the profit may differ from the expected result to the point of the complete loss of the investor’s deposit.

There are no issues when using this approach for the calculation of profitability; however, the risk calculations do have their peculiarities. In any case, the tool’s essence can be summarized as follows: the higher the amplitude of the asset’s fluctuation, the higher the risks of performing operations with it.

So, the higher the Sharpe coefficient, the better the profitability indicators for the portfolio investment, and the easier it will be to manage. In this case, the income will be maximum and the risks – minimal. On the other hand, a negative (or tending to zero) Sharpe coefficient indicates that the profitability of the portfolio investment is lower than the profitability from riskless investments. It’s a signal that the investment will have no profits (or is at least highly dangerous).

We are surprised that the Sharpe coefficient method is hardly used in the cryptocurrency market. Recognizing in full capacity some of its limitations for the crypto-world, we decided to go for a brave experiment and calculate the Sharpe coefficient for every cryptocurrency asset in the TOP-20 for May 2018 (January 2014 was selected as the starting base).

Here are the results we obtained.

Conclusion

It is well-known that investment tools are either highly profitable or highly stable. Sharpe tries to combine these two parameters in order to establish a universal index. Despite the highly impressive ROI for certain crypto-assets, though, risks and volatility remain beyond the limits and give rise to an eerie unpredictability.

So, as the ratings show, the Sharpe index is quite humble for cryptocurrency assets, approaching the ‘red zone’ that is forbidden in the investment world. For example, EOS token is the current leader with a Sharpe index of 1.1, Bitcoin – 0.63, while SPY (the classic in the stock market with a traditionally average value) has a Sharpe-coefficient of 1.14.

Despite this quite mediocre (from the traditional investors’ point of view) crypto-asset result, we can see that cryptocurrencies have a bright future.  We would like to remind you of the limitations that the Sharpe coefficient has with respect to this relatively new asset – cryptocurrency. We believe in the need for new, high-quality tools for asset-rating, and they will certainly come about in the near future as crypto-currency continues to grow and become more publicly accepted.

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