A payback period for digital assets

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When investing in the financial markets, people often underestimate the possibility that over a period of time the investment may decline in value and that temporary losses may take time to recover. The deeper the loss becomes, the more the energy needed to recover the losses increases disproportionately. If I invest $100 and lose 10%, I end up with $90 (whether I keep the investment or liquidate it). So to get back to $100, what returns should I make? I have to earn 11% because, with a base of $90, if I earn 10%, I end up with $99. This effect is amplified if I lose 20% — to get back from $80 to $100, I would need to gain 25%.

Thus, losses are not exactly symmetrical to the gains you need to make to recoup them. If I find myself having lost 50% of my investment, to get back to $100 from $50 I have to double it, so it should be intuitive to the reader that the more magnified the loss, the more energy it takes to recover.

The bad news is that Bitcoin (BTC) lost more than 90% of its value on one occasion, more than 80% on two other occasions, reaching a performance percentage of -75% during this period. But the good news is that he has always recovered (at least so far) from losses in a very reasonable time – even the heaviest losses.

Related: Bitcoin Price Prediction Using Quantitative Models Part 2

The Ulcer Index, i.e. the index created by Peter Martin that calculates how long an asset has been below the previous high, is crystal clear. Investing in Bitcoin causes ulcers for long months, but then leads to incredible returns which, if you have the patience to wait for them, make you forget the period of stomach aches because of the losses incurred.

Compared to the previous two charts, which cover a period of 50 years while this one only covers 12 years, the presence of the loss zone is predominant, even though, in reality, Bitcoin has always achieved incredibly high returns which enabled him to recover. up to 900% in less than two years.

Getting back to the subject of this article, here are some additional methodological notes:

  • The digital asset considered is Bitcoin;
  • The comparison currency used is the US dollar;
  • The frequency of analysis is daily; and
  • The period is from July 23, 2010 to June 16, 2022, the day the analysis was performed.

Although Bitcoin’s history is very recent, its volatility and speed of loss recovery are remarkable, an indication that this asset has unique characteristics to explore and understand to the fullest before eventually deciding to include it. in a diversified portfolio.

As you can see from the length of the chart above, there have been many periods of loss and recovery exceeding 20%, albeit in just 12 years of history.

It is a widely held opinion that one year in crypto is five in traditional markets. Indeed, on average, the volatility, declines and speed of descent are five times higher than stocks. Starting from this hypothesis, while being aware that the period considered is short, we can try to compare it to the analysis of the markets over 50 years.

As can be seen, the days required to have a loss of 40% or more are often less than three months. The darkest point is Bitcoin’s current decline from the November highs, roughly 220 days so far, which brings it in line with the regression line that determines (for simplicity) an average value of the relationship between losses and time to get there.

While an asset having short intervals to bottom means it has a lot of volatility, it also means it is able to recover. Otherwise, it wouldn’t have recovered from that trough and, in fact, there wouldn’t even be a trough to rise from.

Instead, savvy investors who initially doubted Bitcoin until it was found to rise again in the COVID-19 outbreak period (i.e. March to April 2020) realized that this asset had unique and interesting characteristics, not the least of which was its ability to recover from depressions.

This means not only that there is a market, but that there is a market that considers (albeit still with imperfect models) that Bitcoin has a fair value price and therefore, at certain values, it is a bargain to buy. to buy.

Understanding, therefore, the strength of the recoveries Bitcoin has been able to make can give us an estimate of how long it will take for it to recover to new highs – don’t fool us into thinking it can do this in months (even if , on a few occasions this surprised everyone), but to give us the peace of mind to wait if we have already invested, or to understand the opportunity to come if, until now, we have been hesitant to invest.

From the chart above, a regression can be extracted that explains Bitcoin’s relationship with the time it took to recover a new high from the relative low. To give an example, assuming and not assuming that Bitcoin hit lows around $17,000, the recovery it needs to make to get back to the highs is 227%. Thus, the following formula can be derived from the regression line depicted in the graph:

Where G is the number of days expected to recover the loss and P is the required recovery percentage, it can be deduced that it takes 214 days from the low of a week ago to get back to a new high.

Of course, to assume that the low has already been reached is a stretch, because no one can really know. However, it can be assumed that it is very unlikely to see the new highs again before January 2023, so people can take comfort if they have invested and suffer the loss, while those who have not yet invested can may -be realizing that they have in front of them a very interesting opportunity to consider, and quickly.

Related: Bitcoin Price Prediction Using Quantitative Models Part 3

I realize that these statements are strong. They are not meant to be forecasts, but only an analysis of the market and its structure, trying to give as much information as possible to the investor. Obviously, it must be inferred that the worse the loss gets, the longer I will have to be willing to wait to recover it, as can be seen in the graph below, which is the derivative of the regression in the graph above (recovery durations based on loss) related to losses incurred.

A few considerations:

  • The analysis reported here represents an estimate based on historical data; there is no guarantee that the market will recover within or around the estimated values.
  • There is no assumption that would establish the current loss as a low period.
  • Not selling does not mean the loss is not real; the loss is such even if the underlying asset is not sold. It is not realized but it is still real, and the market will have to make the recovery corresponding to the graph at the beginning of this analysis to recover the initial value.

Unlike the two asset classes stocks and bonds, in Bitcoin’s case at this point of loss, exiting represents more of a risk than an opportunity, as Bitcoin has shown that it can recover much faster than these other two asset classes. ‘assets. It should have exited sooner, as we did with the alternative Digital Asset Fund, which is losing less than 20% YTD and will therefore need a ridiculous 25% to get back to new highs for the year, against 227% Bitcoin needs to rally, proof that using trend-following logic reduces volatility and recovery time.

To reiterate, however, the difference between Bitcoin and the other two asset classes (stocks and bonds), I compared the three on this graph of the relationship between loss and recovery time:

It is clear from this chart that Bitcoin has an impressive recovery characteristic compared to stocks and bonds, so having a percentage, even a small percentage, of Bitcoin in a portfolio can speed up the recovery time of the entire portfolio.

This is probably the best reason to have a percentage of digital assets in a portfolio, preferably through an actively managed quantitative fund of course, but you already know that since I’m in conflict of interest.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.

The views, thoughts and opinions expressed herein are those of the author alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.

Daniele Bernardi is a serial entrepreneur constantly looking for innovation. He is the founder of Diaman, a group dedicated to developing profitable investment strategies that recently successfully issued the PHI token, a digital currency with the aim of merging traditional finance with crypto assets. Bernardi’s work is directed towards the development of mathematical models that simplify the decision-making processes of investors and family offices for risk reduction. Bernardi is also president of the investor magazine Italia SRL and Diaman Tech SRL and is the CEO of the asset management company Diaman Partners. Additionally, he is the manager of a crypto hedge fund. He is the author of The genesis of crypto-assets, a book about crypto assets. He was recognized as an “inventor” by the European Patent Office for his European and Russian patent related to the field of mobile payments.

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