Lesson 5 | Portfolio Optimization

I didn’t expect to write this lesson when I began the series, because I didn’t think there were uncorrelated crypto classes. But over the course of the past few weeks it has become clear to me that uncorrelated crypto classes exist, and they are not the same as uncorrelated coins or uncorrelated strategies.

By uncorrelated coins, I mean cases like LUNA and BTC with their -.04 correlation, but not any of the following coins (save for Pax Gold, which is obviously gold).

By uncorrelated strategies, I mean the (possible) lack of correlation you might find among trading strategies like a sentiment strategy–which uses social indicators like Twitter posts–as opposed to a price momentum strategy.

While LUNA might continue to remain uncorrelated, it’s just one coin. Moreover, differences among strategies in the crypto space look so far not to be holding up in the present decline–just as they didn’t after 2018. Sentiment and momentum probably follow each other.

Our dynamic AOTB portfolio, which uses the Three Stage Algorithm, is outperforming precisely because it draws on two uncorrelated crypto classes: cryptos + yield farming. It’s up over BTC by about 17%.

Now, I understand that yield farming may not appear to be a “class” of cryptos so much as a strategy about how to invest in them. So, I’ll give you whatever words you want to describe the difference. The investing point that matters isn’t a semantic one, but a financial one.

If you don’t like the idea of different “crypto classes,” then consider this a list of five different ways to make money using cryptocurrencies as investments. However you parse what follows, there is a significant difference between these five classes and, for example, earning money by making YouTube videos about cryptocurrencies. 

Here’s the list and I assume most will be familiar with these ideas in a broad way.

1. Cryptocurrency Investing (purchasing cryptos in hopes of price appreciation)
2. Yield Farming (depositing cryptos to be used so as to receive a yield)
3. NFT Blue Chip Investing (purchasing NFTs in hopes of price appreciation)
4. GameFi Investing (purchasing and participating in NFT games for appreciation + earnings)
5. VC DAOs (participating in a DAO offering for a venture capital type investment)

Most of the guides here on AOTB are devoted to 1 and 2, so I shall leave them aside for the present. Instead let’s talk about NFT Blue Chips.

NFT Blue Chips 

The definition of NFT blue chips, like many terms in the crypto world, is loose. Typically, it refers to the NFTs within projects with the highest value–the Crypto Punks and BoredApes of the world. 

Nansen, a data firm, has gone some way in standardizing NFT analysis with their set of NFT Indexes (it is a paid and rather expensive service that’s probably not useful unless you are a professional analyst and trader).

Here is the result of their Blue Chip 10 Index (covering Crypto Punks, Bored Apes, etc.).

That 22% decline is not better than BTC’s current 19.1% decline YTD.

For comparison, the AOTB Dynamic portfolio is down about 1.8% YTD. The version that my hedge fund will use is positive for the year about 7%.

Still, the price declines and bounces of that index are not like much of the rest of the market and that is likely to prove an enduring feature of blue chips because they are priced as art is. The Mona Lisa doesn’t decline in value because of a recession and the same rationale for value is operative here.

More interesting is the Metaverse Index – selecting land and real estate from the top 20 projects. Here are those results.

That -5.79% is much better than holding BTC, though it’s not as good as the AOTB Dynamic Portfolio.

Still, the reasons for its performance are interesting, since real estate buying pressure, even in the virtual world, doesn’t operate on the same logic as the rest of the crypto market.

Notably, all the NFTs are too expensive for most people–even for accredited investors. The solution is likely to be an investment DAO of some kind.

GameFi Investing

All of the NFT games presently in existence have associated tokens that are used in the game for some purpose–often for governance (as AXS is). The Illuvium coin (ILV) provides not only for governance, but also distributes back earnings to holders of the coin (if you stake the coin).

Now, buying those coins and trading them is just crypto investing. All crypto riders get access to the output of my algos for those, so we’ve got that covered. Also, and more to the point, gamefi coins do not constitute an uncorrelated asset class.

What would make these an uncorrelated asset class is participation in the games themselves, drawing on the full range of NFT game items including characters, weapons, and land.

Illuvium: Gameplay Reveal Trailer | Collectible RPG & Autobattler Game

Some games, like Farmers Only and Crabada, have a portion of the “gaming” that can be automated by bots. A $10,000 purchase for such a bot is likely to yield quite a bit in return (pay off is often in the 2 – 3 month range). The Hunt Protocol allows you to profit from this approach simply by purchasing the NFT.

But more money is to be made by actually purchasing the right NFTs and then owning your own team–many thanks to @DontAsk6 for illuminating this possibility for me. I think this could be set up as a gaming DAO to own the best competition teams, if you don’t want to do it yourself.

Obviously, the returns are uncorrelated here because the in-game money is earned through playing the game (or having a bot gather resources). In this sense, it makes money because it’s a business, just as decentralized exchange LP farming is really a business.

VC DAOs

And the frequent mention of DAOs brings me to a specific thought: venture capital-styled DAOs (decentralized autonomous organizations).

The most famous, at present, is the Buy The Broncos DAO.

There is no way this DAO isn’t (if successful) issuing unregistered securities. As @Number12 (from our Discord) stated, this is probably just a promotional / awareness campaign.

There is, however, a way to use this idea legally. And I like legal investments because I like not going to jail.

How? Well, crowd sourced fundraising is legal if it is kept to under $5 million in initial capital. Some basic KYC & AML is needed, but beyond that you’re fine. This is what Kickstarter does after all.

It’s possible, then, to raise “bridge capital” for a crypto project which will then move it to the next stage. For example, Silica Nexus needs about $800k to bring their project to the next stage by performing a series of technical tasks (load testing NFTs on the ETH blockchain costs about $200k in gas fees, for example).

Ideally, they want $4 million to complete the entire process. 

What do they do? Their NFT tech allows for the instantaneous transfer of NFTs, in bulk even, from one owner to another. They already have a gift card system up and running with gaming NFTs. Obviously, no one is offering NFT gift cards because to send a $15 card, it costs $85 in gas fees.

Their system also allows for gaming developers to do what is presently impossible: record game states as NFTs. Presently, NFT games have only characters and equipment. But the goal, eventually, is to allow players to save their games as NFTs. Then they could transfer those save game NFTs to others, or rent them, etc.

With Silica Nexus’ tech that will be possible because they can record NFTs in a costless and near instantaneous way.

But they need some cash to get to the next stage. That’s the role a VC DAO could play. People pool their cash, allow the firm to go to the next stage, and then the firm pays back the bridge after 6 – 18 months at 5x (or however this is worked out for each offering).

I know that 5x isn’t the sort of hype that people love in the crypto world, but this is an obvious way to attain nice returns on your investment while the rest of the crypto market crashes. Let’s be honest 5x during a crypto winter is a good return.

Moreover, these returns are uncorrelated with the rest of the crypto market because they work like funding stages for biopharmas. As soon as the firm goes to the next stage you make a gain regardless of the state of the rest of the economy (barring planet-level catastrophe).

Concluding Thoughts

This post turned out a bit longer than I expected it to be, but I hope it’s useful. I needed (at least) to organize my own thoughts around the uncorrelated crypto classes that are available.

I think this also explains my recent obsession with DAOs. Access to NFT blue chips (especially metaverse blue chips), GameFi teams, and VC bridge raises are all possible through the organization of DAOs.

For both the NFT blue chips and the VC bridge raises, these DAOs fall squarely under established crowdfunding rules. They are legal and easy to do–a matter of days to get started in fact.

I’m in ongoing discussions with other people in the DAO space–and many lawyers–to figure out how to execute on GameFi DAOs and (obviously) how to scale the Investment DAO approach for crypto maximalism that we’re discussing on our Discord server.

This week I wrote a number of pieces that are related to this post, so you might want to have a look if you’ve missed them.

That’s it for this week. Remember to join us on Discord if you haven’t already.

Happy Trading!!

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