The Importance of Rebalancing and Reallocation

Authored by Makara


Published September 10, 20215 mins
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As complicated as crypto can be, the very first digital asset investing strategy was simple: You bought Bitcoin or you didn’t. Twelve years later, it’s not that easy.

Why? Well, now there are more than 11,000 tokens. And they do everything. Some, known as stablecoins, are tied to assets like gold or fiat currencies, so their prices don’t fluctuate too much. There are coins that fund virtual gaming platforms, or cloud computing services, or financial products like insurance. One coin mirrors Tesla stock. (Investing in it is essentially the crypto equivalent of buying shares in the traditional asset. As Tesla rises or falls, the mirroring coin does too.) And, of course, there’s Dogecoin.

In many ways, it’s a lot like the stock market. All of these new options allow you to invest in things with different levels of risk, different market caps, and different price histories. And just like in the stock market, you’d be smart to diversify: With a balance of assets, if one of your investments tanks, your portfolio doesn’t necessarily follow it. There is, of course, one big difference. The volatility of crypto means prices can and do change. Rapidly. To be smart, then, a crypto investor needs to make use of another strategy born of legacy finance: rebalancing.

What Is Rebalancing?

Here’s a very simple example: Let’s say you invest $100 in crypto. You decide you want half in Bitcoin and half in Ether. That’s $50 in each. The next day, Bitcoin’s price triples. After annoyingly texting every friend who will listen, you realize you now have $150 in Bitcoin and still only $50 in Ether. Instead of the 50-50 split you wanted, you’re at 75-25. To rebalance, you would sell $50 worth of Bitcoin and invest it in Ether, putting you at $100 in each coin—and the 50-50 split you originally wanted.

Things obviously get more complicated when you hold more than just two coins or care about parameters other than equal weights. Even strategies that sound relatively simple—like investing in the top ten tokens by market cap—require constantly tracking information on the state of the market and your holdings, and then executing as many trades as it takes to rebalance in response. When you start talking about balancing for risk, some very confounding math gets involved. For example, instead of choosing to invest your assets equally across those ten coins, you may want the balance of your portfolio to maximize return at a preselected level of risk. Figuring out how to do this can involve making assumptions based on price history and momentum, and then applying mathematical formulas to ensure the level of risk is matched across the portfolio.

If that’s work you are willing to do yourself, congratulations. You are a wise and worthy investor. The rest of us, however, need some help. That’s why Makara rebalances most of our baskets automatically, using a combination of algorithms and oversight from a human investment committee. Our baskets offer either equally weighted groups of coins, like the Decentralized Finance basket, or a risk-weighted level, like the Universe basket. Every quarter, baskets shift automatically to ensure you’re never too far from your preferred strategy—no matter what the market does. Of course, if one of your baskets shoots up in value, you may also want to rebalance your overall portfolio, reweighting your funds between baskets to stay close to your initial investment goal.

What About Reallocation?

Thanks for asking. It’s pretty similar to rebalancing, which, as we describe above, is a change that occurs to keep the desired proportions among coins in a portfolio. Reallocation, however, is when the coins in the portfolio need to change. So in that example of an investor who wants a position with the top ten market-cap coins, if one of the coins dropped to 25th, it would have to be sold and replaced. Some assets in the portfolio would be reallocated.

If you’re familiar with legacy investment options, you might compare automatic rebalancing and reallocation to index funds, which track a segment of the entire market, or 401(k) investments that are adjusted for the age of the investor—higher risk for the young and lower risk for those who are boxing up their stuff for Boca. Once your money is in the fund, you don’t have to worry about fine-tuning it. That’s taken care of for you.

Most investment strategies at Makara are set to rebalance and reallocate quarterly. As we see it, investing wisely in crypto does require money, but it shouldn’t require too much of your time.