Re-evaluating portfolio diversification and design using cryptocurrencies: Are decentralized cryptocurrencies enough?

Abstract

This paper investigates the portfolio diversification potential of a pool of cryptocurrencies classified based on their degree of leadership. We employ the mean-variance and the higher-order moments optimization approaches to evaluate the diversification potential of centralized and decentralized cryptocurrencies across multiple frameworks. While theoretical implications of the mean-variance and the higher-order moments optimization approaches are similar, our results suggest that the latter provides a more precise portfolio allocation strategy because it considers investor risk-aversion for each moment. Furthermore, we find that extending the pool of cryptocurrencies achieves marginal diversification benefits due to considerable co-movements among the cryptocurrencies. Moreover, we find that decentralized cryptocurrencies offer greater diversification potential than centralized cryptocurrencies, although centralized cryptocurrencies carry some diversification potential during alt-seasons. In order of their weights, Bitcoin, Chainlink, and Ethereum (all decentralized) offer the highest contribution to portfolio diversification across most portfolio frameworks, while Ethereum offers greater diversification benefits during the alt-seasons.