2024 Proved Why We Need A De-Facto Crypto Index

As we start the new year, some of the questions on everyone’s mind are: “Is the crypto rally over ? Is it just beginning? Will Bitcoin go back above 100k? What is the best altcoin to buy?Will there even be an Altcoin season?”. It’s very difficult to answer these questions. Unlike tradFi, there are no fundamentals or macro in to analyze in crypto.

In an attempt to find helpful insights to these questions for the investment community, I’ve spent the past few weeks working on some crypto research. I downloaded data for roughly 10k coins and started several half-done analyses such as calculating some crypto indices, factors and breadth indicators.

Below are some crypto breadth indicators over 2024; the pct of stocks above their 50-, 100- and 200-DMAs. They all show that market breadth is declining. As of 23rd Dec, some 24% of coins were above their 50-dma, 33% were above their 100-dma, and 28% were above their 200-dma.1 I plan to investigate if they can be used to trade crypto, particularly if the extremes are contrarian. If you recall the previous analogous work about S&P 500 breadth indicators, extremes tend to signal reversals. But I’m not sure this would work in crypto.

For the S&P 500, there is a well-defined set of stocks to calculate breadth, so the extremes signal that the S&P 500 is overbought or oversold. In crypto, you first have to ask yourself what coins to include in you calculations since there is no common crypto index. There are a few products out there that serve as crypto indices, but their methodology differ.

So while a breadth indicators may say something about the crypto market, you would struggle to act on that information because it isn’t specific to any particular product. You can try using several representative samples, especially those with a corresponding real-world product, then backtest their performance (don’t worry, I’m on it).

The Need For a Crypto Index

I would hazard to say that the most commonly used index is the CoinMarketCap Crypto 100 market-cap weighted index (henceforth CMC 100). Several products try to mimic it’s performance but the aren’t perfect; it is difficult to calculate the exact same weights that CMC use. I tried this and failed even though I got the data from CMC, but I was close as the chart below shows.

The index has basically doubled this year so it would have offered higher returns than the S&P 500. But a large part of this is because Bitcoin is weighted at about 60%. If compare Bitcoin’s performance to several different assets, it outperformed. The CMC 100 followed (See chart below. The white line is the S&P 500’s return).

So, you can calculate the breadth indicators using the top 100 coins excluding stable coins and wrapped coins, just like the CMC do with their index. In a subsequent post, I will compare it to other versions and backtest them.

Anyway, crypto indices would be a god-send because choosing an altcoin is a difficult task, much like stock picking.

Have you ever wondered what a crypto index can do for your portfolio? Even though the S&P 500 returned over 20% this year, since most portfolios are diversified, few of them outperformed it. If you look at the chart above, most of the diversification candidates would have led to an underperforming portfolio. I can just imagine how hard it is for any fund managers who benchmark against the S&P 500 this year to explain their performance (here’s an extreme case).

A de-facto crypto index (with accompanying ETFs) would have improved many portfolios this year. It would have captured most of the Bitcoin move with less volatility (not much less but less still). The size of the index is inconsequential. As it turns out, there is not much difference in the performance of a crypto index if there are 100 coins, or 500. But a small index would be too volatile for most people’s taste (This SSRN paper has more on this).

I illustrate this in the chart below. It shows what a crypto 500 index looks like (it includes stablecoins and wrapped coins). The performance this year is similar to the CMC 100 because even in such a large index, Bitcoin dominates due to it’s much larger market-cap. A crypto 20 index is a lot more volatile in comparison, but it gives great Altcoin exposure.

I’ll talk more about crypto indices in a coming post. The point I’m trying to make is that this year has proved that there is a need for a prominent crypto index. As a matter of fact, I don’t think an Altcoin rally will happen until there is one. My thinking is that until now, the Altcoin rally has mostly been driven by the idea that a few other coins offer some thing or other that Bitcoin doesn’t. Such coins were expected (and actually have, in some sense) chip away at Bitcoin’s prominence, so they went viral. But now, no one wants to commit money to a coin unless everyone else will as well. This difficulty to form a consensus can only be solved by a prominent index.

“Pct of Constituents Above X-DMA” Is a Sub-Optimal Measure of Breadth

As I was working through all this, I came to the realization that pct-of-constituents-above-Xdma is a sub-optimal measure of market breadth in market-cap weighted indices.

Breadth is meant to tell you how many stocks are participating in a bull market. But market-cap weighted stocks tend towards concentration: a few constituents (or sectors) determine the direction and magnitude of the moves, rendering the rest of the constituents unimportant. So counting the number of coins above a moving average will not give you a good idea of breadth if only a few stocks move the market. Imagine a scenario where the leaders don’t move, but a lot of stocks are above their X-dma. The contribution of the lagards would be small, but breadth would be high, so you wouldn’t be able to use these market breadth indicators for timing and directional views.

Don’t fret, you can correct for this by including some kind of a weighting scheme based on the distance of the stocks to the DMA. The new indicator would have the number of stocks above the dma, weighted by the distance of the current price to the DMA. This captures both breadth and momentum making it more powerful.2 

Autocorrelation Can Help With Market Timing; With a Few Caveats

Part of the difficulty of altcoin picking has to do with timing. Even if you pick a winner, other coins may perform better in the interim, and that would make you want to sell.

I’m looking into some altcoin-picking ideas, and one of them has to do with autocorrelations. In theory, autocorrelations (correlation of a variable with lagged values) should be a great timing indicator. It goes positive when a trend is confirmed and negative when the trend breaks down. So you can use it to follow the trend, or play the mean-reversion.

But it is not as straightforward as that. If you use autocorrelation to confirm a trend, it would only be helpful if the trend starts slowly (small moves) and then develops into big moves or persistent moves in one direction. If the trend starts with big moves, the autocorrelation will turn positive when most of the move has happened. If you use it for mean-reversion, you need to watch out for noise. You first need to look evidence that the trend is done using other tools like RSI, momentum indicators, sentiment, fundamental/macro changes etc, then you can look for entry points using the autocorrelation. Another problem is that you have to decide on a lookback period. RSI uses 14 by default but since few ever change it, then everyone is basically using the same RSI indicators. Since autocorrelation is not a popular indicator, the choice of lookback period matters. You can try to optimize it (fitting past data) but you would likely be overfitting and past performance would be no indicator for future performance. That said, it is a very useful indicator in an opportunity set such as crypto where sentiment and price action are the most useful tools for prediction.

I watched the Netflix Avicii documentary so I’m replaying most of his songs. This is my favorite Avicii tune