Ethereum or Bitcoin

Long Bitcoin, Short Ethereum?

This is not investment advice. Bitcoin is highly volatile. Past performance of back-tested models is no assurance of future performance. Only invest what you can afford to lose. You must decide how much of your investment capital you are willing to risk with Bitcoin. No warranties are expressed or implied. 

Roadmap of Ethereum

Ethereum has a noble goal of a “world computer” with support for many applications including those in DeFi (decentralized finance), where it is now very popular. But it also has a complex roadmap. The umbrella is Ethereum 2.0, which includes many features to support scaling with sharding, and especially a shift to Proof of Stake away from Proof of Mining.

I say especially because for the valuation of Ethereum this is critical. Proof of Mining cryptocurrencies are valued for scarcity, Proof of Stake cryptos for their expected “dividends” as well.

Phase 0 has recently been implemented to allow staking of ETH for staking rewards, as an initial step in this shift. Phases 1.0, 1.5, and 2.0 should be implemented over the next couple of years.

Here’s what Vitalik tweeted in March. Not the simplest of roadmaps.

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Value of Ethereum vs. Bitcoin

I have done a quick Kelly capital growth analysis for a two asset portfolio with Bitcoin and Ethereum. Using performance over the last 13 quarters, the net-net is that one wants to be short Ethereum in Bitcoin terms.

Using quarterly performance Ethereum had 6 relative wins (46.2% win rate), Bitcoin 7 wins. Ethereum’s average win against Bitcoin was 19.0%, its average loss 22.7%. So it lost more often, and by larger amounts, the ratio b = 0.838 indicates the average win amount divided by the average loss.

Over the period starting October 1, 2017 until December 28, 2020 Ethereum lost 62.1% (close to a Fibonacci ratio) of value relative to Bitcoin. (In the last quarter of 2018 alone it lost over 55% of its value relative to Bitcoin.)

Plugging into the Kelly capital growth fraction for an optimal portfolio: f = (p*b - q)/b = (.462 x .838 - .538)/.838 = -0.181.

The answer is a negative number for the optimal fraction. In a two-asset Bitcoin and Ethereum portfolio, according to the Kelly criterion applied to intermediate-term performance you should not hold Ethereum at all; you should be short Ethereum somewhat.