About Index Coin
A key purpose of the DCI is the diversification of a very volatile cryptocurrency market. This allows for an investment in the entire cryptocurrency space without the risk of betting on a single coin and the hassle of holding coins from different exchanges or in different wallets. There are many coins available and some are very valuable investment vehicles. However, others are highly volatile and, frankly, others are worthless. The goal of DCI is to manage an index fund of coins that is the weighted average of the top 30 coins.
While the qualifications of a top performing coin are somewhat subjective, the overall goal is to minimize risk and maximize returns. The key to that is creating a weighted average of many un-correlated or negatively correlated coins with the highest possible expected return including the possibility of replacing coins within the index.
Unfortunately, many coins are highly correlated, very volatile, and some have a non-zero probability of spontaneous failure. There are competing metrics for which one can optimize a portfolio towards; specifically maximizing expected return versus minimizing volatility. The goal of the DCI is to maximize the Sharpe Ratio, which is a ratio of expected portfolio returns over the portfolio standard deviation.
The selection process involves the simulation of millions of possible future single-year market prices, based on the historic volatility and correlation of returns using the last 1 year of data. A penalty is applied to the newest coins that have less historical data and a higher chance of spontaneous failure using a proprietary scoring function based on the Lindy Effect which is explained in the following paragraphs.
Within this simulation, a report of the maximum expected draw-dawn, maximum days of loss, expected return, expected 95th percentile return/loss, and the expected Sharpe Ratio is generated. More importantly, an optimization process, using a genetic algorithm, is utilized to develop an optimal portfolio. After each simulation, the portfolio is rebalanced by up-weighting top performing assets and down-weighting poor performing assets until an optimal portfolio of assets is created across all future scenarios in terms of both minimizing volatility and maximizing return.
This is neither a coin to day trade nor a coin to buy and hold (not HODL). The hard work of diversifying the portfolio for maximum value over the next 1 year holding period has already been completed. Additionally, the portfolio is periodically reweighted to move new top performers in and move bottom performers out. If any asset that is expected to fail, due to a hack, fraud, or any other specific reason, said asset would be immediately removed from the portfolio to be replaced with the next best performing coin.
The Lindy Effect states simply that the future life expectancy, also referred to as the probability of failure, is proportional to both the health and existing longevity of the entity in question. This is also part of the Doomsday argument. Put simply, fads fade quickly and old things tend to remain. For the purposes of DCI, coins that have been around for a long time and have high market share have a near zero probability of spontaneous failure, while newer coins with a lower volume have a higher probability of spontaneously becoming worthless.
Here, the probability of failing on a single day is defined as a function of health (market cap), longevity, percent of coins in circulation, and sentiment.