Protecting your crypto investments while aiming for growth can be a delicate balance. One strategy that has gained traction is Constant Proportion Portfolio Insurance (CPPI). This method, traditionally used in stock and bond markets, is becoming increasingly popular for managing risk with crypto portfolios. Sound intriguing? Let’s explore how to use CPPI strategically for your crypto investments.
What is CPPI?
Constant Proportion Portfolio Insurance (CPPI) is an investment strategy designed to provide downside protection while allowing for upside potential. In this strategy, you essentially have two “accounts:” risky and not risky.
You allocate your portfolio between risky (newer or unstable coins) and risk-free assets (such as stablecoins or fiat). The idea is that as the value of the risky asset increases, you allocate more of your portfolio to it; as it decreases, you reduce your exposure to the risky assets to limit potential losses. This dynamic crypto rebalancing ensures that your portfolio remains protected while capitalizing on growth opportunities.
How CPPI Works in a Crypto Portfolio
Applying the CPPI strategy to a crypto portfolio involves the same core principles as in traditional investing but with adjustments for the unique characteristics of the crypto market and closer monitoring, thanks to volatility. Here’s how you can implement it:
- Define a Floor: The first step is to determine the minimum value you want to protect—this is your “floor.” For example, if you have $100,000 to invest, and $90,000 is your floor, then when the portfolio value drops to $90,000, you move all assets to a conservative investment.
- Determine the Multiplier: The multiplier dictates how much you invest in the risky asset. A higher multiplier means more aggressive exposure to risk, while a lower multiplier is more conservative. For example, if 20% is your maximum “crash” possibility, your multiplier is 1/0.20 or 5. With a $100,000 portfolio, your allotment to a riskier asset is 5 x (100,000 - 90,000) = $50,000. The remaining money goes into a less risky asset balance. The difference between your portfolio value and your floor is called the “cushion.”
- Rebalance Regularly: As the value of your crypto assets changes, you’ll need to rebalance your portfolio. If your riskier holdings increase in value, you allocate more to them. If they decrease, you return funds to the risk-free asset to protect your floor.
Example of CPPI in Action
The numbers can get confusing, so here’s another more detailed example explaining the theory.
Let’s say you start with a $100,000 crypto portfolio. You set a floor of $80,000, meaning you don’t want your portfolio to drop below this amount. You choose a multiplier of 4. If your current portfolio value is $100,000, you will invest $80,000 (the difference between your current value and the floor multiplied by 4) in high-risk assets and the remaining $20,000 in a stablecoin.
If your crypto investments perform well and the portfolio grows to $120,000, the gap between your portfolio value and the floor is now $40,000. With a multiplier of 4, you would adjust your allocation to $160,000 for riskier coins. Since this exceeds your total portfolio value, you would invest the entire portfolio value into the riskier asset and readjust as the value fluctuates.
Conversely, if the market turns and your portfolio value drops to $90,000, the gap is now $10,000. Applying the multiplier, you’d reduce your crypto allocation to $40,000, moving $50,000 into the risk-free asset to protect your floor.
Why CPPI is Important
The primary benefit of CPPI is its ability to safeguard your bottom line in volatile markets while still capitalizing on potential gains through that same volatility. This is particularly important in crypto, where prices sometimes fluctuate dramatically in short periods. By employing a CPPI strategy, you can maintain some protection against significant losses, providing peace of mind and a more stable investment approach.
CPPI and 3Balance
3Balance is a fantastic tool for a CPPI strategy, thanks to its ease of use. Once you have identified your floor and your allocations, making routine rebalances as the market fluctuates is simple. You can convert to any token of your choice across a range of assets, all in a single flow. Plus, our interface offers automated calculations with routes for corresponding trades so you can see your portfolio balance in real time. From there, all you have to do is click execute. 3Balance makes keeping up with a dynamic rebalancing strategy, like CPPI, a breeze.
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