Cryptocurrencies: Asset Classification, Trading and Portfolio Management

Cryptocurrencies’ (cryptos) asset classification presents a conundrum: Cryptos classified as commodities require less regulation, promoting market participation. However, the uncertainties in volatility and correlation generate financial instability. Major cryptos (Bitcoin and Ethereum) exhibit similarities to commodities in terms of statistical features and non-linear machine-learning forecasting results. Trading strategies applied to a crypto and commodity asset pool demonstrate (1) momentum works effectively in bearish markets with high volatility (March 2020), suggesting investors herd in market downturns, and (2) pairs trading works well in high-interest, low-volatility environments (March-October 2023). The crypto futures-commodities portfolio has the highest Sharpe ratio, followed by the crypto spots-commodities portfolio, and lastly, the commodities-only portfolio. Heavy-tailedness violates modern portfolio theory’s normality assumptions.