Threshold Rebalancing - The Evolution of Cryptocurrency Portfolio Management
Threshold based rebalancing is a portfolio management strategy used to maintain a set of desired allocations, without allowing the asset weightings from deviating excessively. When one of the individual constituents of the portfolio crosses outside the bounds of their desired allocations, the entire portfolio is rebalanced to realign with the target allocations.
Target allocations: The allocations which are specified by the portfolio owner for each asset. These are the percentages of each asset which should be held in the portfolio. For example, a specified allocation of 30% BTC, means the target allocation is 30% for the portfolio. During a portfolio rebalance, trades are executed such that at the end of the rebalance 30% of the portfolio value is held in BTC.
The bounds around each allocation are the “threshold”. Set by the user, the threshold prevents excessive deviation from the target allocations.
Threshold rebalancing is a strategy which has been utilized in the traditional market for decades. Designed to reduce risk, it’s a simple solution to the concerns many new users experience when investigating the cryptocurrency market. In addition to reducing risk, rebalancing can also bring increased returns. You can find one of our previous studies which focuses on periodic rebalancing here:
A Threshold Rebalancing Example
Rebalancing based on threshold deviations examines how far each individual asset has deviated from their target allocations. In the example illustrated above, we have selected to evenly distribute our allocations among 5 different assets. These 5 assets therefore each hold 20% of the entire value of the portfolio when we initially allocate the portfolio. Over time, we find the portfolio allocations for each asset deviate from their target allocation.
In order to prevent excessive deviation, we selected a max threshold of 15%. Once an asset diverges from their target allocation by more than 15%, a rebalance will be triggered. Trades will then be executed to once again reach the desired percent allocation for each asset.
Notice the threshold is a deviation from the desired allocation. It is not an absolute percent change. That means our assets don’t need to consume 15% more of the portfolio to become 35% of the total portfolio value. Each asset only needs to consume or lose 15% of their target allocation to trigger a rebalance.
The reason threshold rebalances are executed in this way is because diverse portfolios won’t be able to provide the necessary movement to trigger rebalances if the percentages were absolute. Imagine having a portfolio of 100 assets. If each of these assets holds 1% of the total portfolio value, it would be exceptionally rare to execute a rebalance even with a 1% absolute threshold.
Additionally, distributions of assets can be flexible. Not everyone is looking for even allocations. It’s possible to see a portfolio of 99% in a single asset. To provide consistency on when rebalances are executed, a relative percentage is used for threshold calculations.
Threshold Rebalancing in Shrimpy
In the Shrimpy Application, threshold rebalancing is a strategy which can be implemented by users to control for risk. Automating your portfolio has never been easier. In seconds, implement a dynamic cryptocurrency index fund which tracks the market or allocate a portfolio of your own design. Manage a diverse portfolio across numerous exchanges by linking each of your exchanges to the Shrimpy application.
To get started with a threshold rebalancing strategy, navigate to the "Portfolio" tab and select the portfolio you would like to use with a threshold rebalancing strategy. Once you've selected the portfolio, you will see a drop down under the "Rebalance Period" section which says "Advanced Settings". Under these advanced settings, you will find threshold rebalancing.
Selecting this option will present you with a single box where you can enter the threshold that should be used with your threshold rebalancing strategy. Remember that the threshold is a deviation from your target allocation. The threshold is not based on absolute values. Therefore, like our example above detailed, an absolute deviation of 3% for an asset which has a target allocation of 20% is a 15% threshold.
Threshold rebalancing in Shrimpy has a maximum frequency for which it can rebalance. This prevents situations where the market is rapidly moving and causing excessive trades to take place. This period is 15 minutes. That means if your portfolio rebalances, Shrimpy will not rebalance again for at least 15 minutes, even if your portfolio meets the requirements for a threshold rebalance.
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