Understanding why and how social investing works
A brief overview on why the Avalanche Social Index makes sense
Why social investing makes sense
If there is one thing that the crypto world does not lack is variety. There is more than thousands of projects on the market in several branches of activity: DeFi, independent chains, protocols, NFTS, and indexes. It is extremely hard to follow all of them and to pick the right investments. Differentiating good projects from bad ones is certainly a challenge.
Even if one surpasses that challenge there is still something left to do: setting up the portfolio. Imagine that one has already picked some solid projects to invest, but does not want to work with a fixed portfolio. How to choose the weights and decide the logic that will be used to vary them from time to time in order to allocate a bigger share to the best performing coins?
We believe that the common practice of using market capitalization to decide allocation is not much beneficial. You are just investing in coins that are more expensive or have a larger circulating supply. Price is something decided by the market and follows the hopes, fears, and whims of several unknown agents. Supply is somewhat arbitrary in many cases, some coins don’t have a fixed supply nor a fixed issuance rate. Contrary to stocks, crypto projects do not have a conventional cash flow to help determine a reliable project capitalization or value.
Truth be said, much of crypto today is promise. Promise to deliver and promise to get rich. This does not mean that there are no good teams and solid projects that can actually deliver, just look at TraderJoe at Avalanche, or other successful DeFi protocols. They promised and delivered.
What we propose is to invest in crypto based on the size and quality of the community that surrounds the projects, since that even with a very fine team behind a cryptocurrency, the only way that something will get to see the light of day is a considerable number of people willing to invest and engage with the project.
So if we can measure the community strength of each crypto then we may have a better chance to choose projects that have a high probability of success and appreciation. And more, as we will show further on, if we use social data and not market capitalization, we can allocate capital more effectively.
How to measure communities
The question is how to measure the strength of communities. The tool we developed with our friends at Heimdall is like a listening device, it can hear all the talk and hustle of the communities on Twitter, filtering spam and giving more relevance to important users. We can then use algorithms to evaluate the data and score each user according to their importance to the community. We call this metric the Social Score.
You can take a deeper look at how it works in the following article.
Looks great, but do it work?
Certainly, it must be worth all the effort to develop a metric and abandon the popular and much-used allocation method by market cap. This is what we will show now. But first, some graphs to illustrate a previous point.
We can see in the graph above that the score moves with the price but in a smoother way. The catch is that while a market cap strategy would sell or buy in lows and highs, the social strategy would follow the growth of the community and buy smoothly and in a more controlled manner. It is worth noticing also that sudden price drops will not trigger a large sell because the social score is mainting its growth.
Now lets look at another example:
In the case of sushi, we see that the social score is in a downtrend when the price begins to drop. Then the price stabilizes, while in August a sudden jump occurs and is followed by normal growth. This sudden jump is due to an update in our algorithm that analyzes the data and it won't happen again. What is important to observe is that the social score allows buying at lower prices, exactly what a price-based strategy does not offer.
Now we come to the heart of the matter. How does a portfolio following a social strategy compare to a usual market cap allocation? Using the same coins for both strategies we made the following backtest:
And some relevant metrics:
We see that the social index portfolio is slightly more volatile than the other, however, the mean return is much more expressive.
What explains the difference in performance that is evident after September? How can one portfolio suffer a loss while the other offers gains, although modest? It must be the allocation of the assets. Let's see how each strategy handles the allocations.
There are two major factors that can explain the performance of the portfolios:
- The Social Index portfolio begins allocating or deallocating much sooner than the Market Cap Index.
- There is an opportunity for a coin to overpass other coins. Observe that cvx and mkr change places as well as aave and crv. So a coin that is outperforming the others can get a bigger share of the portfolio. This is something that the constraints of a market capitalization strategy may not allow.
As mentioned earlier the social metric is allowing our strategy to buy at low prices, and this is very good news.
So did we find the road to El Dorado? Of course not.
What we did find is that there are other ways to invest than just to choose coins at random and buy more of the most overpriced coin. It is not a very complicated strategy and the metrics and systems are not that difficult to implement.
Meet the Avalanche Social Index
If you bought the idea, it’s time to meet the first of a series of multi-chain products, done using Kassandra Protocol, that will automagically socially invest:
Learn more about Kassandra:
- Website: https://kassandra.finance/
- Twitter: https://twitter.com/dao_kassandra
- Github: https://github.com/KassandraFinance
