LENGTH ARTICLE

Regime-Aware Digital-Asset Allocation: Balancing

Participation and Downside Risk

Andino Maseleno1,* Aa Hubur2

1 Institut Bakti Nusantara, Lampung, Indonesia

2 Universitas Trisakti, Jakarta, Indonesia

Received: January 16, 2024 Revised: March 10, 2024 Accepted: June 28, 2024 ⋆ Corresponding author

ABSTRACT

The exposure of cryptocurrencies has been so easy to make a part of the digital-asset platforms, but the risk engines

that come with these products are frequently based on static allocations or unconditional correlation estimates.

The problem is that the states that allow participation in upside potential are different from the states that allow

protection against sudden drawdowns; solving both optimization problems as a single problem can lead to a portfolio

that retains too much crypto risk or to a portfolio with a zero digital asset exposure. In this paper, we introduce a

participation constrained, regime aware allocation framework which allocates Bitcoin and Ether alongside gold and

the S&P 500. A pre-specified volatility signal separates out the normal period from the stress period, and normal

period minimum variance optimization enforces a significant crypto allocation during the normal period, whereas the

stress period has an explicit ceiling on the amount of crypto invested. The design is tested without look-ahead bias

over 2020–2023, assuming that there is a 10 basis points per unit of turnover charge for the design. Importance of the

framework for FinTech investment platforms is that it converts a qualitative risk setting into allocation rules that are

easily explainable, auditable, and repeatable. The volatility of the static crypto portfolio was 64.7%, the maximum

drawdown was 72.1%, and the conditional loss at 5% monthly was 34.6% for the portfolio. A crypto-only strategy

had an annualized return of 12.0% and reduced volatility to 16.3% and the 5% conditional loss to 20.1%, while a

regime-aware strategy had an annualized return of 14.9% and reduced volatility to 25.9% and the 5% conditional

loss to 14.5%.

Keywords: Financial technology Digital assets Cryptocurrency allocation Regime switching Portfolio risk

Bitcoin Ethereum Downside risk

1. INTRODUCTION

The digital-asset investing market has evolved from specialist

exchanges to integrated financial-technology platforms that

encompass all facets of digital assets investment: custody,

trading, reporting and automated allocation. This shift has

eliminated operational friction but brought a complex design

challenge for portfolio managers: how to maintain meaningful

exposure to digital assets efficiently without putting your

portfolio’s products at risk when the underlying risk takes

an unexpected turn? There is no solution in the form of a

risk questionnaire, or a static, "balanced" basket. Bitcoin

and Ether can show different volatility, tail behavior and comovement

across the market conditions, which means that

the same allocation could have very different risk at different

times [1, 2, 3].

The large literature focuses on whether cryptocurrencies are

a hedge for equities or a safe haven. Intentionally mixed