A Closer Look at Market Cap-Weighted Crypto Portfolios

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For digital assets, complementing market cap with some measurement of a blockchain’s usage, such as total value locked (TVL), may enhance portfolio construction. Opinion by truvius_tech

One way to do that is with total value locked , which represents the value of assets deposited on a blockchain. A higher TVL suggests greater economic activity and potentially better prospects of future activity or a larger active user base.

By taking the ratio of market cap-to-TVL , we may glean a more fundamental sense of an asset’s utility beyond the superficial view from market cap, similar to how equity investors use ratios like price-to-book to discern a stock’s value. A higher MC-TVL suggests an asset’s capitalization may be bloated, with a valuation that disproportionately exceeds its usage. Conversely, a lower MC-TVL may imply an undervalued blockchain, where markets haven’t yet priced in its activity.

We ran a simulation on a top-10 index weighted by market cap versus one weighted by MC-TVL. The results are below: The MC-TVL approach produced better full-period returns in this hypothetical scenario, driven by outsized positive performance in 2021. Over the period, daily returns between the two had a 0.85 correlation, suggesting that while the weighting methodologies are similar , meaningful differentiation still exists between them. Over the long run, integrating blockchain usage into passive products may improve overall market exposure and help investors better align themselves with crypto fundamentals.

As crypto’s track record unfurls in real time and new, richer on-chain data emerges, investors should monitor how fundamentals-based adjustments to portfolio construction could assist digital asset investment management.Data is for the period Jan. 1, 2021-March 31, 2023. These indexes represent hypothetical backtests rebalanced monthly and do not consider transaction costs or whether assets are feasibly investable.

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