Practically speaking, there are three key components to adopting a risk parity approach to portfolio management within crypto: diversification, classification / calibration, and management.
First, it must be actually possible to diversify across non-correlated assets. This may seem trivial, but until recently this was impossible in crypto. Bitcoin held such a dominant position that all other crypto assets were strongly or weakly correlated with it. Where Bitcoin went, every other asset followed.
But the rise of Ethereum and DeFi in particular has seen crypto asset prices decouple from Bitcoin for the first time, at the same time as crypto as a whole has decoupled from the stock market. The conditions are finally right for the Risk Parity approach to be feasible within crypto, allowing an all-crypto risk-balanced portfolio which can weather any environmental conditions.
Second, there needs to be a reliable way to classify and quantify assets. Investment isn’t an exact science, but it’s impossible to adopt a risk parity approach without a reliable way to classify and track crypto assets and identify negatively correlated pairs.
Fortunately, DeFi is a goldmine of data and token analytics, with smart contracts publicly viewable and transactions transparent and trackable on-chain.
Figure 3 below is an adaptation of Figure 1, replacing stocks and bonds with our own indices that share the same characteristics.