Dynamic Portfolio Optimization of Cryptocurrencies via Clustering Methods

ABSTRACT The rise of cryptocurrencies has generated significant interest from the public and investors due to their decentralized nature, advanced security features, and potential for high returns. This research uses K‐Means clustering and Inverse Covariance Clustering (ICC) to optimize cryptocurrency portfolios by addressing market dynamics and traditional portfolio management limitations. The study involved three phases: collecting daily price data from the top 100 cryptocurrencies from January 2018 to January 2024, performing calculations to identify cryptocurrencies through clustering methods, and constructing and dynamically optimizing investment portfolios from early 2022 to early 2024. We evaluate the constructed portfolios against the Cryptocurrency Benchmark Index (CRIX) using metrics like the Sharpe and Treynor ratios. Results show that both clustering methods can create efficient portfolios, but their effectiveness varies with dataset characteristics and investor objectives. K‐Means produces more diversified portfolios, while ICC yields lower volatility portfolios, with ICC generally outperforming K‐Means compared to the CRIX index. The findings highlight the potential of clustering methods in enhancing cryptocurrency portfolio selection and suggest the need for further research on real‐world applications and advanced techniques tailored for the cryptocurrency market.