Integration of Cryptocurrencies into Investment Portfolios: Application of Modern Portfolio Theory and Minimum Spanning Tree Analysis

Abstract

The integration of cryptocurrencies into investment portfolios has been analysed through two main approaches: Modern Portfolio Theory (MPT) and Minimum Spanning Tree (MST) analysis. While previous research has demonstrated the potential to improve portfolio performance through cryptocurrency inclusion, the current study reveals a more nuanced picture. Empirical results indicate that, under Markowitz's theory, cryptocurrencies are assigned zero weights in the optimal portfolio, primarily due to their extreme volatility (exceeding 50–60% for assets such as DOGE-USD and MATIC-USD). Correlation analysis reveals strong relationships between major cryptocurrencies, such as BTC-USD and ETH-USD (above 0.85), while assets such as DOGE-USD and TRX-USD exhibit weaker correlations with other components (below 0.4). Despite their diversification potential, the high volatility of cryptocurrencies diminishes this effect. The optimal portfolio achieves results similar to traditional benchmarks, with a return of 6.8% and risk around 12%. The study concludes that integrating cryptocurrencies into investment portfolios necessitates more dynamic risk management approaches.