A portfolio is an investment basket consisting of various investment instruments. Throughout the history of finance, professionals and experts have worked to come up with the optimal portfolio. **The purpose of having an optimal portfolio is to get maximum return at a given level of risk or minimum risk at a given level of return.**

Prior to the 1950s, portfolio managers only included financial assets from different industries in their portfolios and reviewed the relationships between these assets to reduce the portfolio's risk. The idea at the time was that the more assets you have, the better. This method was preferred until 1950. In 1952, Harry Markowitz made a significant contribution to finance with his work “Modern Portfolio Theory”. Markowitz defined risk as deviations (standard deviation, variance) in financial asset returns and described them as undesirable. Markowitz argued that this is how portfolios can be diversified and **risk minimized at a given level of return**. Referring to previous diversification studies, he stated that diversification is not related to the number of financial assets in a portfolio. He stated that the correlation between financial assets in a portfolio is more important. Markowitz calculated the return and variance of a portfolio as follows:

The expected return of the portfolio:

For two financial assets (A and B), the return of the portfolio is calculated as follows:

weight of Asset A **X** expected return of Asset A **+** weight of Asset B **X** expected return of Asset B

The variance of the portfolio:

For two financial assets (A and B), the variance of the portfolio is calculated as follows:

weight of Asset A squared **X** variance of Asset A **+** weight of Asset B squared **X**variance of Asset B **+ 2X** weight of Asset A **X** weight of Asset B **X** standard deviation of Assets A & B

**According to the Modern Portfolio Theory, the risks of financial assets consist of deviations in their returns.** If a portfolio is to be created, data showing how much cryptocurrencies deviate from their average returns should be examined.** According to the MPT, this data shows the risk of the financial asset. **Then, the correlation between financial assets should be examined depending on the number of assets to be selected to construct a portfolio. Unlike stocks, cryptocurrencies are examined according to their purpose, rather than sector by sector. For example, we can classify Blockchains, Payment Systems, DeFi (Decentralized Finance), Sports & Games, etc. **It is important that the portfolio has minimum variance, in other words, minimum risk,** which means that the cryptocurrencies in the portfolio are correlated with each other at as low a value as possible. However, **the importance of Bitcoin’s price movements in the cryptocurrency market is different from the price movements in traditional markets**. In the cryptocurrency market, there are negative returns in altcoins during the selling periods in Bitcoin. Therefore, instead of negative correlation, we can consider adding cryptocurrencies with as low correlation as possible to our portfolio.

The table above shows **the correlation coefficients of Bitcoin, Ethereum, Ripple, and Cardano**, which are among the cryptocurrencies with the highest market cap in the cryptocurrency ecosystem. If we want to create a portfolio by randomly choosing among these projects, we should select those with low correlation coefficients. For example, the correlation between Bitcoin and Ethereum is the highest at 0.826, which tells us that the prices of these two projects tend to move together. When there is an increase in the price of Bitcoin, there is a similar increase in the price of Ethereum. Therefore, **Markowitz suggested that we choose assets with low correlation over assets with high correlation to minimize the impact of a possible decline.**

Harry Markowitz made a momentous change in modern finance and portfolio management with the MPT. **Markowitz won the 1990 Nobel Prize in Economics for this work.** Although the MPT received much criticism later on, it still maintains its importance today and is preferred by portfolio managers.