Partnered With:

Cryptocurrency Investment Strategy: How to Use Leverage! Build an "anti-fragile barbell strategy" with fixed income

Read this article in 23 Minutes

"Cryptocurrency Investment Strategies: How to Use Leverage! Build an" Anti-Fragile Barbell Strategy "with Fixed Income"

Original source: James Chiu, Blocktempo

Quote:

The cryptocurrency market has seen a wild bull cycle due to low interest rates and the financial environment of quantitative easing. However, as the economy recovers, monetary policy tightening is a foregone conclusion, which means that the bull market may have reached the middle and late stage, and the market risks are getting higher. At this point, if investors remain in the "all spot/contract" strategy, the weak allocation will allow investors to give back gains or even losses if the market triggers a black swan event. How to use the "barbell strategy" to improve the anti-fragility characteristics of assets is what this article wants to tell readers.

Body:

Antifragile is a concept first coined by Nassim Taleb, author of 'The Black Swan Effect,' which refers to the ability to survive a worst-case scenario without being hurt (much), and one of his methods is the 'Barbell Strategy.'

Extremely conservative + extremely risky barbell strategy

Taleb borrowed the concept of weighting at both ends of the barbell, and adopted the configuration of "extreme conservative" and "extreme risk" on both sides of the barbell respectively to avoid the middle zone, so as to counter the black swan risk with conservative strong characteristics, and gain benefits on the configuration of extreme risk.

-- Photo credit: FourweekMBA --

Taking a traditional financial allocation as an example, if an investor holds 90% of assets in cash and buys the remaining 10% of risky securities, the losses will be limited to 10% no matter what happens in the market, and the risky securities are likely to yield gains. By contrast, if investors allocate 90 per cent of their funds to "medium risk" assets, a black swan event could lead to total destruction.

Interestingly, the barbell strategy is well suited to the cryptocurrency market. It is well known that the cryptocurrency market is fairly bipolar, with cash, futures/options contracts, and crypto derivatives being high-risk investments, while at the other end of the spectrum are "fixed income" with almost zero risk, such as lending and rate arbitrage.

Positive convexity effect of finite loss + infinite gain

In a barbell strategy, the investor has a sword and a shield.

In the face of market risk, the ultra-conservative strategy at the end of the barbell strategy provides the "shield effect", which strengthens the anti-fragility effect. At the other end of the spectrum are extremely risky strategies that create positive asymmetries, which Taleb calls the "positive convexity effect" (Positive Convexity Effects).

For example, at the time of the 312 Black Swan event last year, an investor who had taken 5 percent of a long bitcoin position, either in cash or in a low-rate contract, would have made a return of about $1 billion today1400%, if the investor is writing a 2x leveraged contract, it will get2800%The reward. This is the "effect of the sword".

The sword and shield together create a positive convexity effect with limited losses but unlimited gains.

-- Image credit: ManagerToday --

Fixed income commodity introduction

As investors in traditional financial markets know, US Treasury yields are generally regarded as the risk-free interest rate in the market, which is the safest fixed income commodity. In the cryptocurrency market, there are also nearly risk-free fixed income commodities, namely borrowing and arbitrage of capital rate.

Most exchanges that offer perpetual contracts and quarterly contracts offer option arbitrage and premium arbitrage, but onlyFTX and BitfinexThere are loans available, so the following two instruments will be usedFTXExchange products as an example.

Fixed instrument: FTX loan

Lending is a special product of the cryptocurrency market. As you all know, cryptocurrencies are highly volatile in price, so during a big market, many people will be willing to borrow money at a "high interest rate" for a short period of time, but the short period may be only a few days.

If the borrower succeeds in making a profit, repayment will be easy. If the borrower ends up losing money, the exchange's margin mechanism also ensures that the lender can recover the principal and interest. Lending is thus seen as the risk-free rate of the cryptocurrency market.

Lending rates are set primarily according to market demand for funds. In the FTX, for example, the stablecoin USDT used to yield around 5% to 10% a year, but when a big market hit, borrowing rates occasionally reached 50% or more.

-- Photo credit: FTX website --

FTX lending is also easy to do, with just two steps: click on "Lending Rate" and then select the amount of cryptocurrency you want to lend. The minimum hourly interest rate and the minimum annual interest rate below can be left blank. FTX system will automatically trade at the market interest rate. In case investors fill in too high interest rate, it will not trade.

-- Image Credit: FTX --

Fixed Income Tool 2: Capital Rate Hedging

Perpetual swaps have no delivery date and the fund rate is a mechanism to balance the long and short.

When the perpetuity price is higher than the spot price, the capital rate is positive and the long holder pays an hourly fee to the short holder. This arbitrage mechanism encourages long positions to be unwound, or attracts arbitrageurs. The arbitrageurs can buy spot goods in the market, and then short with one leverage. Under the long-short balance, the arbitrageurs can collect an hourly capital rate.

FTX enthusiastic group of friends Xiaolong organized FTX historical fund rate of Google Sheet (will be listed in a later section), convenient users can refer to the annualized rate of return. The author reminds readers that some competitive coins with high annual returns have a small market value and high volatility. Therefore, in terms of earning capital rate, cryptocurrencies with large trading volume are still recommended, such as ETH (APY: 44.8%), BTC (APY: 37.4%).

Note that the biggest risk of this arbitrage is that if the price of the perpetual contract is lower than that of the spot contract, the capital rate will turn negative, and the holder of the short order will have to pay a fee instead. The FTX pays hourly rates, which other exchanges pay every eight hours. This avoids the risk that the rate will suddenly turn negative before it is paid, and is more reasonable.

How to build a barbell strategy with fixed income

According to the logic of the barbell strategy, crypto investors with low risk tolerance can be considered90/10or80/20Allocate, allocate most funds in fixed income.

For example, if an investor has $1 million in funds, it can allocate 90% of the funds to a lending strategy (900000 dollarsThe current USDT annual return rate of 10% is a little more conservative8%So the annual return of $900,000 is7.2Thousands of dollars.

The rest ($100, 000) could be put into riskier investments, such as cash or contracts. Taking bitcoin investment as an example, the yield of bitcoin in 2018, 2019 and 2020 is respectively-73%, +94%, +303%.

The chart below is a calculation of returns from 2018 to 2020 for Bitcoin-only and Lends-only investments, as well as total returns and return rates for leveraged strategies.

As you can see, a $1 million fund that was fully invested in bitcoin starting in 2019 is the best performer, and the total return rate over the three years is staggering781%.

Not surprisingly, the rate of return for lending only was the most mediocre, the three-year rate."Only 26% of the"; Instead, the return rates of "BTC + loan" and "double BTC multiple order + loan" using leverage strategy are respectively82.5%As well as214%.

Some readers are bound to ask, why not just buy all of bitcoin? The submission rate is the highest.

That's because of uncertainty about whether bitcoin is going down. Bitcoin, for example, is certainly the best performer if you look at 2019 and 2020 alone, but what about starting in 2018?

That leaves 110 per cent, a mere 30 per cent more than BTC + lending, or 10 per cent more a year, but with far more risk to pay.

In contrast, BTC + lending and 2XBTC + lending using the barbell strategy only lost -0.1% and -2.8% when they fell in 2018. In 2019, the funds can be reallocated to 90% lending and 10% BTC, and the investment rate after three years is -0.1%, +16.5% and +37.5%, respectively. Even the total performance of 2XBTC + lending (122 %) was better than All in BTC starting in 2018, but with much less risk.

There's also no way to know for sure whether bitcoin is going all the way up, or plummeting as it did in 2017 and 2018. Suppose that in 2021, Bitcoin drops by 70%. What happens to the graph above?

As you can see, in case of a black swan event in 2021 and a 70% drop in Bitcoin, the full bitcoin offer rate from 2018 is -25.7%, and this is the total offer rate for four years, which is equivalent to losing 6.4% in one year. In this way, it would be better to deposit in the bank.

Even investors who only started full bitcoin holdings in 2019 were left with a bet rate of 134%. It is only 18% above 2X BTC + lending, but the position is highly exposed.

On the contrary,If you use the barbell strategy to spread your risk, you'll only see a 0.1% and -3% drop in 2019, while the total offer rate will be around 60% and 116%, respectively, which equates to an annual offer rate of around 15% and 30%.

This is the advantage of a leveraged strategy, which can limit losses in the event of a black swan but still maintain good performance in a bull market.

Subaccounts facilitate risk management

For investors who want to manage risk well, FTX has an extra handy tool: sub-accounts.

The sub-account creation feature allows users to manage different assets separately by simply creating sub-accounts within one account.

Funds are kept separate between sub-accounts, allowing investors to separate accounts that trade equity tokens from cryptocurrency accounts, allowing them to better manage assets, control risk, and have a clearer picture of rewards.

Spot Leveraged Trading (Spot Margin Trading) allows users to borrow against a different asset as collateral against a spot.

For the above example, suppose the user buys bitcoin spot (100000 dollars), so that bitcoin is not expected to fall more than 70%, and users can lend out stables as collateral and use the money in other investments, such as Defi mining, to increase returns.

This is the advantage of spot leverage, which increases the efficiency of the user's capital. But I warn readers that there is also an interest charge for mortgaging a Bitcoin lending asset (LendingUSDSo other investments need to earn more than interest to make a profit.

In addition, it is also necessary to pay attention to risk control, spot trading,DeFiAlthough investments such as mining can get high profits, at the same time the risk is also high, if the investor does not understand the investment commodity, or the risk tolerance is low, it is not recommended to use cash leverage.

Investing is like driving a car. You don't need to be a race car driver to get there

Everyone's risk tolerance is different, and the chart above is the most conservative90/10Fixed income and bitcoin are also available for investors with a little more risk tolerance80/20Allocation, and even conservative allocation can be added to the capital rate to cash out, increase income.

By the end of 2017, bitcoin had gone from a high19891It took just eight weeks for the dollar to fall to6000The dollar, equivalent to about a drop70%Back to a year ago, when the real economy had a liquidity crisis, Bitcoin fell more than two days ago50%, ask investors can bear in a short period of time, profits are taken?

What's more, not everyone has such a high risk tolerance. Therefore, it is very important for ordinary people to allocate capital with leverage strategy and strengthen the anti-vulnerability of allocation.

The essence of barbell strategy is not to seek "profit maximization", but to strengthen anti-vulnerability, first seek to reduce the loss, and then seek to create more benefits with limited positions. When it comes to investing, a barbell strategy can create a more stable portfolio while retaining the positive convexity effect.