Surviving Market Mayhem: Levva’s Guide to Resilient, Smarter Portfolios

Market massacre 

It's that time of the market season again when crypto is flying all over the place, with daily price swings reaching 25% in both directions. Alts are doomed. People who had leverage positions were liquidated. Newbies who bought memes or entered the market close to the end of last year are down +50% on their bags. Tough market, you might say? 

What if I told you that crypto investing can and should be much less painful than this? With little practice, help from Levva, and some systemic approach, you can avoid crashes like this, if not entirely, then probably to a degree where your personal portfolio will only show a drawdown magnitude less than what we typically see on the market. 

Common market wisdom 

Before we go on, there is some conventional crypto market wisdom we would love to share with you. If you don’t want to take our word for granted, I suggest performing all of the technical exercises described here yourself and comparing the results. 

1. Crypto is super volatile (well, duh)
2. Crypto assets are highly correlated - average correlation levels are around 0.7 - 0.8
3. The correlation between crypto assets and lending yields is low, around 0.1-0.2 on average. 

With such an exposition, classical approaches from TradFi to portfolio optimization will yield unstable results, where even slight changes in volatilities or expected returns may lead to optimization weights exploding or an optimizer allocating to a single asset. Let’s take a look: Imagine we have a simple 2-asset portfolio where one asset has 100% yearly volatility (A typical token), another has 5% yearly volatility (typical lending protocol), and their correlations are 0.2. What's an optimal portfolio that maximizes the geometric mean of this portfolio, as well as another one that maximizes the Sharpe ratio? Let’s additionally consider the following expected returns: a typical token has an expected return of 30% a year, while a typical lending position has an expected return of 5% a year.

1. Geometric Mean Optimal Portfolio:
   1. Allocates 24.70% to the high-volatility asset (token)
   2. Allocates 75.30% to the low-volatility asset (lending)
2. Sharpe Ratio Optimal Portfolio:
   1. Allocates 0.5% to the high-volatility asset
   2. Allocates 99.5% to the low-volatility asset

Key insights

1. The Sharpe ratio optimal portfolio favors the low-volatility asset almost completely because the increase in expected return (6x) doesn't compensate for the increase in volatility (20x) from a risk-adjusted return perspective.

2. The geometric mean optimal portfolio includes around a quarter of the allocation to the high volatility asset (about 10%) because:

   - The geometric mean considers both growth and risk

   - The higher expected return of the first asset contributes positively to long-term growth

   - The optimal portfolio finds a balance where the additional expected return justifies the increased volatility

These 2 examples demonstrate how different optimization objectives lead to very different portfolio allocations, particularly when there are large differences in the risk-return characteristics of the assets. The geometric mean optimal portfolio takes on more risk to achieve higher long-term growth, while the Sharpe ratio optimal portfolio maintains a very conservative allocation to maximize risk-adjusted returns.

Now, does it mean that we have to be almost entirely invested in Lending in DeFi and forgo the market opportunity completely? Absolutely not!

Clever approach to managing personal funds in crypto

Given everything that we’ve just said above, what's an optimal strategy for one that doesn’t want to do shit and still sleeps like a baby without nightmares about their portfolio getting hammered? Simple:

• keep most of your assets in lending protocols (Aave, Morpho, Maple, etc..). 
• keep up to 25% of your portfolio in tokens (ETH or BTC). 
• get exposure to LSTs like wstETH and eBTC to earn additional yields on your tokens.  
• If you think you can time the market and cherry-pick assets, you can switch ETH and BTC in your portfolio to the asset of your preference. But please remember, most likely, you are not that good at forecasting, so stick to something simple and liquid.

Can we do better? You bet we can! We can vary token allocation (e.g., scale the token position between %0 and 25% allocation) based on momentum strategies and price action.

For example, a simple 30-day rolling max/min indicator showed that I need to be 0% in ETH as early as ~20 Dec 2024. 0% in ETH can be achieved by selling a perp on ETH with wstETH as collateral. With such an approach, not only do we cut our losses in situations like the current one on the market, but we also leave room for some growth when everything is mooning. 

Final thoughts

Essentially, Levva is here to provide you with the type of strategies and market insights we’ve described in this post. Put your stablecoins into the Levva vault and let the intelligent investment system do the rest! As a result, when the market hits really bad, like over the past weekend, you will end up with drawdowns of around 2-3% on your portfolio while everyone else will be sitting +%50 underwater.