Crypto barbell strategy: the very basics

The Barbell strategy is supported by Nassim Taleb. Here’s how it works and how it might be applied to crypto.

• Nassim Taleb argues that we can’t accurately predict trading risk, and more data actually leads to worse trades.

• Building on this, his barbell method implies allocating a large part of one’s portfolio to low-risk assets, a small portion to high-risk assets, and none to medium-risk assets.

• This approach can make sense for crypto, but it comes with nuances.

His basic conclusion is that we have no idea what we’re doing. In his opinion, we’re finding patterns where there aren’t any. We’re making predictions based on false assumptions. We’re trying to understand things that can’t be understood, and we’re trying to control things that can’t be controlled.

Taleb further concludes that the harder we try, the worse we do. We think that if we push ourselves harder, read more, consume more data, more data, more data, we can get on top of the data, master it, understand it, predict it, and make money from it. Wrong.

Instead, Taleb proposes that our strategy for trading (along with everything else) should be antifragile.

Taleb says that “antifragile” is the opposite of “fragile.” But most of us think the opposite of fragile is “strong.” If something is fragile, it breaks easily. So the opposite of fragile should be something that doesn’t break easily, right? Not to Taleb.

Muscles work this way. When you exercise, you break your muscles down, and they grow back stronger.

Forests work this way. When a forest fire breaks out, it clears old growth, makes space for new growth, and the whole forest gets stronger.

Markets also work this way. When businesses enter the marketplace, some fail, others succeed, and the whole market gets stronger.

Of course, this only works if the injury isn’t so destructive that the antifragile thing dies. A moderate forest fire is good for the forest, but only if there are enough trees left to keep growing afterward.

Taleb proposes that you can build this idea into your portfolio by using the barbell strategy.

Taleb has two central tenets of trading:

1. Our market predictions are bad, and analyzing data makes them worse, so we have no idea what’s going to happen.

2. We want to be antifragile, so when volatility hits the market, we not only survive it but profit from it.

The barbell strategy, Taleb argues, can serve both of these needs if we sort every potential trade according to its risk level:

• Low. Traders often consider cash and U.S. government bonds to be low-risk.

• Medium. They often see mutual funds like the Vanguard 500 to be medium-risk.

• High. Crypto, options, startups, and high-growth tech stocks are usually seen as high-risk.

Next, the barbell implies stockpiling assets usually seen as low-risk, such as cash. Taleb’s reasoning is that because we can’t accurately measure risk, we need to assume that we could lose everything we invest. That’s why he recommends acquiring enough low-risk assets to survive, no matter what happens.

Finally, the barbell strategy implies pursuing aggressive, high-risk trades — with a small portion of one’s portfolio. These are asymmetrical opportunities because if our trade craters, our maximum loss is limited to that small allocation. If a favorable wave comes in, on the other hand, we could catch it and maximize our profits.

When it’s set up, a barbell portfolio looks like this —

Taleb summarizes it this way:

Where could crypto fit into this mix?

Now, trading in crypto comes with much higher risk — but also with more upside. Faced with the choice of allocating a portion of one’s portfolio either in an S&P 500 fund or in crypto, the barbell strategy would suggest acquiring a small crypto position, and staying away from the S&P 500 fund. But that’s not the end of the story: there’s a barbell within the barbell.

Who knows what the next wave will look like?

Surf’s up.