Shannon’s Demon: Crypto Rebalancing and Volatility Capture
Summary
The document explains Shannon’s Demon, a portfolio strategy that repeatedly rebalances between cash and a volatile asset. In a simplified random walk, the strategy can gain from price fluctuations even when the asset has no positive expected return. The article then tests a threshold-based version: it rebalances when an asset’s price doubles or halves relative to its previous rebalance level.
The Bitcoin backtest covers 899 days and records three rebalances; the strategy trails buy and hold during a strong price rise. A second test on Augur’s REP token records five rebalances over 308 days. It returns less than buy and hold, but has a smaller reported maximum loss and a slightly higher annual Sharpe ratio. These are limited historical examples, not evidence of reliable future performance. The article notes that transaction costs can undermine the approach and that results depend on volatility, price trends, and how often the portfolio rebalances.
Key ideas
- Rebalancing between cash and an asset can harvest gains from price fluctuations without relying solely on asset appreciation.
- A threshold-based version waits for the asset price to double or halve from its previous rebalance level.
- In the reported Bitcoin test, infrequent rebalancing and a strong upward trend left the strategy far behind buy and hold.
- The REP test showed lower returns than buy and hold but lower reported downside and a marginally higher Sharpe ratio.
- Transaction costs and the limited historical samples constrain the conclusions.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.