Thread by @Thyborg_

The $LUNA crash was particularly hard on #LUNAtics because many had most of their net worth on #Terra

It was also felt across the #Cosmos because $UST was a base pair on Osmosis, Sifchain & Crescent pools

A quick primer on Modern Portfolio Theory in that context 🧵

That thread was actually inspired by that honest & candid post by @larry0x, which I then saw echoed by many other smart people in the Terra community

https://twitter.com/larry0x/status/1524350056090025984

@larry0x Modern portfolio theory (MPT) is a theory on how investors can construct portfolios to maximise expected return based on a given level of market risk

It involves several useful concepts which I'll do my best to explain here without using the underlying mathematical model

@larry0x The basic premise is that b/w two portfolios that offer the same expected return, investors will prefer the less risky one

An investor should only accept increased risk if they are being compensated by higher expected returns

@larry0x Using the expected return & the variance (proxy for the risk), we can draw the efficient frontier, i.e a set of optimal portfolios in the sense of risk-return tradeoff

The portfolios below the line are not efficient because they don't provide enough return for the level of risk

@larry0x The main finding of the model is the benefit of diversification: you reduce a portfolio’s risk by simply holding a combination of assets that are not positively correlated

This is illustrated visually by the curvature of the efficient frontier line on the graph below

@larry0x Let's repeat the most important part of the model: the assets should not be positively correlated

$LUNA, $ASTRO, $MARS etc. were all very positively correlated since they were all heavily dependant on $UST maintaining its peg

@larry0x Similarly, pooling any Cosmos native assets like $ATOM, $OSMO or $SCRT with $LUNA or $UST on Osmosis created artificial correlations between the liquidity provider's assets & the success of Terra:

@larry0x Unfortunate Osmosis LPs saw the value of the OSMO-UST pool fall off a cliff as people rushed to swap $UST for $OSMO and exit their $UST positions

An emergency governance proposal was eventually passed to let them un-bond early and remove their liquidity, but the damage was done

@larry0x Although digital assets are highly correlated, you can diversify away risk in a crypto-only portfolio by adding assets from different ecosystems

In other words, you may be very bullish Cosmos but hold tokens from the Ethereum or Polkadot ecosystems for diversification purposes

@larry0x It may also be wise to avoid pairing these tokens with your Cosmos tokens in liquidity pools to avoid creating an artificial correlation through the LP token

In fact, you may not even bring these assets to Cosmos, as that in itself creates risk correlation (chain attacks etc.)

@larry0x I'm planning to cover the MPT & closely related topics (PMPT, Sharpe ratio etc.) in more details in subsequent threads

If you're interested to read about my selection criteria for adding coins & tokens to my portfolio, have a look at the thread below

https://twitter.com/Thyborg_/status/1530866549153681408

@larry0x And since I'll also be covering the entire Cosmos ecosystem through educative & digestible threads on governance, airdrops, tokens, teams & projects, you may consider retweeting & giving me a follow @Thyborg_ ✌️

https://twitter.com/Thyborg_/status/1533765663927324673