Willing to pay for volatility is not accepting losses, but taking back the pricing power.

Written by: Huang Shiliang

Anyone who has invested has probably secretly calculated how much money they can make.

At a glance, if I made 10% this month, I open the calculator, multiply by 12, then compound it, pull up an Excel sheet, extend it to the third year, and the number gets so big that I can't help but be pleased. At this rate, financial freedom is right around the corner next year.

When making contracts, I've calculated, and even more so during arbitrage. The strategy has been running for half a year, with positive results every month, and the net value curve looks great; just extending the curve to the right reveals financial freedom.

I've damn well calculated this too many times. But never once have I truly lived to the end of the timeline of that curve. After making so many mistakes, I reflect: where did I go wrong?

Looking back, my biggest mistake was that I only calculated income, never expenses. Expenses aren't just gas fees or wear and tear; those are too simple. What I actually overlooked is: what if these twelve months calculated don't go according to the way I agreed upon? This thing is called volatility; more colloquially, it's called unexpected events, but using "volatility" has a more academic flavor.

When pulling up that Excel sheet, those who multiply by twelve assume that there is no volatility line.

Unfortunately, it's not zero. It just doesn't get collected monthly. It accumulates and is taken all at once in a specific month.

It's not just about currency. Losing a job means collecting three years' worth of savings in one month. When illness strikes, a single bill can take away ten years. If a car accident happens, in one afternoon, what gets taken away may not just be money but also life. None of this is in the income calculator, but they will all come; it's just a matter of when.

In the realm of cryptocurrency, the special thing about paying for volatility is that it collects the fastest and the most frequently. In other fields, you might encounter two or three instances in a lifetime; in cryptocurrency, you can face it three times a year.

Having faced liquidation, experienced illness, and encountered danger, the older I get, the more I realize that volatility is something everyone must face. No one can escape paying for volatility.

What is Volatility

The term volatility is a bit academic and pretentious, but it must be clarified first because it's more specific than "risk".

Volatility isn't necessarily a bad thing.

Our expectations for the future are often projected linearly from the present, with an added optimistic coefficient. But the real world is not linear.

Cryptocurrency prices aren't. Stock prices aren't. Real estate prices aren't. Company revenues aren't—our monthly salary appears linear because companies bear the risk; when they can't handle it anymore, they cut jobs, and then a major volatility hits.

Berkshire Hathaway's experience is the most convincing. In March 2020, on a day when U.S. stocks experienced a circuit breaker with the Dow Jones dropping over 2,000 points, Buffett was interviewed the next day and said: I mentioned many years ago that as long as you stay in the market long enough, you can see everything. In the next ten days, U.S. stocks experienced another three circuit breakers. It’s truly surreal.

Volatility has two sides. The upward side is called profit, and the downward side is called loss. Two names, one event. To take the upward side, you must endure the downward side; no one can only buy one half. Thus, volatility itself is not bad; it is the source of all profits. It only makes one request of you: that when it falls, you are still in, meaning you don't have to sell when it drops.

The reason our lives are relatively stable is often because someone or some mechanism flattens the volatility that already exists. Companies flatten our monthly salary, insurance companies flatten accidents, and the government flattens public safety.

However, flattening volatility costs money.

How to pay for the inevitable volatility—I have truly experienced this.

My Bills Paid for Volatility

In the early years of working at a company, social security was paid by the company. I never thought about it; there was a line on my pay stub, and if it was deducted, it was deducted.

When I left the workforce, I found ways to withdraw my housing fund and medical insurance as much as possible.

After leaving the company and becoming unemployed, I stopped my social security. It was stopped for many years. Looking back on how I acted over twenty years ago, I was truly crazy, completely ignoring future risks.

Over ten years ago, I really didn’t buy any insurance, not even cash reserves. No critical illness insurance, no savings, not a dollar just sitting around. All my money was damn spent buying Bitcoin and stocks, the most volatile things in the capital market. I only had enough money for a few days' meals.

Looking back now, those years, I didn’t not pay for volatility. I just stopped all potential upfront payments, leaving only one way to pay: wait until the risk hits and pay it all at once.

Fortunately, life risks truly didn't come. Financial volatility, however, came several times, and I didn’t pay a single dime in advance. The costs paid afterward did not decrease: how many times I had to sell off assets that should have been held long-term at low prices just to eat.

After the market surged in 2017, I renewed my social security, paying the minimum tier. In the subsequent rounds of hard times, I learned to keep cash— not much, just enough for that month, so I wouldn’t have to sell coins at a low price. After earning money, I completed my social security payments and also bought critical illness insurance.

After 2020, I joined the DeFi army. At first, I didn’t know what hedging was; I didn’t even know about insurance. After experiencing “512” and “312”, I finally understood: if I didn’t buy hedging, no matter how much I earned, it wouldn’t count; the next wave of volatility would come to take it away. Then I learned to buy hedges and options.

From not paying anything to paying the minimum to paying fully, I have walked this path for almost ten years. Each step wasn’t thought out; it was only after being hit once that I began to pay.

Three Ways to Pay for Volatility

This is something I've truly understood after more than ten years: no one can escape paying for volatility. The difference lies in whether you pay upfront or afterward.

The first method is to pay upfront. Small amounts, set the price yourself. Insurance is one such method, annual health check-ups are another, holding non-interest cash is a form, and borrowing less money also falls here. The commonality is: you pay before the risk occurs, you know how much you're paying, you can calculate it, and it is proactive.

The second method is paying afterward. Large amounts, prices determined by impact. Being forced to sell at a low point falls here, borrowing high-interest money after losing a job, borrowing money for medical treatment during illness, and using leverage without protection, getting liquidated during a drop. This kind of pain, I’m sure many friends understand. The commonality is: you pay at the moment the risk occurs, how much you pay is not up to you, and you are passive.

The third method is having someone else pay for you. Relatives, friends, or the government. But typically, this is more expensive than paying upfront yourself; the repayment afterward will be much higher than the initial cost.

There is no fourth method. Those who do not pay do not exist. You might think you haven’t paid; it’s just that the day hasn’t come yet, or when it comes, someone else pays for you.

I have actually gone through all three methods. The third method seems to be absent—thinking back, what my parents paid for me when I was young does count.

Why Paying Upfront is Right

Investors usually think the same when they are young: every dollar must be placed in the place with the highest return; when empty, they will borrow more money to invest. The things paid for upfront—insurance, cash, hedges—are seen as losses in our eyes.

By expected value, they are indeed losses. Insurance companies need to profit, and the premiums you pay must be more than the average amount they pay out. Cash sitting idle earns nothing, and considering inflation, it shrinks every year. Protection positions bought in quantitative strategies are destined to incur losses over time.

Some upfront payments don’t require advice. An annual health check for a few hundred yuan; once diagnosed with late-stage cancer, hundreds of thousands may not even help. Everyone can calculate this: paying in advance for health check-ups is cheaper in total, so of course, one pays. The difficult part lies in the other types: paying upfront makes the total cost higher.

If the total cost is higher, why pay upfront at all? Three reasons, none of which I invented, but are already widely accepted.

First Reason: Diminishing Marginal Utility

Paying for volatility has a feature: it picks the moment you are the thinnest to collect. The day cryptocurrency crashes is your thinnest day; the month you lose your job is the month your income goes to zero. Every penny you pay afterward is the heaviest at that moment. Paying upfront moves that money to when you’re still thick, breaking it into smaller payments. The total may be higher, but each part is lighter. The same ten thousand yuan, paid in ten installments when you have money, and paid at once when you have none, differ greatly in pain.

This is why when you have the money, you should buy insurance, when your quantitative net worth is rising, you should buy hedges, when you’re healthy, you should go to the gym, and when you have a job, you should study hard.

Second Reason: Kelly Criterion

The famous Kelly Criterion: you know the winning probability and odds, how much to bet each time to maximize returns over the long term? For the specific formula, you can ask AI, but the answer has a clear feature: the bet is always less than the total. Moreover, the greater the volatility, the smaller this ratio.

The reasoning is not complex: volatility means there is always a drop at some point. Those who bet everything will be wiped out when that drop occurs, and any subsequent gain will no longer concern them. Betting a thousand yuan and betting ten million yuan are the same mistake, regardless of how much the principal is. That portion of money not bet is the money you paid upfront for volatility. It's not cowardice; it's the calculated optimal solution.

Third Reason: Scarcity and Leisure

In 2013, two economists published a book called "Scarcity." They discovered that people who are financially tight make poorer decisions, not because they are stupid but because their attention is entirely consumed by the next due date.

When volatility strikes, it's precisely when you need your wits most — to sell or not, to borrow or not, to wait or not. Those without leisure have only one thought: where will next week’s money come from? They are not making decisions; they are reacting. Only those with leisure truly have the option to choose. The three months of living expenses set aside means you are not only ensuring you won’t go hungry for those three months, but that during those three months, you can still think normally.

These three reasons address one thing: the money paid upfront might be considered a loss by expected value, but by marginal utility, long-term reasoning, and cognitive clarity, it is profit.

How to Pay Upfront

Volatility is certain to come, so pay upfront. There are four methods, and I have used all four.

Reserves. Keep a sum in cash that isn't invested or earning interest, enough to last you through the month. What you pay is the potential earnings and the loss to inflation of that money. What you gain is: when that month comes, you don’t have to sell or borrow. This is the cheapest form, and also the one most people do not pay, because it seems like nothing has been done.

Insurance. Social security, critical illness, vehicle insurance. A million people each contribute a bit, and when someone has an accident, that’s who gets paid. What you pay is the premium, which is more than what you receive on average, and insurance companies rely on this difference to survive. What you gain is: the kinds of bills that arrive and could be hundreds of thousands that you cannot save on your own.

Hedging. Create a position, then buy a contrarian protection, such as holding currency and buying a put option. What you pay is the option fee, which most of the time expires worthless. What you gain is: when the currency drops below your margin, the option compensates you; you don’t have to sell at a low point.

Diversification. Not putting all your money into one entity. What you pay is an opportunity cost—you have given up the chance of hitting the best one to obtain an average of several investments. What you gain is: even if any one goes to zero, you won't follow suit. "Always less than total," as described in the Kelly Criterion, practically translates to this.

All four payments are for the same sum of money, just in different forms. By expected value, all four are losses. But when that month comes, those who have paid upfront have options, while those who haven’t do not. That’s where the difference lies.

Pricing Power

Returning to my own accounts.

Those years, I sold cryptocurrency at the lows; the money was what I paid, and the price was not set by me.

Now, I pay upfront. Insurance, hedges, cash that has not been moved for three years. By expected value, all these are losses. I continue to pay.

Willing to pay for volatility is not to accept losses, but to take back the pricing power.

Correspondingly, most people should be willing to pay for volatility; collecting money by selling volatility is a good business.