Market-Neutral Strategy
A Market-Neutral Strategy (Pseudo-Delta-Neutral) is a leveraged yield farming strategy where you can yield farm high APY pairs while minimizing your risk by hedging out market exposure. The Automated Vault eliminates market risk by farming long & short positions simultaneously, and rebalancing them for you to maintain neutral exposure. Or if we put it in alpaca language: high yield and low risk.
This is achieved by opening one long position and one short position at optimal sizing to achieve zero net market exposure on the volatile asset in a token pair. As the price of the volatile asset moves, the vault automatically executed repurchasing to rebalances the positions at ideal parameters so that they maintain 0 market exposure, while you earn yields from market-making the entire time.
1.) Farming with leverage allows you to earn higher yields. However, it comes with additional risk; Mainly, liquidation risk if the market moves against your position.
- Example: If you open a 3x leveraged position on BNB-USDT (borrowing USDT), you will have a 1.5x long exposure on BNB.
2.) With the market-neutral strategy, we seek to eliminate the exposure on the volatile asset (i.e. BNB) by borrowing the right proportion of assets to hedge out the exposure on the volatile asset.
- Example: For 3x leverage, the optimal ratio is borrowing 1.5x volatile asset and 0.5x stable asset. As you can see below, with this ratio, we will end up with 1.5x of volatile asset and 1.5x of stable asset (1x from equity + 0.5x from borrowed funds.)
As you can see from the diagram above, the borrowed assets are exactly what is required to create LPs at 3x equity value. Hence, you achieve market neutral and only have 1x exposure on the equity you bring.
We are also able to achieve this setup without having to do any swaps. The total required amount of assets are first borrowed before separated into two positions as shown above.
3.) As time passes, the positions will not remain neutral due to the accumulation of compounded earnings, borrowing interest, and price movements of the volatile asset. With the automated market-neutral strategy, we allow for the positions to fluctuate within a narrow range, but once the exposure goes beyond a pre-determined threshold, the repurchasing transaction will be triggered to reset the exposure back to zero. You can read more about how repurchasing work here.
4.) In addition to the repurchase, we also have a rebalance transaction as a fail-safe mechanism that will do a swap on DEX to reset exposure to zero.
5.) One major advantage of using our Automated Vaults vs. manually performing similar strategies is that Automated Vaults running market-neutral strategies will not have liquidation risk. The Automated Vaults' positions will not have connected liquidation bots, or allow liquidation.
However, there is effectively 0 additional risk of bad debt for lenders from turning off liquidation, because due to the two positions in this strategy hedging each other, the % change in equity value is small even after a large price movement. Furthermore, rebalancing to neutral once price moves is guaranteed through our automated rebalancing bots.
- To illustrate the point above, let's take an example of the 3x leverage set up. In this case, the volatile asset's price could move 40% in either direction, and if we assume no rebalance were to happen, the equity value would only change < 7.5% (see figure below.) In reality, the rebalancing would have happened much earlier, which means the equity value change would be much smaller (mainly due to the lower swap costs and IL of rebalancing).
