Cle4ncuts: Premium Unification Gambit Strategy (PUGS) on Mirror

Hi there fellas, Dr Clean again here. There’s been quite some changes since the last time I wrote here… Especially with me now building Y-Foundry DAO almost 24/7.

However, I still have plenty of alpha to share with you guys… and TODAY we are going to explore an interesting arb opportunity on Mirror that can potentially net you upwards of 10% in portfolio value growth in a day if executed right.

Yes, that’s right. Let’s talk about how to make money from Negative mAsset Premiums on Mirror.

The mKO Phenomenon

Last week, you may have seen a drastic change in the premium of the mKO (Synthetic Coca Cola stock) asset on Mirror Protocol. If you could chart it, it would seem obvious on that something happened on February 2, 2022.

And it was this:

One tweet that drove the sudden increase in minting of mKO on Mirror, and therefore a sharp change in the mirrored asset’s price. Meanwhile, in NASDAQ, the real life price of Coca-Cola remained more or less the same.

Why did this deviation happen? If you haven’t already read the original thread linked above, here is a summary:

• Route2FI discovered, as I had about a month before, that you could borrow aUST against mKO which had a low minimum collateral ratio of 110%, and thus have a resulting high number of aUST compared to your original amount.
• With Route2FI’s method, at 4x leverage, you would effectively be earning 80% APR a year against your initial capital.
• After publishing the thread, a lot of people decided to try it for themselves, resulting in a furious flurry of mKO minting activity.

What was the result? Within the next two days:

- an additional 1.2M was added to mKO-UST liquidity (60% increase)

- trading activity increased

- the premium of mKO fell from 0.70% to a negative of -1.2%

There was definitely demand for this type of stable-earning strategy. And 80% APR is pretty crazy. For comparison, other stable strategies on Curve, Celsius, Nexo etc. would usually pay out anywhere between 8–12% APR. Anchor on Terra pays out 20% APR, and is probably the closest alternative for Terra users.

This is a 4x leverage on Anchor, and for many the gains were too good to pass on. As we can see, more people entered the similar position in the coming days.

And as of tonight, mKO’s liquidity has already doubled from its original 2.4m to 4.7m within 10 days. Here’s the chart from Smart Stake’s Mirror Analytics, with areas of growth circled in red:

Fig 1: mKO mint positions and LPs staked from Jan 6 to Feb 13, 2022. Smart Stake mirror analytics.

But unfortunately, this also caused a dip in the market price of mKO, which went as far as -5% based on my own observations. It has since recovered to -3.47%, which may be in part due to my testing of a strategy that could potentially erase this premium back to 0.

In one of my previous articles, we discussed how Anchor-Leverage (DGSF) can be used to recover a positive premium and normalize it for the benefit of the market, helping Mirror Protocol keep assets from going above peg.

Today we will discuss how we can do the same service from the opposite direction — keeping a negative premium from going out of control.

Why does an mAsset premium become negative?

Fig 2: mKO with a negative premium

We all know that a positive premium is a result of supply and demand. Demand for a geo-agnostic, transferable, low-cost, easily collateralizable synthetic stock is high. So high that, on average, mAssets trade on a premium of 5–9% compared to their real-life counterparts.

A positive premium means that the cost of buying the mAsset on Mirror is higher than the price of the asset in real life. This discourages buyers from buying from the platform as they have to pay more to get the same equivalent amount of asset price exposure.

But what happens when the supply of an mAsset goes up in a short period of time, like with mKO? The opposite happens, and the mAsset starts trading at a negative premium instead.

This negative premium can be caused by a low demand of an mAsset, or in this case the oversupply of it. This makes it attractive for borrowers (or shorts) to close their positions by buying the mAsset at a lower-than-market price to repay their loans.

However, there is a problem here: mKO is a relatively new asset, meaning there hasn’t been that many users that are waiting to close their loans at a profit. In addition, there are a lot of new users who are minting to get into the 80% APR position.

How then can we reunite the price of mKO with its real-life counterpart market price?

How to do the PUGS

The Premium Unification Gambit Strategy, or PUGS for short, is not a yield-earning strategy. Instead, it is a moving arbitrage that allows you to help re-peg two assets at the same time, by making them pull each other out of the path of deviation.

Here’s how it works. On Mirror Protocol, the price of a collateral asset is determined by its price oracle. For assets like LUNA, aUST, the collateral value is determined by its asset price on-chain. If 1 LUNA trades at $55, the same LUNA would then be worth $55 in collateral value when deposited in a Mirror CDP (Collateralized Debt Position).

Sidebar on CDPs

CDPs are useful for people who want to take up a non-expiring short position on an mAsset (for example, you are bearish on Tesla’s price and want to short TSLA). But another useful thing that it does is create mAssets that are backed by a user’s debt: the depositor basically has an agreement via smart contract to keep a certain amount of collateral available to maintain backing of an mAsset.

This can then be enforced by smart contracts via a liquidation mechanism that sells the collateral at a discount to repay the debt keeping the protocol solvent. This is also what gives mAssets an intrinsic backing value — it is worth as much as the same proportion of liquidat-able debt on the protocol.

For mAssets however, it is slightly different. Because mAssets are backed by debt, the collateral value of an mAsset is determined by its oracle price (debt-value). Meaning, even a non-borrower can use an mAsset as collateral to borrow other mAssets at its full oracle value, regardless of its market price.

Now, understanding this principle, we can get into PUGS.

PUGS is very easy to execute. All you need to do is:

1. Have UST (e.g. $1,000).
2. Buy mAsset at negative premium (e.g. Swap $1000 for mKO at a -3% discount, end up with $1030 worth of mKO)
3. Using the negative premium mAsset as collateral, borrow/mint a different mAsset with positive premium (e.g. mTSLA, at +9.47% premium) at a reasonable LTV (e.g. 50%).
4. Sell the mAsset you borrowed/minted. (e.g. $515 of mTSLA, at 9.47% premium, you sell it for $563.77)
5. Using the UST, repeat steps 2–4 into the same position until you achieve your desired safe collateral ratio (e.g. 176%).
6. Close and repay your position whenever either mAssset or both mAsset premiums have returned partially or fully towards normal (0%).

Using this as a test a few days ago, I managed to bring the negative premium of mKO from -5% up to -3%, a range where it has remained until now.

You will notice that at no step above did I mention short farming, or staking, or getting tokens. That is because this strategy is an arbitrage, and requires 0 token yields to work. It is simply using two opposing forces to equalize each other, and performing an arbitrage across two different assets, thanks to the magic of Mirror CDPs.

Here’s a sample of my spreadsheet which I used to calculate the projected gains (Added $2,863 to my portfolio with $20,000 start capital, a 14% gain in one day):

In summary, mAssets lag behind their market price due to the unstable forces of minting/staking, usually into the positive due to yield farmers buying them to farm tokens. But now that Degen Stable Farming (DGSF) with Mirror and Anchor is a thing, premiums will go into the negative as well.

So PUGS uses this to its full advantage by using discounted mAssets as collateral to borrow mAssets with high premiums, and perform recursive looping, gaining two advantages:

• A collateral value that is worth higher than market value
• A debt value that is below market value

In that sense, for a borrower of mKO, a negative premium would represent an opportunity to repay their debt at a discount. But it is not something they would want to do if they are earning a steady 80% APR on their position, therefore their position can be opened perpetually and they would never have any compelling reason to close. Meanwhile, the price of mKO continues to spiral down as more users join them.

But with the PUGS strategy, we incentivise other users to balance out the price premium on the other direction, using it as a way to profitably arb mAssets. To exit a PUGS with profit, you will only need to do one of the following:

• Repay your mAsset debt (e.g. mTSLA) at a market price lower than the premium you sold at.
• Sell your collateral (e.g. mKO) at a market price higher than the negative premium you bought it at.

As a PUGS user, knowing that other people are minting mKO with a borrow position means that you have every opportunity to find buyers for your collateral who would pay the oracle price (debt-value) of your asset, even though you bought it at a lower price than the market.

Selling the mAsset debt (e.g. mTSLA) at a positive premium gives you more UST to work with, enabling you to buy more discounted collateral (e.g. mKO) to mint more mTSLA, repeating the cycle until both opposing forces have been balanced (0% premium). You are then free to exit the position if you choose, repaying your debt at fair market value and selling your collateral.

Risks

As always, with any DeFi interaction there are always risks. What are the main ones to consider with this particular strategy?

RISK 1 — Strategy assumes that mAssets eventually return to their fair market value (0% premium).

RISK 2 — Mirror Protocol smart contract risk, risk of exploit/component failure (oracle) etc.

RISK 3 — Subject to market risks (shorted asset price could rise sharply, collateral asset price could go down sharply).

RISK 4 — Liquidation if LTV reaches liquidation threshold due to insufficient collateral.

If this feels like a lot to wrap your head around, don’t worry. I’m sure many people are feeling the same way.

Feel free to reach out to me on Twitter at https://twitter.com/DrCle4n if you have any questions. As always, I am building Y-Foundry DAO which will give regular users access to these types of sophisticated strategies at minimal effort, and in the future you can simply deposit in one of our vaults to enjoy its benefits.

Hope you enjoyed reading this. And as always, travel safe crypto cowboy!

P.S. There may be a thread coming later from @Route2FI. Stay tuned!