Understanding The Crypto Volatility Index (CVI): How to trade volatility using CVOL tokens
Including example calculations for the funding fee and rebasing mechanics in practice
This guide specifically refers to usage of the newest CVI V3 on Arbitrum.
This article is intended as part of a multi-part series that will continue to be released shortly. This part explains all the fees, risks and benefits involved with trading CVOL, and subsequent parts will discuss the Theta Vault, GOVI staking and tokenomics and CVI ecosystem as a whole.
So you understand what volatility and the CVI are, and have decided you’d like to try making your first trade using crypto volatility tokens (CVOL), whose price track the Crypto Volatility Index.
Understanding at first how every nuance of the whole CVI ecosystem works can feel a little overwhelming. But fear not, if you simply want to take a long position on the CVI, you can completely ignore everything about the how the Theta Vault, staking and GOVI work.
You need only understand:
- How you can buy and sell CVOL, and any fees and time-based restrictions involved.
2. The time based cost (theta decay) of holding CVOL tokens.
Other than that, rest easy in the knowledge that any trade you make, no matter how profitable, is fully backed by liquidity inside the Theta Vault and is always redeemable. This is not like trading on a CEX where your positions might be closed out early if they are too profitable, or they declare they are suddenly bankrupt and unable to honour withdrawals!
Buying and Selling CVOL
There are currently two ways you buy and sell CVOL, both with their own advantages and disadvantages depending on your strategy and desired transaction size:
- Directly on the CVI platform (minting and burning).
- Through the SushiSwap CVOL-USDC DEX pool (buying and selling).
Firstly, you can buy or sell via directly creating and redeeming CVOL (termed “minting” and “burning”) directly through the CVI AMM platform at https://cvi.finance/ on the“Volatility Tokens” page:
Minting and burning CVOL in exchange for USDC directly through the CVI AMM induces no price slippage, but bears a standard time to fulfilment of 60 minutes, which can be expedited to 60-20 minutes for an additional 0–1% fee.
There is also a 0.3% minting fee and 0.1% keeper’s fee (capped at a modest $0.1) for a total of 0.3%-1.3% + up to $0.1 depending on the expedition amount and order size (max keeper fee is reached at order sizes >$100).
Burning is subject to exactly the same fees, minimum time to fulfilment and expedition options, which makes a round mint-burn tip cost 0.6%-2.6% + up to $0.2, depending on how quickly you want it completed and order size.
You can also buy and sell CVOL on the SushiSwap DEX:
Here you’ll pay normal DEX fees (which are currently 0.3% per trade on SushiSwap) so 0.6% for buying and later selling combined, and gas fees for the transaction, which are very low on Arbitrum currently (fractions of a dollar).
Your trades will execute (almost) immediately, but are subject to the usual price slippage of trading in a liquidity pool, which can be quite significant for even medium sized trades depending on liquidity in the pool (several % or more).
In short, small purchases are probably almost always better made on a DEX as they will execute faster and incur barely any price slippage, but big transactions will usually benefit from direct minting/burning to avoid price slippage, unless for some reason you really think the CVI will change very sharply before your order can fulfil, in which case it might be better to use a DEX anyway.
CVOL funding fee
The most important thing to understand about holding CVOL is you pay a continuous time based tax for holding it.
This is called the “funding fee” and is necessary otherwise you could just buy CVOL at some given CVI level <200 (the max value of the 0–200 CVI range) and wait for for the almost certain eventuality that sometime in the future the CVI is higher than it currently is, and sell in profit.
Since this would obviously be too easy (and who would be willing to provide the counterparty liquidity to pay your eventual profits- remember, trading is effectively a zero sum game- for every $ someone wins, someone else has to lose the same amount) there has to be a cost for “sitting and waiting” holding CVOL waiting for the CVI to rise.
This funding fee is paid to liquidity providers inside the Theta Vault who are the counterparty to your trades and will pay you your profit if you trade successfully.
This is necessary to make the game balanced between traders and liquidity providers, forcing you to have to be correct about the CVI value spiking “soon”, or else the funding fees you pay overtime will probably exceed any profit you make selling CVOL higher per unit in the future.
The funding fee is quoted as an hourly figure and its’ magnitude depends on:
- The current CVI value
and potentially
2. The current collateral ratio (not an activated mechanic yet)
The relationship between the CVI value and the funding fee is described by the following curve:
The funding fee increases as the CVI value goes lower and decreases as the CVI rises, which basically just compensates for the fact that volatility is more likely to mean revert upwards to a more average level if it is temporarily really low, and more likely to mean revert downwards to an average level if it is really high.
Since you make money on CVOL if the CVI rises, it needs to be more expensive to hold if its more likely to rise, and cheaper if its more likely to fall, to calibrate risk-reward fairness for traders vs liquidity providers along all points of the CVI curve.
The current funding fee range is 0.008333% to 0.333333% per hour, reaching its maximum and minimum at CVI=50 and CVI=150 respectively.
That said, the curve is calibrated on historic data for the CVI, so is subject to being recalculated over time if CVI behaviour patterns begin to change.
Such a re-calibration actually recently just happened, where the team significantly lowered the funding fee for the lower end of the CVI range, off-set by a slight increase in the more active range. This was a reaction to historic and sustained all time lows in volatility making the funding fee unattractive and the system too heavily skewed in favour of liquidity providers.
How the funding fee is paid/rebasing mechanic
This is probably the part that most confuses people, and its mechanism changes slightly depending on whether the timeframe you hold CVOL is within a single daily cycle or across multiple daily cycles.
First of all, its important to understand you CANNOT AVOID PAYING the funding fee in some way or another.
The funding fee is effectively enforced as so:
- Within a 24-hour cycle, the CVI value and CVI AMM platform CVOL price begin perfectly matched with each other. As time passes, the CVOL platform price begins to drop compared to the actual CVI value as an exact function of the accumulated hourly % funding fees.
- After 24 hours, at midnight UTC, a global rebasing occurs. Your wallet CVOL balance adjusts downwards by a % equal to the total day’s effective funding fee.
- The CVI platform CVOL price is reset (rising upwards) back to match the actual CVI value, and the cycle repeats.
Why does this work? Because within a daily cycle whilst you have not actually yet lost any CVOL tokens to rebasing, the price you can fetch for them when selling has been effectively lowered by the total funding fee for that day compared to when you bought/minted because the CVI platform price is this amount lower than the actual CVI value.
You might ask, what’s to stop me selling my CVOL for the real CVI value that presumably exists on a DEX?
And the answer would be, the trading value on DEXes should also lower throughout the day compared to the actual CVI value to stay pegged with the CVI platform price. Why? Because any discrepancy between these values incentivises arbitrageurs in the normal way to step in and mint and sell or buy and burn CVOL to extract personal profit whilst closing the price gap.
Obviously, the value of a CVOL couldn’t endlessly drop against the real CVI value or else it would lose effective meaning, which is why there is a neat, programmatically efficient once a day rebase that taxes everyone’s wallets by the funding fee accumulated for the whole day (it does this by rebasing the total amount of CVOL tokens downwards- CVOL supply is elastically adjustable using the same ElasticToken interface pioneered by the Ampleforth project in 2020). The CVI platform CVOL price is then reset back to the actual CVI value.
You might think there are advantages/disadvantages in trying to “game” the system by minting/burning at specific times, but you’d be wrong.
For instance it might be tempting to think its especially bad to mint CVOL just before the midnight UTC rebase, as straight after if say the total funding fee for the day was 5%, you’d immediately lose 5% of your CVOL to the rebase. This is however incorrect reasoning, as in reality you are getting to mint CVOL ~5% cheaper than the actual CVI value just before the rebase, so even though you then immediately lose ~5% of your tokens to the subsequent rebase, you can then immediately sell them for ~(100/95)% more after the rebase as the platform price adjusts back upwards to the real CVI value, effectively cancelling out the loss in amount of CVOL owned.
By similar logic in the reverse scenario, no material advantage is gained by minting just after a rebase.
Example calculations for the funding fee/rebasing mechanic in practice
It can sometimes be easier to digest a concept with specific numbers, so lets run a concrete example to get a clearer picture of exactly what’s going on.
Let’s assume a hypothetical scenario where:
- The daily rebase at midnight UTC has just occurred, so its the start of a fresh day in terms of the daily cycle, and
- The CVI=50
- The funding fee is 0.2%/hour
- You’ve just minted or bought 100 CVOL
Then, at the start of the daily cycle, the CVI=50 and the CVI platform price for CVOL also =50.
Lets assume for simplicity the real CVI value stays static for the whole 24 hours (unlikely I know) and thus the funding fee also stays constant at 0.2%/hour.
Then,
- After 1 hour, the CVI still = 50, and the CVI platform price has lowered to 50* 0.998 = 49.9 to account for the 0.2% funding fee.
- After 2 hours, the CVI still =50, and the CVI platform price has lowered to 50 * 0.998² = 49.8002 (equivalent to 49.9* 0.998) to account for 2 hours of a 0.2% funding fee.
- After 10 hours, the CVI still=50, and the CVI platform price has lowered to 50* 0.998¹⁰ = 49.009 to account for 10 hours of a 0.2% funding fee.
- In general after X hours, with 0< X<24, the CVI is still 50, and the CVI platform price has lowered to 50*(1-funding fee%)^X.
Say you want to sell after 10 hours.
Then the platform will only pay you 49.009 per unit of CVOL when you bought for 50, and the price on the DEX should be no better because its incentivised to be almost the same via arbitration. Therefore, the funding fee has effectively been enforced.
Say instead you want to sell after 30 hours.
Then since this period crosses over at least 1 daily rebase cycle, part of the funding fee will effectively have been enforced via rebasing, and part by intra-day price slip on the CVI platform CVOL price vs real CVI value.
Firstly, you need to work out how much you’ll lose to rebasing for the first 24 hours funding fee.
That is given by 0.998²⁴ = 0.953 (3 sf), so the price on the CVI platform will show 50*0.953 = 47.65 just before rebasing.
Your 100 CVOL will be rebased to 100*0.953 = 95.3 CVOL just after the 24 hours.
You can check this makes sense because selling your 100 CVOL for 47.65 per unit = $4765 and selling 95.3 CVOL for 50 per unit also = $4765, so it indeed makes no difference whether you sell just before or after the rebase.
Now for the remaining 30–24 = 6 hours, you simply incur price slippage on the peg again: 50*0.998⁶ = 49.40.
So you paid your funding fee for the first 24 hours by losing 4.7 CVOL to rebasing, and you paid your funding fee for the remaining 6 hours by being able to sell your remaining CVOL for less.
So in total if you bought 100 CVOL at 50 per unit ($5000), held for 30 hours at a 0.2%/hour funding fee, and then sold, you’d only be able to sell 95.3 CVOL at 49.4/unit = $4707.82.
Now 4707.82/5000 = 0.942 (3 sf) (a 5.8% loss) which you can see is exactly equivalent to having simply had the CVI platform price slip for 30 hours without resetting:
50* 0.998³⁰= 47.085, therefore selling your 100 CVOL at 47.085/unit = $4708.50. The tiny difference just comes from small compounding errors in the rounding in these calculations.
So you can see that this daily rebase + intra day price slip allows the funding fee to be collected continuously, whilst keeping the CVOL value no more than a day’s funding fee error out from the real CVI value, keeping a good and intuitive UI for user experience.
Of course, when buying CVOL we do hope that the CVI will rise, so that we might make a profit by selling CVOL sufficiently higher that even after funding fees we still make a net profit- no one in their right mind would (or at least should) buy CVOL if they simply expected the CVI to remain static!
And so with that, hopefully you feel equipped with the knowledge of how to trade CVOL and the fees and risks involved.
Stay tuned and follow/subscribe for the next instalment in the series which will cover everything you need to know about generating yield and the risks involved with the Theta Vault!
