10 days left to use this Algorand DeFi Strategy

Summary

• The governance arbitrage strategy can be used to gain an extra boost in your stable rewards
• It relies on Governance rewards and AlgoFi Vaults
• You can only enter in the governance registration period (within the 10 days from the time of writing for Gov round #4)
• You can only exit after the governance period completes, otherwise you make less money than the basic strategy.

I generally prefer to talk more about underlying tech and how things work and less about finance strategies but I saw this interesting opportunity and thought it would be a great exploration about the unique mechanics of Algorand governance and how it affects trading strategies.

Below I talk about a strategy that leverages the governance participation rewards and AlgoFi’s Vaults and DeFi Suite to significantly augment your returns with minimal risk.

Let’s start with a recap of the basic parts

Algorand Governance

The Algorand foundation is the non-profit arm of the Algorand core community tasked with encouraging the development and decentralization of the Algorand blockchain.

This is the mission statement from their website:

The Algorand Foundation’s mission is to enable an inclusive, decentralized, and borderless global economy — at scale — based on the Algorand blockchain technology.

Besides communications and documentations, one way they accomplish their goals is through grants and rewards.

The Aeneas program as well as other grants offer financial incentives to encourage community participation and building on the network and serve an obvious benefit to the community.

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They also provide similar incentives to community governance. Community governance from Algorand stakeholders is a key component for the foundation to work their way towards further decentralization. Thus, the foundation has set up governance registration, voting functionality to allow any algorand wallet to vote. More importantly to this article, the foundation sets aside a pool of ALGO tokens to be distributed to governance participants.

Governance works as follows:

1- Every quarter, there’s a governance registration period. Within that period, any wallet can register, but that wallet needs to stake whatever amount of ALGO they desire into governance

• The staked amount can be withdrawn at any time, but if you do you become ineligible for the governance rewards you would have gained for the period
• Be careful not to convert the money into other tokens such as DeFi tokens or withdraw the money.

2 - There will be votes announced in which you must participate. So far it’s only been one item to vote on but it could theoretically expand in the future.

• Generally there’s a lot of documentation and discussions on reddit/discord on the merits of each option. The foundation also provides a recommendation and an easy way to “vote for those recommendations”
  (N.B., although the foundation can recommend, they do not have a vote)
• If you do not participate in the vote, you become ineligible for the governance rewards you would have gained for the period.

3 - Finally, you wait until after the governance period is over before you can withdraw your rewards

• Even though the voting period ends well before the end of the governance period, be careful not to take your money out of the wallet. I myself made my account ineligible and lost out on some rewards for making that mistake.

Long story short, if you’re a longer term ALGO HODLer, this provides a risk-free, low-effort way to make decent returns.

Pro Tip: Because eligibility is ALL or NONE for any given wallet, a good strategy is to separate your funds into multiple wallets so that if you need some emergency liquidity, you can make one wallet ineligible without preventing the other wallets from gaining returns. you have to do more transactions for registering and voting, but the negligible fees on the Algorand network make this a very worthwhile strategy to get a lot more flexibility

A sharp reader would notice that staking your ALGO would have the opportunity cost of not being able to use that ALGO in DeFi staking and pools. Indeed, you participate in governance directly, this is the case.

But what if I told you there was a way you stake your algo in governance, but also use those Algo tokens in DeFi…

You can do this with AlgoFi.

Enter AlgoFi: a one-stop-shop for DeFi on Algorand

AlgoFi is a DeFi protocol on the algorand network that offers several core components necessary for decentralized finance. This includes:

• Lending and overcollateralized borrowing functionality
• A stablecoin (STBL) pegged to USD
• A standard Decentralized exchange (DEX) like uniswap or tinyman
• Nano-Swap: a curve-style low-fee/low-slippage DEX for stables

Recently, a new feature was introduced called Vaults.

This feature opens up the option both to stake your ALGO into governance and use it in DeFi!

Through the vaults smart contract, you can stake into governance, vote and claim rewards, just like staking into governance directly. However, unlike the direct participation, your stake counts as collateral from which you can borrow. Vaulting your Algo opens up the door to borrowing off it of and participating in DeFi.

Furthermore, if you borrow Algo based on your vault you get one particularly unique benefit, price fluctuations would not have any impact on your collateralization ratio… In other words, you don’t have the risk of being liquidated.

Now that we know the core components, let’s dive into the strategy!

The Governance Arbitrage Strategy

The strategy will give you larger returns than just providing stable liquidity but at the same time, not expose you to the price fluctuations of the Algo token. It involves the following steps:

1. Bring USDC and lend it on AlgoFi
   Starting with USDC will remove any exposure to price fluctuations on the Algo tokens. If you want exposure, then you should skip step 1 & 2. This should give you a bit of interest and algo reward on the USDC as well.
2. Borrow Algo
   You need to do this to get Algo to stake, however, because you are not trading it for anything, you will be receive and return the same amount of Algo tokens you borrowed. Thus, you’ll never be exposed to risks (or benefits) due to price changes.
   Note: you will be charged interest for this, but the staking rewards should cancel it out and leave you with a surplus.
3. Supply the Algo to the governance vault
   Throwing the borrowed Algo in the vault, all the Algo we borrowed will now be generating rewards for us. However, it will also be providing collateral. This means that the Algo we borrowed will not count against the collateral! We are also not subject to the price of Algo tokens because the collateral vaulted Algo and the borrowed Algo will go up and down by the same amount.
4. Borrow STBL and/or USDC
   At this point you should borrow some stables. Right now it seems STBL and USDC are around the same price. I think that there will be some price fluctuations but they’ll return to the same price by borrowing a bit of both you can take advantage of minor price fluctuations between the two. If you want to just play it safe or if you don’t trust STBL, you can always play around with USDT instead of STBL.
5. Provide and stake liquidity in the STBL/USDC nanoswap pool
   I trust STBL and USDC will keep it’s peg but this can be replaced with USDT if it’s more reasonable to you.
6. Remember to Vote and hold through the end of the governance period
   This is crucial. If you become ineligible, instead of running up a surplus, you would have to pay for borrowing Algo. Make sure you participate in governance, or this strategy will not outperform just borrowing and LPing directly.

In essence, the strategy above allows you to gain the difference between borrowing interest and governance rewards for free. The only thing you have to do is make sure that you hold your position for the entire period, and that you remember to vote.

Let’s see how this strategy plays out!

Let’s assume that I have $20,000 to work with. This is how I mildly conservatively expect it to play out for Governance period #4:

Basic LP Strategy:
- Just lend and borrow, used the borrowed collateral to provide LP

Governance Arbitrage Strategy:

Looking at the results, you can see that essentially:

You’re getting $200 free for essentially just clicking the vote button.

Note: Both strategies make assumptions:

• Borrowing / Lending rates fluctuate a bit
• We won’t know the final Governance vault rate until we know how many total Algo tokens are staked in governance. 9% does seem like a conservative estimate though
• We’re assuming for simplicity that STBL/USDC hold similar value and that prices hold stable for ALGO.
  … If the price of Algo goes up, the benefit from the second strategy will be greater and if it goes down the benefit will be less.
• Assume that transaction and conversion fees to enter into LP is negligible.

Assessing Risks

• Becoming ineligible for governance

If you do things like forget to vote or withdraw early. You don’t get any governance rewards. Thus, there will be nothing to cancel out the interest paid to borrow Algo tokens and you would have to cover that from your LP profits.

This also means that the strategy only works if you lock into it for the whole quarter. If you exit the strategy early, you become ineligible.

• Assumptions are wrong

At the end of the previous section I mentioned some of the assumptions I made for simplicity or because I thought they were safe bets. I think these assumptions are valid but it is possible that they do not hold

If Algo Borrow rate goes above the governance reward rate, then this strategy becomes invalid. It is extremely unlikely for this to occur but is possible. The risk can be mitigated by monitoring. With proper monitoring, you can then make a decision to either hope thing will stabilize in your favor or exit the strategy and lose the governance reward interest.

• Exploit in the Vault and/or AlgoFi smart contracts

Since the governance tokens are in the vault smart contracts, it is possible that an exploit could be found and the tokens can get compromised. This is a general risk with participating in DeFi in general and I do think that AlgoFi is generally trustworthy and supported by the Algorand foundation so I expect this to be a digestible risk for anyone participating in DeFi in Algorand.

• Trusting AlgoFi

Alongside smart-contract risk, it is not clear if AlgoFi could arbitrarily change vault collateral weightings or other parameters in the lending protocols that could accidentally or purposely lock funds or force a liquidation.

This is a trade-off that I think is relatively low risk as per state in the previous risk but it should be considered. Especially, in the era where large (albeit significantly more opaque and centralized) entities in crypto the finance eco-system are disabling withdrawals and performing other sketchy antics.

• STBL (or USDC) De-peg

STBL is a pretty new and relatively untested stablecoin. It is overcollateralized on solid crypto assets AFAIK so this makes it less risky than an algorithmic stablecoin but it is definitely still not as battle-tested as USDC/DAI/USDT.

If there’s a de-peg, and you borrowed the coin that was not depegged, then you will have to find a way to pay the difference to pay back what you borrowed.

This problem affects both strategies and is not a risk unique to the governance arbitrage strategy. One way to mitigate this is to use the USDC/USDT pool but I don’t think at this moment you can borrow USDT from AlgoFi, so you’ll have to borrow USDC completely and convert.