Delta neutral farming I: Strategies and Opportunities
Too lazy to read? TLDR here
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The BERA has been tough on most and possibly even worse for the humble farmer seeing their capital rekt by 70% in a single move but harvesting only a measly 0.3% a day.
In one of my previous posts, I mentioned delta neutral strategies as something for the bear market. Perhaps the bottom is in, and the Degen in you says “Fuck it ser. All in.”. But perhaps it isn’t or we chop even more. Regardless, market neutral strategies will likely play an increasing importance going forward, as market participants realize that it isn’t always up only. Similarly institutions which are more risk averse will also be interested in way to deal with unwanted volatility in the crypto world.
Wat mean Delta neutral?
Delta neutral is a strategy where you take upside and down side positions which ultimately balance out to neutral/zero exposure.
In the TradFi markets, an example of this would be buying a commodity spot for $100 and simultaneously sell a fixed date futures contract for $104. Assuming the cost of carry being $2, you pocket $2 of profit.
Of course this is an oversimplification of delta neutral strategies within the TradFi markets which are extremely sophisticated.
Delta neutral for the crypto farmer
Delta neutral strategies are not unique to crypto. In fact, one would probably find the most advanced strategies coming from TradFi given the maturity and diversity of products and instruments available.
Therefore, I shall be focusing this piece on crypto centric strategies which take advantage of one thing crypto does better than TradFi — Yield. In the current backdrop of DeFi / Crypto, liquidity is essential for any project to succeed and are therefore inclined to bribe participants with high yields funded through a mix of revenue and token emissions.
Single-sided staking
Let’s start with something simple such as a delta neutral single-sided staking. Simply put, this refers to creating a market neutral position while staking a single asset for yield.
1. Delta neutral with on-chain borrowing
Many assume that delta neutral means hedging with some sort of instrument. But what if I told you that you can do it all on-chain within the same protocol?
Step 1: Supply $100 of $USDC on Bastion protocol for 4.65% APR
Step 2: Borrow 50% of $USDC collateral in $stNEAR tokens at 0.92% APR
Step 3: Stake borrowed $stNEAR for 5.21% APR
Step 4: Slurp net yields of 6.8% APR
How is this delta neutral? Because you have borrowed $stNEAR and not $USDC, you return $stNEAR at the end of your farming period. Whether $stNEAR price increases or decreases has nothing to do with you.
Risks:
1) Liquidation risk due to potential price swings.
2) Interest rate risk based on the net position of APR and cost of borrowing.
How to identify opportunities:
Opportunities like this are generally hard to find due to how quickly the retail market picks up on the arbitrage opportunity within a protocol. A lot of active research is required in order to take advantage of smaller / earlier protocols providing such attractive rates.
2. Delta neutral with perpetuals
Seeking purely on-chain opportunities are often difficult as one would likely be hard pressed to find a lending protocol which will let you borrow money cheaper than the cost of supplying liquidity. So what do we do? We take advantage of CeFi opportunities on exchanges.
Step 1: Stake $LOOKS for 61.63% APR ($LOOKS 25.00%; $ETH 36.63%)
Step 2: Short $LOOKS on OKEX (annual funding rates of 29% = get paid to short)
Step 3: Slurp net yields of 90.63% APR
Risks:
1) Liquidation risk on open short position
2) Interest rate risk based on the net position of APR and funding rates
How to identify opportunities:
Just use the resources provided below and cross reference against funding rates to find your instant arbitrage ;)
Resources:
Funding rates @ Coinglass
Staking yields @ Staking Rewards
But ser, net APR too low ser…
This Cat has got you covered you greedy Anon. To boost your APR, find a protocol which allows you to borrow against your staked asset. This works for both delta neutral with perps and on-chain borrowing.
Take for example Bastion protocol which we discussed previously. With the cost of borrowing for $stNEAR being lower than the supply APR, we are essentially getting away with free leverage on the staked asset for anyone willing to manually execute the strategy. Simply borrow $stNEAR against your collateral and redeploy into the staking position as many times as you want.
The upside:
You will only need to delta-neutral your initial position.
The downside:
You will need to manually repeat your borrow-supply strategy. Returns are also diminishing as you will typically only be able to borrow less than 100% of supplied collateral.
Liquidity pool farming
Liquidity pool farming is a “riskier” version of staking in that it comes with the big scary beast known as impermanent loss. Because of that yield is also typically higher. The example provided earlier on $LOOKS should be treated as an outlier rather than the norm.
With great APR, comes great complexity. Delta neutral also becomes more complicated due to impermanent loss, but let’s get to that later and assume the world runs on zero IL for the sake of illustration.
1. Psuedo delta neutral with borrowing platforms
To execute this strategy you must be able to borrow the asset you are intending to farm. Why? Because when you return the asset, you return it in the form of the number of tokens borrowed as opposed to the USD value of the asset. As long as you are able to get more than a net 0% yield on borrowing + farming, your delta neutral position will be profitable.
Step 1: Deposit $100 of $USDT for 0.11% APR
Step 2: Borrow up to 80% in farming token which in this case is $80 in $FTM at 4.94% APR
Step 3: Supply FTM-USDC LP on Spookyswap for 32.95% (Additional $80 in USDC)
Step 4: Slurp net yields of 27.15% APR
Risks:
1) Protocol risk. The more interactions across protocols, the more likely you run into issues with hacks and rugs.
2) Liquidation risk due to potential price swings.
3) Interest rate risk based on the net position of APR and cost of borrowing.
4) Impermanent loss risk due to LP pool model of x*y=k.
How to identify opportunities:
Anon, alfalfa below ser. Seek and you shall find.
Resources:
LP yields @ Coindix
2. Psuedo delta neutral with farming aggregators
Examples of such platforms are Tarot or Impermax which consolidate LP pools across various AMMs and allow the farmer to utilize leverage on LP pools beyond 100% thereby enabling much higher yields than a typical undercollateralized lending platform. Given that borrowing and LP farming is all done on one single platform, this methodology provides much more advantages over using a simple borrowing platform.
The delta neutral here involves borrowing the equivalent amount of non-stable LP tokens and then selling it into stablecoins. For example: Take a $4,000 LP position comprising of 1 $ETH (~$2,000 per $ETH) and 2,000 $USDC. By borrowing 1 $ETH and selling it for stablecoins, the farmer receives $2,000 in USD while the borrowed 1 $ETH is repaid when the position is closed using the 1 $ETH in the LP position
Step 1: Deposit ETH-USDC LP for 25.65% APR
Step 2: Borrow $ETH equivalent to the amount LP’d at 4.41%
Step 3: Sell $ETH borrowed into stables.
Step 4: Slurp 21.21% APR
Leverage booster
The real alfalfa here is taking advantage of the leverage offered on these protocols. To do so we introduce the next step:
Step 5: Increase leverage.
This allows the user to boost yields by 3–4 times or even more depending on how much leverage they are given, making this sort of LP farming extremely capital efficient. The drawback however is increased liquidation risk as these ranges become tighter as leverage increases.
Risks:
1) Liquidation risk due to potential price swings.
2) Interest rate risk based on the net position of APR and cost of borrowing. Specific to LP farming aggregators, borrowing cost increases exponentially when utilisation of available funds exceeds the “kink”.
3) Impermanent loss risk due to LP pool model of x*y=k.
3. Pseudo delta neutral with Mirror Protocol
This strategy while somewhat dead due to the UST depeg is probably still worth mentioning given its status as one of the OGs of the delta neutral play. Instead of using crypto native asset LP pools, Mirror uses LP pools comprised of UST and synthetic stocks.
Step 1: Open short position for synthetic asset on Mirror
Step 2: Open long LP position for synthetic asset on Mirror
Step 3: Enjoy pseudo delta neutral yields
This can also be paired together with the use of Anchor protocol to enhance yields namely by first depositing $UST into Anchor and using the deposits of $aUST as collateral to create the short position.
Single sided staking vs LP farming
A comparison of the two strategies seems to indicate that single sided staking is probably the superior strategy and that it would be a no brainer to consider this over any thing else.
However, the ease of execution also means that it the alfalfa on this strategy will likely diminish much quicker over time. As mentioned the $LOOKS opportunity is an outlier and not the norm. Most single sided staking opportunities do not deliver high yields like that and if they do are typically not yet listed on exchanges to be hedged.
LP farming yields on the other hand, are likely remain high over the medium term given the availability of leverage and the challenge of managing impermanent loss which requires dynamic hedging to make the LP position truly delta neutral. We will touch upon this in part II…
Final thoughts
Alfalfa is everywhere as long as you look hard enough and understand the risks that come with it. This Cat has done his part, are you willing to do yours?
Anon, will you farm your way to success or ride the market roller coaster in hopes that you get off at the top and not the bottom?
