Deep Dive into Rage Trade’s Delta Neutral Vaults
Can you earn Real Yield with GMX and Rage Trade?
Rage Trade plans to release their Delta Neutral Vaults in November or December 2022. At the core of the strategy is a GLP position from GMX, which is hedged on AAVE. The result is an assumed 24–25% APY for the Risk On Vault.
Our DAO member Ape/rture did an in depth analysis which won the Rage Trade thread competition. We converted the thread into this article. Below you will find an explanation of GLP, the mechanisms of the vaults and an analysis of the backtest results. The article ends with a suggestion for the Rage Trade team. If you are a team building in crypto and are interested in the critical views of our DAO members please reach out to us. We are happy to help.
What you’ll learn in this article:
- What is GLP?
- Is it possible to make a GLP position delta neutral?
- The Risk-On and the Risk-Off Vault
- The Risk-On Vault backtesting results
- Risks
- Suggestion for Rage Trade
- Conclusion
This article is not Financial Advice and doing your own research is always advised. The article tries to describe a balanced analysis of the benefits and risks of these types of strategies.
1. What is GLP?
For trading on a Decentralized Exchange (DEX) you need a counterparty to provide liquidity. GMX solved this by introducing a liquidity provider token called GLP. GLP is an index of tradable assets that are listed on GMX. Liquidity providers (LPs) can buy into the GLP pool and be that counterparty, for which they are rewarded with trading fees in ETH.
Since the LPs are on the other side of the trade, they also get rewarded when traders on GMX lose, but these LPs lose when the traders are profitable. In general traders aren’t net profitable (on GMX, but also in the wider market) which results in extra profit for the LPs.
This is the net Profit and Loss (PnL) from GMX traders.
The composition of the index for GLP currently looks like this. As you can see the majority is stablecoins, ETH and BTC. The UNI and LINK portion is neglectable.
The risk of holding GLP however is that as an LP you are directionally exposed to the market. If BTC and ETH go down in USD, the USD value of your GLP goes down too.
Below you see that the returns on GLP year to date are around -13% with drawdowns going as deep as -35%, while the yield was around 16%. Rage Trade is trying to solve this by providing a strategy that hedges the directional exposure and captures just the yield.
2. Is it possible to make a GLP position delta neutral?
Delta is a metric that estimates the change of price of an asset or derivative. A trader can use multiple positions so the average delta is 0, which is called delta neutral. To simplify: a trader can take both a long and short with an equal size to remove the exposure to the movements in a market. Often traders do this to capture some kind of premium or yield.
In theory we could be long GLP and short the directional assets in GLP (BTC and ETH) and be delta neutral. Then we walk away with that juicy yield that GMX is rewarding us with. How does this look on-chain?
3. The Risk-On and the Risk-Off Vault
We will start with the Risk-On Vault, which was previously called the Junior Vault. This vault earns yield on GLP while shorting the ETH and BTC exposure, thus being delta neutral. The short position updates if GLP or the vault receives new funds. The yield on GLP is compounded and returns 24–25% according to the backtesting data. Very high for a stablecoin vault!
The Risk-On Vault takes a Flash Loan from Balancer in ETH and BTC and sells that for USDC. Now it is already short, but it has to repay that Flash Loan in the same block. Within the same block the USDC received is put in AAVE with extra USDC from the Risk-Off Vault to have sufficient collateral. The Risk-On Vault then borrows ETH and BTC and repays the Balancer loan.
The Risk-On Vault keeps the USDC but has a debt to AAVE: the short on ETH and BTC.
Since BTC and ETH can be volatile enough collateral needs to be posted on AAVE to ensure the positions don’t get liquidated. The Risk-Off Vault (previously called the Senior Tranche) provides this extra collateral. This vault is considered risk off since the only exposure is to the position on AAVE. Users get rewarded by the yield from AAVE but also a portion from the GLP position. The yield is approximately 6–8%.
4. The Risk-On Vault backtesting results
The part you have been waiting for! Some data crunching on the returns of the Risk-On Vault. 24–25% is quite high for a stablecoin vault. How is this achieved?
Special thanks to 0xAthanase / FinQuant from the Rage Trade team for providing me with the backtesting data and a good discussion. The data ranges from 1st of January 2022 to the 30th of September.
Feast your eyes on the full HD (1080p) chart of the impressive Risk-On Vault returns. In red you see the Risk-On Vault returns YTD at 24.58%, while the return on GLP in blue during the same period would be -13.72%.
Apart from the nice returns, two important stats jump out. The standard deviation on the Risk-On Vault is quite large, which we can see in the noisiness of the chart too. This is because the GMX trader positioning against the GLP position has some randomness (most human and bot behavioral data has!), which creates deviations in the vault strategy. No big problem, since this is a longer term strategy, just be aware if you are monitoring the vault returns daily.
The drawdown in the Risk-On Vault is quite large, which happens at the start of the backtesting period. The vault recovers and especially in June increases in profitability.
Let’s zoom in on specific periods to see what happened. Starting with the period January to May 2022. The Risk-On Vault has a drawdown but also the volatility is high.
Red = Risk-On Vault returns
Blue = GLP returns
Green = ETH price
This is because the GMX traders first were profitable but eventually also started losing. In general this period had both uptrends and downtrends on ETH, but usage of GMX was also quite low. This led to more volatility in the PnL too.
Data from GMX: https://stats.gmx.io/Over time more traders start to use GMX. A big portion of them are ETH bulls. In June ETH takes a dive and the GMX traders PnL ends up generally in the red, which is good for the GLP LPs and thus the Risk-On Vault since they are on the better side of the trade! You can see the inverse correlation with the Risk-On Vault and ETH price directly in the chart.
The GMX data shows that on the 10th and the 18th GMX traders lose the most. The Risk-On Vault captures the extra profit. In June the vault captured 13.76% profit.
So far the vault gave decent and stable returns, but most of the profit comes from GMX traders losing, which seems correlated to the ETH downtrend. One of the questions we have to ask: what happens when these traders become profitable or what happens when ETH goes up?
The last part of the backtesting data is the period July to October 2022. In the period leading up to the Merge (before September 15), ETH was in an uptrend. Luckily the returns from the Risk-On Vault also kept sloping up, unbothered and moisturized. Note the small period after the 15th of September, where ETH goes down and the Risk-On Vault returns get a small boost.
In the period before the 15th of September in the ETH uptrend, the traders on GMX weren’t that profitable! After the 15th, we see a big red spike in the GMX trader PnL. Looking at the PnL we can see they were short at the bottom (start of July) and longed the lower high (September 15), but got hurt on the move down.
The Risk-On Vault seemed to be on the good side of the trade because traders kept losing, even when the market went up.
5. Risks
The market keeps reminding us the black swan could always be around the corner and we need to understand what risks are associated with our strategies.
Risks of the Risk-On Vault Vault:
- The GMX traders start winning. So far they have been losing, but there might be a scenario where they are all gonna make it. One of these could be a prolonged BTC or ETH uptrend. We saw a small uptrend around the Merge, but this was in an overall bear market. If traders start winning the GLP pool goes down in APR, but the JR tranche would still capture fees. For now I assume this would net 0 and not specifically a loss. In addition, bull markets don’t go on endlessly and even during bull markets liquidation events happen to shake out the biggest of bulls.
- Usage of GMX and liquidity going down in the GLP pool. At the start of 2022, the volatility in the Risk-On Vault returns was high when less trading happened on GMX. The result was a drawdown. Luckily, GMX volume, fees and AUM have been in an up only paradigm, which makes this scenario less likely to occur now.
- Platform and Smart contract risks on GMX and Rage Trade. A risk with every protocol in DeFi. Front-ends can go down, smart contracts might have bugs. External audits or data checks (like this backtest!) help remove some risk, but can’t negate risk in full.
- Higher on-chain fees. Right now fees in the backtesting on-chain fees are assumed to be constant, but during moments of high usage, fees can spike up. Luckily, fees on Arbitrum are fairly low already.
- Borrow fees on AAVE go up. This scenario happens when borrowing of BTC and ETH increases. High fees are great for the Risk-Off Vault since they get yield from AAVE, but the Risk-On Vault pays higher fees to borrow, which results in a lower return for depositors in the vault. Users that have exposure to the Risk-On Vault can offset this risk by also depositing in the Risk-Off Vault.
6. Suggestion for Rage Trade
To conclude the article we want to make a final suggestion to the Rage Trade team. The best feature of GLP LPing is receiving ETH. ETH bulls want to be max long the Vitalik Coin in the next bull run, but can we help them in their search for digital gold? Optimal for them would be a vault with stablecoin liquidity, ETH yield out.
Consider the scenario where the vaults don’t compound, but give the user ETH. Use a portion of the yield to make sure fees are taken care of. At this moment I assume a 10% APR ETH would be doable. That yield is much lower compared to the 24–25% on the Risk-On Vault, but when most ETH bulls expect multiples on their ETH in the long run, the return would actually be better. On top of that, the users would be incentivized to stay in the pool longer, since the current Risk-On vault underperforms GLP and ETH in a bull trend.
7. Conclusion
The Risk-On and Risk-Off Delta Neutral Vaults from Rage Trade serve the DeFi users needs for higher yields using one of the most popular DEXes from last year: GMX. The Risk-On Vault utilizes a delta neutral strategy to capture a decent 24–25% yield from year start to October, but does this mostly when GMX traders are losing.
