5 Ways Borrowers Can Manage their Crypto-assets Portfolio Risks Despite Cryptocurrency Volatility

It has been a run of chaotic months for Blockchain startups and investors as cryptocurrencies took a sharp decline. While this crypto winter has made Blockchain technology and cryptocurrencies more popular, it is not for the right reasons.

The volatility of crypto-assets has strengthened the debates over regulating the crypto market. Regardless of the bear market and pending when cryptocurrencies gain more stability, Equilibrium has developed mechanics which allow borrowers to manage their crypto portfolio and balance their portfolio risks.

Without further ado, let’s find out how borrowers can manage their portfolio risks. But first, how does Equilibrium price borrowers’ interest?

How Equilibrium Prices Interest on Borrower Loans

To be clear, we do not set prices on borrowers’ loans. Borrowers set the interest rate themselves.

We have developed a sophisticated model from classical finance to price interest on our loans. It is derived using the varying strike protective put option to solve the collateral-backed (stock loan in traditional finance) loan problem.

The stock loan problem very broadly tries to answer the following question: “How much money can we lend out to a borrower who uses a certain stock as collateral, and how much interest should we charge him?”

Despite the complex model, we have simplified it into an equation that describes Equilibrium’s interest rate model so beautifully:

Interest rate ~ Leverage * (Portfolio volatility * scale factor)

Don’t be tricked by its clarity, though! There are a lot of running parts that we will explain in the simplest ways possible.

Factors Responsible for Interest Rates

This formula implies that every borrower pays varying interest rates which depend on the following three factors;

• The amount of leverage the borrower uses: The higher the leverage the borrower uses, the higher the interest rate they will pay, and vice versa. In other words, the more or less debt a borrower has in relation to the collateral the user provides, the more or less interest they’ll pay.
• The borrower’s portfolio: Borrowers’ portfolios usually comprise two types of assets; collateral assets (which have positive weights) and debt assets (with negative weights). To calculate the portfolio risk, we use volatility as a risk proxy, so the higher the volatility, the higher the interest rate will be and vice versa.
• Scale factor: This factor scales borrowers’ interest rates by analyzing the entire system’s solvency. If there is enough insurance in the system to cover the worst-case scenario collateral drop, the scale factor is low, which can incentivize borrowing. On the other hand, if there is not enough bailsmen liquidity to absorb possible liquidations, the scale factor will be higher. This will dis-incentivize the borrower and attract more insurance with higher applicable interest rates.

These factors (except, maybe, for the scale parameter) have shown that interest rates are mainly controlled directly by borrowers.

5 Ways Borrowers Can Manage their Portfolio Volatility

Now we know how the interest borrowers pay is calculated; the interesting part is that if you use the following guideline, you, as a borrower, may be able to control how much interest you pay.

Here are the 5 ways users can control their portfolio risks.

1. Borrow against stablecoins

We earlier mentioned that having a low debt-to-asset ratio (low leverage) can reduce portfolio risk and the interest rate you will pay. Furthermore, using low volatile assets (stablecoins or some stable price LP tokens) as collateral may significantly reduce the interest you will pay.

2. Balance leverage with volatility

You can balance high leverage with low volatility assets or low leverage with high volatility assets.

3. Borrow against correlated assets

Correlated assets are assets that move in the same direction such that when one cryptocurrency moves up, the other moves up and vice versa.

Unlike the traditional equity market, most cryptocurrencies are highly correlated. For example, correlations on daily returns between the 4 digital currencies, i.e., BTC, ETH, LTC, and BCH, were over 75%.

The volatility of cryptocurrencies calls for the development of market-neutral trading strategies. Their high correlations motivate us to investigate co-integration or mean-reversion strategies. This is a deep subject in itself, but in its simple form, you could borrow ETH against BTC and enjoy a price-stable portfolio. With proper practice and timing (e.g., adding more BTC collateral or winding down some of that ETH debt), you could profit from your “market neutral” position.

4. Borrowing a stablecoin against other stablecoins

EQD is Equilibrium’s cross-chain stablecoin that can be used as collateral on other blockchains. Borrowing one stablecoin against another stablecoin is virtually risk-free. So if you are seeking exposure in DAI / USDT / USDC or ACA and only have EQD at your disposal, you can enjoy low volatility.

5. Borrowing DOT against wrapped DOT

DOT and xDOT (Equilibrium’s wrapped DOT) possess the same value. Borrowing DOT against various DOT wrappers which derive their prices directly from the price of DOT is considered to be virtually risk-free and may be done with the highest possible leverage.

These are just a few examples that come to mind when you start thinking about the way Equilibrium money market operates. Of course, there are tons of others for you to discover and play with! So don’t hesitate, come out and play!

About Equilibrium

Equilibrium is a one-stop DeFi platform on Polkadot that allows for high leverage in trading and borrowing digital assets. It combines a full-fledged money market with an orderbook-based DEX. EQ is the native utility token that is used for communal governance of Equilibrium. xDOT is a liquid and tradeable wrapped DOT that unlocks liquidity of DOT locked in parachain auctions and delivers multiple crowdloan bonuses on Polkadot.

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