How to: make 10x returns on Compound.finance
Do you think that Compound floating rate is too high or too low? You can trade on this view with 10x leverage. Even more, by doing this, you help the community and create a proper swap curve!
In the financial world, money is continuously lent and borrowed to/from each other. There is an “overnight rate,” the rate that is set up every day and used to end money for a day. Sounds similar to DeFi! Many banks and companies invest with this floating rate for months and years. In London, the central money market place in the world companies use “EONIA” (Euro Overnight Index Average). Just like floating rates in DeFi overnight rates depend on supply and demand and can change significantly.
But it is not very convenient to invest and borrow with the variable rates! So traders created an expectation market for these rates. The idea is simple: market participants can lock fixed rates for some period for a mutual benefit. One company wants to receive a payment with a variable interest rate, while the other wants to limit future risk by receiving a fixed-rate payment instead. The agreed fixed rate is called a swap rate.
It is not very convenient to invest and borrow with the variable rates! So traders created an expectation market for these rates.
At the moment, Swap Rate has 12 rates for the next 12 months (it is called “swap curve”).
How does swap market work?
Every deal (swap) is a contract with a counterparty where one party is paying
variable rate return in exchange for a fixed rate return. So I can always exchange my variable rate return for a guaranteed fixed return or another way around. Swaps are an essential part of the financial market, and I would encourage to read more about them.
Trading strategies
Very important that one can take long and short positions for the variable rate itself, and below are some strategies.
Pay floating — receive fixed
This strategy used when you expect that the variable rate will give you more return than the quoted fixed rate over the investment period.
Example: You see that the swap rate for 12 months is 10%, you think the variable rate will give you less.
You may get into a swap in which you receive a guaranteed 10% fixed rate and oblige to pay the floating interest of Compound.finance over the next 12 months. Suppose you choose 1000 DAI as a nominal, you would only need to lock 100 DAI as collateral due to 10x leverage.
After 12 months, one of the situations can occur:
- The accumulated rate of Compound for these 12 months is less than 10%. Let’s say it is 7%. You will get 30% return on your strategy! Indeed, you will get your 100 DAI back, plus you will receive 3% (10%-7%) over your nominal of 1000 DAI.
- The accumulated rate of Compound for these 12 months is more than 10%. Let’s say it is 12%. You was wrong, and you will lose 20% on your strategy! Indeed, you will get your 100 DAI back minus 2% (12%-10%) over your nominal of 1000 DAI.
- If the Compound rate is exactly 10%, you will just get your collateral back.
Pay fixed — receive floating
This strategy you can use if you believe that the variable rate will give you less return than the quoted fixed rate over the investment period.
Example: You see that the swap rate for 12 months is 10%, you think the variable rate will give you more.
What can happen after 12 months:
- The accumulated rate of Compound will be indeed more than 10% and in this case you will profit. Imagine, floating rate will be 15%, then your profit is 50%.
- If the rate will be less than 10%, let’s say it is 7%, then your strategy was wrong and you will lose 30%.
- And if the Compound rate will be 10%, as in the previous example you will get your collateral back.
You can always combine swaps with your existing deposits and loans, effectively fixing the interest rate! You can read more about it in our previous article.
Summary
With Swap Rate, you can make 10x leveraged returns by the trading of the expected Compound rate. You can also hedge your existing deposits and loans. Some geeks already run smart market-making strategies on our swap curve, and we expect an increasing demand.
Think of the situation when the Compound rate is getting low for a while: users are not running away because they have fixed their returns with a swap.
The swap curve makes the market more efficient, allows to trade floating rate risks and it brings predictability for the community. Think of the situation when the Compound rate is getting low for a while: users are not running away because they have fixed their returns with a swap.
UDP: We have built a straightforward version of the return calculator.
YOU CAN:
- Fill in your expectations about Compound supply/borrow rate
- Calculate possible return and correct strategy
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