How Rivera is helping institutional investors generate 40% APY on stablecoins
Yield farming is a novel way for investors to generate a return on their crypto portfolio. Investors can stake their assets and provide liquidity to a protocol, in turn, generating mouth-watering APY. However, the volatility risk of crypto assets refrains investors from taking exposure to the asset and participating in the yield farming opportunity. In this blog, we will discuss how we are enabling our institutional partners to generate more than 40% stable returns without getting exposed to asset volatility.
Market-neutral farming strategy is a method in which we take a long and short position in an asset at the same time to cancel out the effect on our portfolio when the asset price moves. The strategy attempts to generate yield by staking the long assets into a DeFi pool. The earnings are harvested regularly and compounded back into the principal amount.
Though the strategy seems simple in nature, in a realistic scenario, there are a few considerations we need to keep in check to operate it properly.
1. Deviation from neutrality: Yield in the long position will be compounded with time while the fee expenses reduce the short position value. If investors have taken leverage on their positions they can also be subjected to borrow interests and funding rates. These factors can deviate the neutrality of the short and long positions. This changes strategy performance and risk exposure to the underlying asset.
The graph below shows the deviation from neutrality while executing this strategy with AXS. We can note that a deviation of 20% on either side can occur quickly, creating risk exposure for investors.
In general, we quantify portfolio risk in terms of the volatile asset’s un-hedged position. As we deviate from neutrality, the asset risk increases in either direction as represented by the graph below.
2. Liquidation of short position: If investors have taken leverage on their short position, they can be subjected to liquidation when the asset price changes. The higher the leverage more liquidation risk investors can be subjected to. Liquidations can be subjected to a high fee expense and they will be left exposed to the underlying asset.
3. Compounding inefficiency: In order to maximize capital efficiency investors will need to harvest reward and compound it back into the principal amount at the optimal period. Leaving rewards unharvested will lead to poor capital efficiency damping their overall APY while the various fee expenses that come up with compounding can erode their earnings when compounded too frequently.
Simplifying Execution:
To mitigate the above risks we have built methods that are backed by precise calculations ensuring the highest capital efficiency to the strategy. At a high level, these methods instruct investors when to optimally rebalance positions and compound rewards. Investors need to actively take care of two things to operate this strategy properly, rebalancing and compounding.
1. Active rebalancing protects investors from risk exposure created by deviation from neutrality as well as the short position from getting liquidated. To achieve this we set up a tolerance band around the hedge ratio of our positions. The hedge ratio keeps long and short position values in check and once the ratio is out of the tolerance band the sheet instructs users to move required funds from one side to the other.
We have back-tested multiple market-neutral strategies with different combinations of tolerance values and here are our findings in one such example. The table below shows the strategy APY we simulated with AXS for various rebalancing tolerance. Clear from the table below that we don’t want the rebalancing tolerance to be very low (less than 5%) as frequent fee expenses eat up the yield and a larger tolerance band (more than 15%) increases the exposure.
2. Active compounding maximizes strategy efficiency. We have designed a harvesting equation that takes into consideration of transaction fees and instructs users to harvest when the optimal amount is collected.
Our strategy execution methods and equations can be found in this spreadsheet. In the next blog, we will explain how you can use it to operate a market-neutral farming strategy to earn 40% APY on your stablecoin portfolio.
Strategy pilot with Cashaa:
Using the methods explained above, we ran a proof of concept with Cashaa, one of our institutional clients. We used AXS to generate a high staking reward while keeping the position neutral by shorting AXS/USDT on Binance.
Strategy execution and transaction logs can be found here. The strategy generated a stable 40.15% APY on USDT during the investment duration.
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