Core Delta-Neutral Strategy
Beep boop. Hello humans.
Welcome back to another enthralling installment of Modelling DeFi. This piece is much less mathematical and much more informative. We will look at RoboVault’s new delta-neutral strategies, and explain how they achieve safe, sustainable yield for your stablecoins.
Let’s start by taking a look at the diagrammatic representation provided in their docs. The strategy is explained in their docs very well, so my intention is to provide additional educational content to complement their docs.
When a user deposits stables, a portion of those stables is lent on Aave, and collateralized to borrow a secondary token (in this case AVAX). This borrowed AVAX is paired with remaining stables and farmed as liquidity to earn rewards. Rewards are then compounded back into the strategy.
Of course, this strategy introduces borrowing and impermanent loss, so we need to understand the safety mechanisms in place to ensure the strategy doesn’t get liquidated, and that users can withdraw funds regardless of AVAX price action.
Suppose a user deposits 100 USDC into the delta neutral strategy vault.
The maximum LTV on AVAX borrowing on Aave is 65%, so the strategy aims to maintain a debt ratio below that. For this explanation, we can say that the target LTV is 60%, and we will call this 100% of the debt ratio. Therefore, from 100 USDC, 62.5 USDC will be deposited into Aave, to borrow $37.5 of AVAX (60% of 62.5), which will be combined with the remaining 37.5 USDC to form TraderJoe LPs that are farmed on Vector. We are losing on AVAX borrowing interest, but we are earning USDC lending interest, LP swap fees, and Vector emissions.
We can see this pathway represented diagrammatically in RoboValult’s docs.
What Can Happen?
Now that we have established a start-state, we can look at some possible events, consequences, and mitigations integrated into the strategy. The best way to do this is to map out, sequentially, what can happen, and how that affects the position. Remember that the quantity of AVAX borrowed is the quantity of AVAX in LP tokens, so the strategy is theoretically insensitive to price action. I have highlighted certain outcomes in red if they directly jeopardize the safety of the strategy.
Note that the debt ratio going down does not jeopardize the safety of the strategy, but it is suboptimal for returns, so triggers a rebalance regardless. There are additional considerations, like the USDC lending interest and AVAX borrowing interest, that may trigger a rebalance over time, but generally speaking, price action will trigger rebalances much more frequently. Rebalances protect the strategy from IL and liquidation.
RoboVault has provided its own simulations in a Medium article to demonstrate the effects of automated rebalance due to both price action and debt ratio. We can see the effects of negative AVAX price action on the left, and positive AVAX price action on the right.
We have seen that RoboVault requires active position management to keep users’ funds secure and delta-neutral, and they achieve this with off-chain infrastructure. It’s important to note that while rebalancing is triggered at 2% deviations from delta-neutral, those 2% deviations do occur. To mitigate any potential losses at rebalancing, RoboVault also maintains a small drawdown reserve to cover up to 0.5% drawdowns in the strategy.
Beep boop. Thanks for reading! This article wasn’t particularly model-focused because the team at RoboVault has already done all the modeling. However, it does highlight the power of modeling in strategy design, which is something I always like to see. As always, feel free to get in touch and offer feedback or suggestions. I’m excited to watch DeFi develop and learn along the way.
Beep boop. Goodbye humans,