Brahma’s DegenVault journey only began a short few weeks ago with the launch of the Protected Moonshots DegenVault (⚛️ PMUSDC). This first DegenVault focused on providing a more sustainable yield for a user's stablecoins by combining DeFi-native yield with on-chain derivatives strategies to enhance returns.
However, users are continually searching for the best yield opportunities on not only stablecoins but on all of their assets (productive assets aren’t a meme?). With the positive feedback received on the PMUSDC vault the next design space investigated was an ETH Vault.
Why ETH you ask?
Even Bitcoin maxis own ETH at this point so it doesn't take an MBA to detec product-market fit. The long awaited and much anticipated merge should also soon be upon us; surely we can’t be let down again?
Even though Jerome Powell and the FED have stopped their money printer going brrrrr, ETH continues to go burrrrrn. Basically, the time couldn’t be better to keep stacking ETH.
Let’s begin by outlining the high-level strategy of the vault:
- Single-side deposits are accepted in ETH
- The vault supplies this ETH to the highest yielding Curve pool and LP tokens are staked on Convex
- Which pool? stETH/ETH - more details below
- At the end of every week, all accrued yield is harvested and converted to ETH
- The yield is bridged to Optimism and used to take a leveraged bet on crypto prices
- What leveraged bets are used? 1 week ATM options are purchased on Lyra Finance - more details in the coming sections
- Any trading profits at the end of the week are converted back to ETH, bridged back to mainnet and compounded into the strategy
For those familiar with the PMUSDC vault, you will note the similarities. The strategy is centred around preserving the users' hard-earned capital but still looks to provide enhanced returns by taking regular small, but leveraged, bets to generate asymmetric payoffs.
Further details about the two key components of the vault, the Base Yield and the Weekly Leveraged bets, are discussed in the sub-sections below.
Base Yield - Curve Pool Choice
Liquid staking tokens have been a key building enabler in DeFi; unlocking capital efficiency for those looking to earn those sweet ETH staking returns. Being an LP in some of the Curve pools for liquid staking tokens provides some of the most attractive returns for ETH at the moment as protocols look to attract deep liquidity to ensure peg stability.
The monstrous ETH/stETH pool currently dominates the landscape with around $4.5bio in liquidity. rETH and sETH2 are alternative liquid staking tokens that are looking to grow liquidity for their assets which could present attractive yield opportunities in the near future; there are a lot of mouths to feed in a $4.5bio pool.
The recently launched rETH/wstETH pool looked like a great place to deploy capital initially but CRV emissions to it have since flatlined in April with emissions only resuming recently. As a result, the vault will deploy deposits to the ETH/stETH pool initially. However, strategists are continually monitoring yields to ensure your assets are getting the most attractive yield - users no longer have to worry about the never-ending search for the best base yield and the resulting switching costs.
Weekly Leveraged Bets
The leveraged bets that the vault takes using the previous weeks’ harvested yield can be broken down into two components - the market direction of the bets (is it a bullish or bearish bet?) and the type of instrument used to take this bet (Perpetual future, vanilla option, binary option, Squeeth etc).
For the market direction of the bet, the vault uses a simple momentum strategy to determine the direction of that weeks’ trade. The aim of the vault is to provide enhanced returns throughout all market cycles and it looks to abstract the switching costs and decision overhead away from the user that a dual vault structure would create.
The on-chain derivatives market has exploded recently, giving strategists a wide variety of trading instruments to integrate. For this strategy, products of particular interest are those that provide leveraged exposure to prices. This includes products such as perpetual futures (used in the PMUSDC strategy), options and squeeth.
Although the PMUSDC DegenVault currently uses perpetual futures for the weekly leveraged bets; the use of other instruments is investigated in an attempt to overcome some challenges the initial strategy faced. Brahma’s first ever Vault Improvement Proposal outlines some of these challenges and highlights the use of other instruments.
The backtest of the ETH Maxi DegenVault was conducted with the below aims:
- To confirm that enhanced ETH returns can be achieved by taking weekly leveraged bets with the yield earned on ETH deposits (given the low base yields vs stablecoins).
- To determine whether the vault should be flexible or singular in the market direction of its weekly trades.
- Ascertain the most suitable on-chain derivative instrument/s to express the weekly leveraged bets.
In order to backtest the strategy performance for a range of linear and non-linear derivative instruments, historical price data as well as historical option price data is required.
For price data, 1 year of historical price data for ETH from FTX is used. To generate historical options prices, 1 year of historical Implied Volatility data for 1 week at-the-money ETH options is used.
Initially, the total weekly trading returns for a variety of different derivative strategies and signals is compared. A constant base yield on ETH holdings of 6% is assumed. All the tested strategies and signals are outlined below.
- Perp Simple: 8x leveraged perpetual future trade taken with the direction given by the signal.
- Perp Improved: Current PMUSDC strategy, 8x leveraged perp trade taken with the direction given by signal. Trade is continuously monitored and closed if stop loss and take profit conditions are met.
- Option Buying: Weekly yield is used to purchase a 1week ATM option, put/call decision determined by signal.
- Option Selling: Weekly yield is used as collateral to write a 1week ATM option, put/call decision determined by signal.
- Squeeth: If bullish signal, weekly yield is used to purchase oSQTH tokens; if bearish signal, weekly yield is used as collateral to mint oSQTH tokens which are sold.
- Straddle Buying: Weekly yield is used to purchase 1 week ATM call and put options, no signal is needed
- Straddle Selling: Weekly yield is used as collateral to write 1 week ATM call and put options, no signal needed.
- 100% Accurate: For illustration purposes only, results are shown assuming the signal was able to look into the future and predict the market direction with 100% accuracy.
- Long Only: The vault takes bullish weekly bets every single week
- Short Only: The vault takes bearish weekly bets every single week
- Momentum: The direction of the weekly trade is determined by a simple momentum signal
Initial results can be seen below:
First, it can be seen that the momentum signal outperforms the long-only and short-only signals. A flexible strategy that is able to take advantage of upward and downward moves outperforms singular directional strategies for all derivative strategies tested. The vault looks to provide users enhanced returns throughout market cycles. This result highlights why a single vault that executes trades based on a simple momentum signal is offered instead of offering two vaults and getting the user to choose the vault direction.
It is important to note that the option purchasing strategy significantly outperforms the enhanced perp strategy when our signal is 100% accurate resulting in more than 2x improvement in the base APR. When using the momentum signal, similar performance is seen for both strategies with the base APR improved by 1.25x. Importantly, the option buying strategy is much less operationally intensive as it does not need to be monitored for take profit and stop loss conditions. This is because a long option position cannot be liquidated, unlike a leveraged perp position whose returns will always be path-dependent due to that liquidation risk.
The Option Selling, Squeeth and Straddle strategies all fail to generate any meaningful trading returns:
- Option Selling: Only have weekly yield available for trading and since one has to fully collateralise option sales (at the moment) only achieve 1x exposure to price moves.
- Straddle Buying: Half of the premium will always be lost, the market has to move significantly in 1 week to just recover the initial premium
- Straddle Selling: Similar reasons to option selling
- Squeeth: Meagre returns since it only provides 2x leverage (delta of ETH^2 is 2xETH), although it does provide added convexity for large moves it comes at a cost via funding.
It’s clear that the option purchasing strategy has the potential for outsized gains however the incorrect signal direction is more costly for the option strategy as the weekly premium paid is forfeited.
Further investigations are performed to further optimise the option purchasing strategy when using the momentum signal.
Option Purchasing Returns Analysis
The weekly returns of the option purchasing strategy are analysed by plotting them against various option related parameters. These include:
- Implied Volatility (IV): the main determinant of an option price
- Realised Volatility (RV): a measure of how volatile an asset has been, realised volatility in the period preceding that week's option trade is used
- ETH DVOL: Deribit’s volatility index (VIX equivalent) for ETH which is an average measure of implied volatilities for various strikes
- ETH DVOL - Realised Volatility: The difference between DVOL and Realised Volatility
Of particular interest is the last charts showing weekly trading returns vs the difference between DVOL and realised volatility. For the option strategy, the majority of positive returns are clustered in the middle of the (DVOL - Realised Volatility) x-axis.
On the right-hand side of the x-axis are areas where DVOL (an average measure of average option IVs) is much higher than realised volatility. One can say options are expensive in these areas as the market needs to move significantly more than it has been in order to just recover the option premium. In these weeks purchasing options may not be the best trade
On the left-hand side of the x-axis are areas where realised volatility is higher than implied volatilities - typically this means the market has just had some very large move. In these areas, it makes sense that our momentum signal will perform poorly since the market is not trending in one direction but rather having large fluctuations. In weeks when there is less confidence in the signal, it is preferred not to trade options given the possibility of losing the entire interest amount.
Volatility Regime Dependent Strategies
Based on these findings, 2 improved strategies are implemented to test how the strategy performs when filtering trading based on the volatility regime.
- In weeks where the DVOL premium is an outlier no trade is taken; in all other weeks options are purchased (denoted Options Buyer++).
- In weeks where the DVOL premium is an outlier the current perp strategy is used; in all other weeks options are purchased (denoted Options+Perp).
Adjusting the option strategy in weeks where the DVOL premium is outside of the range provides promising results.
Doing nothing in those weeks gives similar results to executing perpetual future trades in those weeks. Importantly, the trading alpha is significantly improved by using options in the weekly trading strategy and provides a 1.4x boost to the base yield.
The below conclusions are drawn from our backtesting analysis:
- Although ETH base yields are lower than stablecoin yields, the high-level strategy of using the weekly yield from ETH deposits to take leverage bets on crypto prices can still provide enhanced returns.
- It is imperative for a vault to have the flexibility to take advantage of both up and down price movements in order to provide returns throughout market cycles. Bi-directional vaults outperformed static directional vaults for all strategies tested.
- Using a Squeeth based, option selling or straddle based strategy does not provide any meaningful trading returns as leveraged exposure to price movements is limited.
- Using a simple options purchasing strategy provides similar returns to the enhanced perpetual future strategy.
- Adjusting option purchasing activities based on the volatility regime provides a significant boost to the trading returns with base yields being enhanced by 1.4x without having to put underlying capital at further risk.
All backtest code and data used can be found here.
DegenVaults are unaudited experimental strategies. Investors that are resistant to such degen-like products are hence gated and the vaults are currently accessible over and above the 420 KARMA threshold. Meanwhile, audit formalities are scheduled to happen this forthcoming months of Q2.
Even as a DeFi degen, investooors are recommended to thoroughly navigate the docs before apeing in. Some of the strategy risks are highlighted below:
- Momentum signal accuracy degradation: vault returns will underperform if the market direction is poorly predicted. [Brahma continuously looks to improve signalling and provide more attractive payoffs]
- ETH liquid staking token pegs: ETH will be deployed to the ETH/stETH curve pools and staked on Convex. The strategy will suffer capital losses if any stETH loses its peg to ETH. [Pool liquidity will constantly be evaluated and Brahma will look to diversify the pool exposure going forward if necessary]
To conclude, The ETH Maxi DegenVault will deploy ETH deposits to the Curve stETH/ETH pool and stake LP tokens on Convex. The weekly yield will be harvested and, provided that implied volatility premiums are in range, used to purchase 1 week ATM ETHUSD options on Lyra Finance. Call or put options will be purchased based on a simple momentum signal. This strategy has been shown to provide a 1.4x boost in the base ETH yields without putting further capital at risk.
ETH Maxi DegenVault goes live on the 28th of April 2022 at 2 PM UTC with a TVL cap of 333.33 ETH🙏🏼
Time to ape them ETH bags and make your way to the citadel.
While you’re at it, Brahma is rewarding the fastest set of depositooors that tip the vault, a distributable bounty of 10,000 KARMA points. KARMA will be vested over a period of 6 weeks and will be distributed proportionately.
Until then, make sure you check your KARMA to be eligible for vault access. May the 420 be with you!
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Disclaimer: The content of this post is provided for informational purposes only.
This article is not an offer of securities, an invitation to sell or a recommendation to subscribe for or purchase any securities, and it has been prepared without any consideration of particular investment objectives. Nothing herein constitutes investment advice or recommendation. Nothing on this site should not be relied upon as a basis for making an investment decision.