You can generate passive income using your cryptocurrencies without exposing yourself to market price fluctuations. This is the principle of so-called “delta-neutral” strategies. We will see in this article how to implement this type of strategy with a concrete example, after having seen what it consists of.
The principle of a delta-neutral strategy
The Delta (Δ) is the measure of the change in price of an asset. The purpose of a “delta-neutral” strategy is to neutralize the effect of this variation while obtaining a return. In other words, “delta-neutral” means that the variation in the price of the asset used for the strategy does not affect your performance.
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Setting up a delta-neutral strategy on Mirror (Terra)
Introducing Mirror Protocol
Mirror is a DeFi protocol on the Terra blockchain that enables the creation of synthetic assets called Mirrored assets (mAssets). Massets mimic the price behavior of real-world assets (Apple stock, Coca Cola, etc.). This allows users to gain exposure to changes in the price of these assets in a decentralized way.
We will not go into the general operation of this protocol here, but we will retain this: in order to keep the price of mAssets close to that of reality (peg), Mirror needs users to bet down on these mAssets. To incentivize them to do so, Mirror gives them its governance token (MIR) as a reward. The yields offered are visible in the “Short” column (2) of the “Farm” tab (1).
Presentation of the strategy
The idea of this delta-neutral strategy is to take advantage of the returns offered for the “Short Farm” without being exposed to variations in the price of the mAsset used (ie without actually betting on the decline).
The diagram below summarizes how we will achieve this. It is not necessary to go through Anchor Protocol to be delta-neutral. However, we will still integrate it into our strategy to increase returns.
- Our initial capital is divided into 3 parts.
- We deposit 2/3 on Anchor to receive august.
- Those august are deposited on Mirror to borrow a mActive and put it in the “Short Farm”
- 1/3 of our capital is used to buy the same mActive.
We thus find ourselves in a “delta-neutral” situation. In effect, we immediately buy the same amount of mAsset as we borrow. We will thus be able to repay our debt at the price it cost us!
If we are not afraid of the variation in the price of the mAsset for our return, we remain however exposed to a certain number of significant risks:
- Liquidation risk (see our article on loan): we will take here a collateral ratio of 200% in order to leave us a margin of safety. In fact, the change in the price of mActive has no impact on the return on our strategy but does on our borrowing: if the price of the mActive borrowed increases too much we can get liquidated. The maximum price increase will be calculated according to the mActive borrowed and time spent (the value of our collateral increasing over time – 20% APY from Anchor).
- The risks of hack and smart contract : we are exposed on the Anchor and Mirror protocols
- The risk of losing the UST peg : If the stablecoin UST is no longer worth $1 we can get liquidated faster than expected
- The Oracle Risk : the oracle may not give the “real” outside price of the underlying asset. This can lead to an unforeseen liquidation.
Implementation of the strategy
- Have installed a compatible Terra wallet (Terra Station Wallet, Ledger, Wallet Connect)
- Have UST on his wallet
Deposit on Anchor
We will start here with a capital of $90 in UST (plan for a margin of safety to pay the transaction costs and deal with the premium and price variations while implementing the strategy). We will start by going to deposit 2/3 of it (i.e. $60) on Anchor by going to “Earn” (1) then “Deposit” (2).
After entering the amount, we deposit them on the platform.
In exchange, Anchor gives us august. We can see our deposit appear on the platform.
We will use these august to go for a short mActive on Mirror. To choose our mActive we will look at the history of returns over the last 30 days to choose the most profitable (you can of course base yourself on other criteria)
We will choose here to short mAMD which has returned 22.86% over the last 30 days. To do this we go to the “Farm” tab (1) and choose to short mAMD (2).
We choose theaugust as collateral (1) and deposit those we have in our portfolio with a collateral ratio of 200% (2). We see that the platform will take 1.5% of the amount “ minted »when closing the position (to be taken into account in our profitability calculations). Number of mAMD short is 0.29 (4).
By going to the “My Page” tab, we can see our position appear. We are going to have to immediately buy back the number of mAMD that we borrowed.
There is a price difference in the mAMD borrowed and the one bought and the one sold due to the premium (see our article on the loan). We go to the “Trade” tab and select mAMD versus POSITION then “Buy”.
Returning to the “My Page” tab (1) we see that we have indeed purchased the same number of mAMD (2) than the one we borrowed (3) and are rewarded with VOLUME up to 19.27% (4).
Our delta-neutral strategy is in place. If we go to Anchor we will no longer see a deposit because the august that we had received were redeposited on Mirror. To recover our POSITION you will first have to recover the august on Mirror.
During this time we will have to watch that the price of mAMD does not increase in such a way as to make us liquidate (minimum collateral ratio of 150%).
We can also see from the previous screenshot that in 2 weeks we will be able to claim 34.45 UST which we can redeposit on Anchor to earn more interest or reuse it for something else.
Another strategy is possible to potentially increase the return on your position. You can deposit the USTs you recover in the liquidity pool with the mAMD you own (in the “Long Farm” tab). However, this strategy is beyond the scope of this article because it is no longer delta-neutral. In this case, you will indeed be subject to intermittent losses (see our article: Become an LP Provider).
In our article “Using a Yield Optimizer” we have seen that Aperture Finance allows you to set up this type of strategy automatically. The collateral ratio is also adjusted automatically so as not to be liquidated.
“Delta-neutral” strategies are particularly interesting when the market is undecided. They allow to generate passive income without having to constantly follow the evolution of prices.
If you decide to implement a strategy of this type, take the time to assess the risks to which you are exposed.
Other methods are possible to create “delta-neutral” strategies. We will see in a future article how to set up positions “ neutral pseudo-delta ” on the swimming pools liquidity, i.e. how to take advantage of their return without exposing ourselves to price variations and therefore to intermittent losses.
If you are looking for other ways to generate passive income, you can also check out our previous articles on the loan, staking Where this loan.
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