[Strategy Paper] Overview of Stablecoin Investments 2022

This paper summarises the current stablecoin investments as of December 2022. We have first written a paper back in Oct 2021, which is also listed below, as a reference.

Providing Liquidity in Stablecoin Pools

Providing liquidity mean deposit your stablecoins into a specific pool in an AMM (Curve, Balancer or Uniswap, etc.) For instance, purchase MIM and provide liquidity in Curve’s MIM pool (paired with USDC, USDT and DAI). The yield is the trading fee within that pool, as well as protocol rewards.

When you deposit stablecoins into a DeFi protocol, it’s often possible to have protocols further built upon the original protocol. For instance, the certificate of deposit into a Curve pool, often referred to as Curve LP tokens, can be further deposited in Convex Finance, to receive additional rewards.

The risks in this investment strategy is mainly the protocol risks and the depeg risks of the stablecoins you are exposed to.

Folding or Leveraged Lending

Folding is a term for repeatedly lending and borrowing in the same Defi lending platform. For instance, if you lend USDC in Compound Finance, you can borrow USDC or another stablecoin like DAI, and deposit back to Compound again. This is to take the advance of DeFi protocol rewards, when they are given to both borrowers and lenders with no staking requirements. Below is an example for dForce.

Delta Neutral Lending

This refers to deposit stablecoins into a lending protocol, borrow another token, which can give better yield by other means like staking. For instance, deposit USDC into Aave on Mainnet and borrow ETH, and the borrowed ETH can be used for ETH2 staking or lending on other chains for higher yields.

Delta neutral lending can be used creatively in many cases. For instance, one can borrow CRV to invest into Curve or Uniswap’s CRV-cvxCRV liquidity pools. The development of EVM chains also make it possible to find yield arbitrage opportunities cross-chains.

An alternative way to hedge a non-stablecoin token position is to short that token in dYdX or buy a put option in Ribbon. These are more exotic ways of investment.

Delta Neutral Liquidity Providing

This is an extension of the old strategy “Investment in Uniswap Pairs”. This strategy is deposit stablecoin and borrow another token, and pair it into a Uniswap or other AMM liquidity pool. For instance, deposit USDC to borrow ETH in Aave, and pair it into ETH-USDC pool into Uniswap.

This strategy contains a possible impermant loss component, which cannot be hedged easily and can be hugh if the token price swings largely from the paired stablecoin.

The basic yield of this strategy, ETH-USDC and ETH-USDT pair in Uniswap V2 yields less the derived impermanent loss and hedging costs, are included in our weekly. This is not the best yield you can get using this strategy, this is rather the least you should expect, if you are taking additional risks beyond Uniswap V2 and Binance.

Using this strategy, one can be creative as well, in targeting smaller farms or AMMs on EVM chains. Another alternative will be borrowing two non-stablecoin assets, and use them to form a AMM pair for higher yield.

Funding Rate Arbitrage

The funding rate strategy is the same as last year: buying coin ABC, deposit into the Coin-margined Futures of an exchange like Binance, and short the exact amount.

An alternative way, and probably a more general way of doing this, is to long a token and short a token at the same time. For instance, you can buy ETH and stake it in Lido, and at the same time short ETH in dYdx.

Capital efficiency needs to be calculated here to strike a balance between yield and leverage (i.e. liquidation risks). Also, slippages and trading costs can be huge, possibly reducing the yield materially if one adjusts the portfolio too frequently.

A summary of funding rate information can be found in Coinglass.

Fixed Term Loan Protocols

Defi gets a bit more complex in 2022, and we see developments in Fixed Term Loan Protocols, namely two large ones: Notional Finance and Pendle Finance. The mechanism of these platforms are complex: in a nut shell, they create zero coupon bond markets.

For users, you can either lend into a fixed-term pool, e.g. 3m, 6m or 1y, when the rates are desirable to you; or provide liquidity for these fixed term instruments. Liquidity allows lenders to cash out before the fixed maturity term.

Underwriting Trades, Derivatives and Options

A significant development in DeFi in 2022 is the growth of trading platforms, beyond AMM. Instead of having users pool liquidity for trading, a growingly more popular concept is to underwrite trades. For instance, users first pool USDC liquidity into a protocol; traders deposits USDC as collaterals, and trade tokens like BTC or ETH based on oracle prices, and traders’ profits and losses are settled against liquidity providers.

Therefore, this strategy is basically providing such liquidity in stablecoins, and acts as counter-party for traders, derivatives, and price options.

A popular example is GMX (hedging similar to delta-neutral liquidity providing strategy is required).

Stablecoin Fund Managers

Since the DeFi summer in 2020, we already had yield aggregators like Yearn and Vesper Finance. In 2022, yield aggregators behave more like a fund. Examples for stablecoins are Gro Protocol and Overnight Finance. Gro invests stablecoins pooled from users into Convex pools; Overnight invests into more aggressive protocols similar to our Folding or Underwriting strategies.

Other Things to Note

In 2022, investments in stablecoins have certainly become more complex. Here are a few things to note:

1. Always beware of the counterparty risk, whether DeFi or CeFi.
2. Watch out possible scenarios of deprived liquidity. Protocols, especially leveraged ones, often run into liquidity crunch by design or un-intentionally.
3. Make a judgement on the stablecoins on the collaterals, design and NOT on team promises — against, counterparty risk.
4. It’s possible to self-compose something cool based on more than one strategies above. But always watch out your leverage and exposure.
5. Make use of yield aggregator sites like DefiLlama or subscribe to professional services for a second opinion.

Lastly, good luck for the year ahead!

The Old Paper On Stablecoin Investment on Oct 2021

This strategy paper summarizes the strategies of investing stablecoins, based on our previous Strategy Papers since Nov 2020, and it provides a support to our weekly updates. Our first general strategy overview was in Nov 2020, and subsequently briefly updated in Mar 2021; as our followers might notice, a lot has since changed in this industry. We will continue to monitor this industry and keep it updated. All information is published periodically on our Medium and Twitter.

Investment in Curve and Yearn

Curve now is the biggest platform for stablecoins trading and investments. Yearn provides two services: auto-compound and share of boost. Investing in Curve is as simple as providing liquidity into the different pools; then one can either stake with Curve for CRV or stake with Yearn. In our weekly, we assume that staking with Curve has a boost of 1.5x; this will require locking some CRV for evCRV. Yearn, on the other hand, has a reasonable boost and no lock-up, but charges a fee of 2%+20% like a fund (v2).

We summarize the yield of largest pools in Curve/Yearn, as a reference rate. An average is taken (other than the 3pool) itself.

For details on Curve and Yearn, you can start with our article in the Medium: Curve and Its Investment Value, and the sequent updates.

Investment in Other Stablecoin Platforms

One of the trends over the last six months is that the incentised platforms flourished. Not all of them are dedicated to stablecoins, but quite a number of them provide rewards for depositing stablecoins. Investment in these platforms are basically deposit stablecoins into them. A typical example is Vesper Finance.

Different platforms have different functionalities, e.g. KeeperDAO is to raise funds for liquidators; different yield distribution rules, e.g. mStable requires locking 80% of rewards; different risks, e.g. Frax’s FRAX-USDC pair has exposure to its own stablecoin FRAX. And these are changing all the time, so do refer to our coverage articles for details.

Investment in Other Platforms (Non-USD Products)

Similar to Other Stablecoin Platforms, this category has platforms that accept depositing coins not representing USD, but also stable in nature. For instance, you can deposit EUR stablecoins with Curve or Yearn, for a higher yield than deposit USD stablecoins.

We now accept very few products in this category. Currently there are: gold or silver derivatives from Mirror Protocol and their UST pair; hedged insurance product from Cover Protocol; fixed rate lending product from Ruler Protocol.

Investment in Uniswap Pairs

This is our very first strategy, which was tested during De-Fi summer of 2020. This strategy is not purely on-chain. It requires investment into a Uniswap pair, and hedging the non-stablecoin pair of it. For instance, one can invest in ETH-USDC pair, and hedge the same amount of ETH in Binance. This is not 100% market neutral, as there’s always impermanent loss. The calculation of return is also depending on how much fund is deposited into Binance as futures collaterals. For more details on this strategy, please refer to our early articles: Hedged Liquidity Providing in Swaps (1~4). The same strategy can be applied to any other AMM, e.g. Balancer, Sushiswap, or 1Inch.

Do note that due to the impermanent loss, the yield from this category is not comparable to other strategies.

A variation of this strategy is that one can use Alpha Homora to borrow ETH and leverage this strategy. For details please refer to this article on Alpha Homora. The yield is higher, but there’s also a risk of your vault being liquidated.

Investment in Compound and Leveraged Mining

Another traditional strategy is to borrow and lend stable coins at the same time in Compound (or AAVE in Polygon, Klend on Binance Smart Chain). This is a relatively low risk strategy but the yield are usually low as well. We do not have an article on Compound (as it has never been executed by us in fact, due to the lower return), but you can refer to our article on Cream’s ETH2 staking product for details on the principle of this strategy.

This strategy works when rewards are directly delivered based on lending and borrowing, and no staking is required. For instance, other platforms like WePiggy and Fulcrum do give incentives for lending but staking is required — and staking will remove one’s liquidity out of the leverage, thus defeating this strategy.

Investment in Binance’s Coin Futures for Funding Rates

Last but not least, one can invest in other purely off-chain: buying coin ABC, deposit into the Coin-margined Futures of an exchange like Binance, and short the exact amount. Details please refer to our article: Hedged Futures in CEX. By doing so, there’s no market price exposure (100% hedged), nor there’s liquidation risk (100% pledged). The yield is funding rates, every 8 hours. Theoretically, funding rates can be negative but most of the time it’s around 0.01% per 8-hr, and can go very high sometimes.

We use Binance as the reference exchange for this strategy. Also note that the yield for USDT-margined futures are usually higher but the strategy of arbitraging funding rates are much more complex and risky.

Other Notes and References

We publish the market returns of each strategy on Monday. All yields are APY, i.e. on the assumption that the yield is compounded in not less than weekly basis.

Yields derived from mining reward tokens are based on the prices of tokens on the date of publishing. For instance, Curve’s mining returns are based on the price of CRV on that Monday the update is released. Some yields are cumulative, e.g. Uniswap and Compound’s basic earnings and Binance funding rates, and are actual yields over the last week, compounded weekly to derive the APY.

Some platforms have rewards lock-ups, withdrawal fees, deposit fees, etc. and are not listed in the weekly updates but usually they are mentioned in our articles or strategy papers.

(Serenity Team, 10 May 2021, Twitter: https://twitter.com/SerenityFund)