Behind the Product #4 — Leverage & Hedge with Stablecoin
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Behind the Product #4 — Leverage & Hedge with Stablecoin

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Behind the Product #4 — Leverage & Hedge with Stablecoin

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MeterUSD, a.ka. USM, the stablecoin, the core product of Standard Protocol is just around the corner. If you have not tried our testnet on Rinbeky, I strongly encourage you to get yourself prepared, as our Metis production version is now counting in weeks. Meanwhile, let’s take some time to talk a bit about what an overcollateralized stablecoin protocol can do, especially to those might be new to this area.

In fact, it’s much more that just a pegged token for locking profit.

It all starts from borrowing

In general most algorithmic stablecoin these days, be it requiring over-collateralization or just fractionally backed, it requires some level of collaterals to mint the stablecoin. In fact, this has been just a mechanics to let users to borrow a numbers of claim-to-be-pegged token with certain reputable assets, like ETH, and this is where the intrinsic value of most stablecoins come from, which create both a financial and cognitive understanding that this token is believed to be at least tradable at the pegged value when regulated algorithmically through each of their grand design.

If you think about it, it’s pretty much like mortgaging your house so that you have the cash for other financial needs. In Defi, this is a very similar thing, with a twist — you have a lot more to do with what you have borrowed.

Let me show you two basic use cases that you may do with the USM you have minted.

Think like a Degen

First of all, not a financial nor investment advice. (oh believe me this worth it’s own line.)

Jokes aside. two basic mindsets for a Degen: Profit Maximiser and Lose Minimizer. When we have a borrowing mechanics, we can now easy apply two different strategies during a different market conditions to achieve these goals, through leveraging and hedging.

Maximizing Gain with USM

This is not a unpopular knowledge to most of you: you use a smaller capital to gear for a high gain. This can be in fact achieved throughout most of the collateralization-based stablecoin protocol. The idea is, when you’re longing a asset, like METIS, you can consider to use it to borrow USM, then use the USM to buy more METIS. This will put you into a leverage position that price movement will have much higher impact to your profit gains (and lose!).

Here’s an example.

  • Assuming METIS/USD at $100 and you have $1,500, i.e. 15 METIS in total
  • You collateralize all METIS at 150% collateralization ratio, mint $1,000 of USM and got yourself a CDP
  • you use the $1000 borrowed to purchase 10 more METIS. now you own 25 METIS in total.

After these, assuming METIS/USD is now at $120, a normal HODLer will yield a $300 profit but if you apply leverage as above, your 10 METIS will now be worth $1200. After repaying the $1000 and get back the 15 METIS, your total profile will be $200 + 15 * (120–100) = $500. in such that case you have maximize your profit for the same capital.

But of course, the downside will also apply the same leverage, so more loses. Hence this is a considerable tactics when you’re optimistic on the price of collaterallable assets.

As of writing there’s no perpetual future or options that allow 5x or even 10x leverage on Metis yet, so someone might find this useful.

Minimizing Lose with USM

What about if you are pessimistic to the price of a fundamentally strong asset in the short term? Some people might consider to short the assets now and hoping for a gain when it really dropped, but there are so many instrument in Defi, and what you might really want to do is using the same mechanics to mitigate the risk to the stablecoins.

Example as always.

  • Assuming METIS/USD at $100 and you have $2,000, i.e. 20 METIS in total
  • You collateralized all 20 METIS at 200% ratio, minting $1,000 of USM and got yourself a CDP.
  • Now, swap 50% USM to USDC and enlist the total of $1,000 LP on a DEX with 4% yield.

Says METIS/USD go downs by 20% down to $80, unless you short your asset otherwise your booking value is $400 at lose. For Degens, now you have additional 4% of yield that coming from farm. As long as your CDP is healthy (i.e. far away from liquidation threshold), you are yield a small amount to compensate your lose.

An aggressive player in this situation would be even consider to deleverage partially their CDP in this situation.

  1. withdraw the $1,000 LP
  2. use $400 to buy 5 METIS from the market,
  3. spend the remaining $600 to repay for 12 METIS
  4. and leaving 8 METIS in CDP

After such operation you will have 25 METIS in total with 8 of them locking within the CDP at 160%. Of course one may simply use all of those $1000 to buy back from the market and netting a $600 on paper, yet this approach may be more risky as if the collaterals asset continue to go down, you won’t have sufficient capital to redeem your CDP. Here’s an illustration gains on booking value.

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Hedging with stablecoin by bearing liquidation risk.

What Self-sovereignty means in action

Regardless which tactics you wish to apply above, you are in fact risking a higher loses when your CDP being liquidation. At this point, normally this is where your Defi strategic plan might end for most stablecoin protocol, as you can only choose when to payback and get back the collaterals before “things get ugly”. But not in Standard Protocol.

The unique beauty of Standard Protocol is its self-sovereign design, as detailed in our CDP NFT and seamless liquidation process. Since our CDP are designed as NFT that owned by borrowers, in the sense that you can actually trade your CDP when you see fit. This open up some new options to Degens. Taking the last example, if you have partially payback that $400 of your loan (which should already net your booking profit zero during a crash of METIS, the collateral, from $100 to $80), rather then just sitting there and let the market to decide when you should payback the rest of the CDP, you can in fact consider to sell your CDP to others who hold an opposite belief as you. In this way, you no longer need to repay with USM so as to retrieve your collaterals back, you just need to sell your CDP with a price tag in your collateral, METIS in this case.

To facilitate the secondary market of CDPs, the first of its kind in the current Defi landscape, we have pinned down our resources on developing a CDP marketplace on our DEX in coming months. Once ready, non-tech savvy users will have much more convenience and transparency to utilize our unique stablecoin protocol design.

Final Words

Putting stablecoin protocol back into perspective as being a mortgaging tool will open up opportunities to both upside and downside, as long as you understand the intrinsic risk (i.e. liquidation risk). Still, provided that there’s different view from different investors in the market, you should have more tools to articulate your position whenever you need to, however you want to.

That’s why being a self-sovereign protocol is the key for building a Web3 currency. Or, maybe even a Web3 bank.

That’s, the Standard Team ambition.