Pseudo Delta Neutral Yield Farming- How Important is Rebalancing?

My Experiment

Price at time ‘t’ depends on: the price at time ‘t-1’, the expected return (mu), the expected standard deviation (sigma) , and a random variable (Z)
Z is just the standard normal random variable

Rebalancing Strategies Tested

  • No Rebalance — This one is simple, set it and forget it. This strategy initially set up a delta-neutral position at time 0 and let it go for the entire 365 days for every trial
  • Daily Rebalance — This is simply rebalancing at the end of the day ‘t-1’ (or you could think of it as beginning of the day ‘t’). This rebalance occurs every day for 364 days
  • Weekly Rebalance — This is rebalancing each 7 days, starting on day 7, then 14, etc.
  • 5% Threshold — This is basically rebalancing of you Assets / Equity (leverage) is outside of the band 2.85–3.15 (3+/-( 5% * 3)). This is very similar to rebalancing when the price of the risky assets has changed by 10% relative to the last time you rebalanced
  • 1% Threshold — This is basically rebalancing of you Assets / Equity (leverage) is outside of the band 2.97–3.03 (3+/- (1% * 3))
  • Hodl — This is just hodling 50% of your total equity in the risky token and 50% in the stablecoin (so if initial equity is $200, $100 in risky and $100 in stablecoin)
  • Yield Farming — This is just normal unlevered yield farming using the same initial equity amount (so if initial equity is $200, $100 in risky and $100 in stablecoin).

Model Assumptions

  • Yield = 40% (unlevered), Borrowing Rate on both tokens A and B = 20% (unlevered).
  • The expected return of token A is 20% annualized.
  • The expected standard deviation of token A is 100% annualized.
  • Token B is a stablecoin pegged to the US with an expected return and expected standard deviation of 0% (perfectly stable).
  • Token A starts at $100 USD and token B starts at $1 USD.
  • 1000 trials are run, and in each trial: each day new profit/loss is calculated for the entire 365 day period.
  • You initially supply $200 USD worth of token B (200 token B).
  • You initially apply 3x leverage (so borrow $400 worth of both tokens, which leaves you with $600 of total assets). You apply leverage so that 75% of your borrowings are in token A (borrow 3 tokens) and 25% in token B (100 token).
  • No fees are taken into account, no swap fees or transaction fees. (This is important, because fees would eat into your rebalancing P&L… shame on this author).
  • There is no liquidations. P&L can be negative.

Results

Histogram of Token A prices at the end of the period (t=365) across all 1000 trials

Summary

Appendix A

Expected Return 0%, Expected Standard Deviation 100%

Expected Return 20%, Standard Deviation 50%

Expected Return 20%, Expected Standard Deviation 150%

Expected Return 40%, Expected Standard Deviation 100%

Expected Return 0%, Expected Standard Deviation 100%, Yield Farming Yield increased to 80%

Expected Return -20%, Expected Standard Deviation 100%

Appendix B

Appendix C

About the Author

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TradFi background, DeFi Degen. Love SOL, ADA, ETH, DOT, NEAR, Aurora, ALGO, MIOTA plus NFTs

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Marco_112358

Marco_112358

TradFi background, DeFi Degen. Love SOL, ADA, ETH, DOT, NEAR, Aurora, ALGO, MIOTA plus NFTs

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