Building Blocks

Overview of the simplest components of a DeFi vault strategy

A simplified view of the different strategies possible in DeFi involves segmenting them along liquidity, risk and leverage dimensions:

• Liquidity

  • Instant: deposits are available on-sight

  • Term: deposits are partially invested for a longer period

• Risk

  • Prime: solvency risk is mitigated through collateral selection

  • High Yield: higher solvency risk through higher-risk collateral

• Leverage

  • No leverage: 1x, i.e. gains and losses track linearly

  • Moderate leverage: 1-2x, i.e. some portion of the equity in a position is borrowed against to magnify gains and losses to a limited degree

  • High leverage: >2x, i.e. a significant portion of the equity in a position is borrowed against to magnify gains and losses to a large degree

From these dimensions, various strategies are possible:

• Repo (overcollateralized lending)

  • Instant liquidity

  • Prime or High Yield risk

  • No Leverage

• Term (liquidity is locked for a period)

  • Term liquidity

  • Prime or High Yield

  • Any degree of leverage

• Carry (borrow low lend high)

  • Term liquidity

  • Prime or High Yield

  • Typically No Leverage or Moderate Leverage

• Looping (borrow low lend high with correlated assets)

  • Term liquidity

  • Prime or High Yield

  • Typically High Leverage

Many crypto strategies exist with complicated names (delta-neutral, basis trade, hedging, derivatives, etc) which mostly reduce to one or more of the above categories. For example, a basis trade strategy involving going long (buying) spot and going short (selling) a futures contract is a complicated form of Carry that bets on the 'lending rate' of the futures leg to be positive (depending on the market direction).