By Jon Queen, CAIA, CFA, is the Business Development Director for Eco-Elta.
The Decentralized Finance (DeFi) universe has greatly expanded in recent years and is rapidly developing at an increasing rate. This has opened the door to a higher sophistication level and more diverse set of investment opportunities in the cryptoverse, beyond merely speculating on coins and taking simple buy/sell/HODL views on coins or tokens. (“HODL” is an acronym for “Hold on for dear life.” You often see the term in various cryptocurrency forums and social media circles.) This short article introduces some of DeFi’s latest developments for your consideration. However, it is not meant to provide an exhaustive or complete in-depth summary of DeFi’s gradual convergence with traditional finance; nor is it intended as an endorsement of any specific platforms or protocols below. If you are interested to learn more about any of these topics, you should conduct further due diligence and additionally read the project documentation available on the websites provided in parentheses below.
Going Long/Short Cryptocurrency, Buying Options and Using Leverage
One of the main limitations to crypto investing through common platforms like Robinhood (www.robinhood.com) or CoinDesk (www.coindesk.com) is that you are mostly limited to pure “buy low, sell high” types of investing or trading. There can be significant opportunity from such “long only” strategies given crypto’s famously high levels of price volatility. However, such strategies miss out on the value to be gained from negative price movements and increasing or decreasing volatility levels – this is where call/put options, shorting and applying leverage can add missing pieces. DeFi now has a growing set of tools that allow investors to capture the value of volatility and price movement in either direction in a more sophisticated way; market participants can benefit if prices go down instead of simply wondering if it’s time to buy the dip.
Some of these new DeFi tools can be found on the Synthetix platform (www.synthetix.exchange). Investors can gain either long or short exposures to most main cryptocurrencies and tokens by buying either a “synthetic” (long) or an “inverse” (short) version of the same. Buying Synthetic Bitcoin, for example, provides a long exposure to Bitcoin without actually having to buy Bitcoin on an exchange – while buying Inverse Bitcoin provides a short exposure to Bitcoin where the value of your token increases when the value of Bitcoin declines. You can take similar positive or negative views on Ethereum, Ripple, Cardano, Litecoin, Monero, Dash and several other leading coins and tokens. In this manner, you can take positive or negative views on the market and capitalize accordingly.
Platforms such as OKEx (https://www.okex.com) and Deribit (www.deribit.com) allow users to purchase call or put options on Bitcoin and Ethereum, with leverage. On the dYdX platform (www.dydx.exchange), investors and traders can connect their crypto wallets and buy Ethereum on up to five-times leverage. You can also “short” Ethereum on dYdX by borrowing a fixed amount of Ethereum purchased in DAI for a specified period of time, immediately converting that Ethereum back into DAI and later repurchasing Ethereum (at hopefully a cheaper price) in DAI to repay the loan. If Ethereum decreases in price during this period, you will profit by the amount of DAI price difference between when you sold your borrowed Ethereum and when you later repay it.
Borrowing and Lending with Interest
Platforms like Aave (www.aave.com) and Compound (https://compound.finance) allow users to connect their crypto wallets and then borrow or lend a range of popular cryptocurrencies and stablecoins at fixed agreed rates. The collateral required for such loans is stated upfront in the form of a select subset of coins and/or tokens. You can either earn a rate of return for lending coins or tokens on such platforms, or you can earn a return on coin value gains/losses by borrowing on margin and then going “long” or “short” the coin or token (converting immediately to DAI for example, in case you have a short view, and then repurchasing the borrowed coin or token to repay your loan using fewer DAI than what you originally sold it for). There is also the new development of “value added” lenders such as Yield (https://www.yield.app), that publicly offers 12-20% return on loans, and also Alchemix (https://alchemix.fi), that actually seeks to repay your loans for you over time if you borrow with them.
Investing in Synthetic Stocks, Commodities and Currencies
The Mirror Protocol (https://mirror.finance) offers anyone the opportunity to create and trade tokens that synthetically track the prices of publicly traded stocks, commodities, currencies and other coins or tokens in the cryptoverse. The value of these tokens is programmed to track the public pricing data for the underlying asset attached to it. Once a token has been created, you can find it on several exchanges like Synthetix (www.synthetix.exchange), CoinCost (www.coincost.net) or market price data sites such as CoinGecko (www.coingecko.com) or Coinbase (www.coinbase.com).
There are also a growing number new decentralized asset management platforms, such as TokenSets (www.tokensets.com), that allow you to invest in baskets of tokens as a strategy (such as baskets of mirror FAANG stock tokens) or to buy into successful traders’ strategies and benefit from their decision making abilities. The key point to keep in mind is that when you’re investing in tokens based on stock prices, you will not receive dividends since these apply only to actual equity stockholders of record. A second key point for any mirror asset tokens, regardless of whether they mirror stocks, commodities, currencies or other assets, is that their prices may not perfectly track their underlying asset’s price levels or movements. This is because token prices have two elements to them: first, the price of the underlying asset they are designed to mirror; second, the actual supply and demand for that mirror token in the cryptoverse. If you wish to buy or sell a mirror asset token that has either limited supply or limited demand in the cryptoverse, you may find significant price inefficiencies for those tokens that can sometimes skew their pricing significantly.
One of the more interesting developments in DeFi, in my opinion, is the rise of “costless” lotteries, where you can buy tickets for daily or weekly lottery drawings and be refunded the cost of your ticket each time when you don’t win. An example of this is PoolTogether (www.pooltogether.com), where you can buy lottery tickets for regular daily or weekly drawings. When each drawing’s winners are announced, participants either win a payout, are eligible to receive a full refund, or can roll their earlier lottery ticket investment into the next lottery without paying additional capital. The only cost of participation, therefore, is the opportunity cost of your time. Some have theorized that, due to its costless nature, participating in such regular daily or weekly lotteries can, in theory at least, potentially provide a higher expected rate of return than typical crypto lending rates. The risk inherent to such “lottery over lending” approaches is the distinct possibility that you might not win a single lottery over time, while lending provides a more predictable rate of return.
The world of DeFi is steadily growing each month, with the range and types of asset classes, tools and derivatives expanding even as I write this article. As with any crypto investment or trade, there are different levels of important risk considerations including market risk, tracking risk, counterparty risk, programming risk, security risk and future regulatory risk that everyone must be aware of and keep in mind. The goal of this short article simply is to introduce how DeFi allows now allows folks to use crypto to invest and trade in a far more sophisticated manner than HODLing or buying the dip. DeFi now enables everyone to trade and invest in asset tokens that mirror non-crypto markets, take long or short views on the crypto market, buy call or put options, take views on volatility, and to chase yield through either lending or increasingly complex derivative product offerings. The degree of sophistication and creativity within DeFi builds upon itself as innovations and ideas steadily are built on top of existing products to create “money LEGOs.” It is exciting to watch DeFi develop, expand and mature. If you currently are in the crypto markets but feel frustrated at the apparent simplicity of trading strategies currently available to you, I invite you to dive deeper into discovering how DeFi can potentially add new dimensions to your investment and trading strategy!
Like a wine pairing, here are 2 entertaining links to related topics from the Corey Hoffstein and Jason Buck a.k.a. the Pirates of Finance!
- Crypto Cash + Carry Trade:
- (un)Stable Coins:
Part I of the Series:
About the Author
Jon Queen, CAIA, CFA, is the Business Development Director for Eco-Elta (www.ecoelta.com), a blockchain, IT and artificial intelligence company based in Europe. A lifelong learner, Jon has an Economics Degree from Cornell University, a Juris Doctor from The University of Pennsylvania Law School, and an MBA from Kyiv School of Economics. In addition to being passionate about alternative investments and innovation, Jon is a member of the CAIA Rocky Mountain West pre-chapter planning committee where he hopes to continuously enhance CAIA's presence and message in Colorado and its surrounding states.