๐ฉบFractality Investment Methodology
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Goal
Fractality Yield Vault seeks to deliver high yield (~20%) to users with limit risk (drawdown of ~2%) plus low cost (no need for high frequency trading).
Investment Instruments
We focus on Defi. The income sources are categorised into:
Mining/Staking
Borrowing/Lending
DEX and Liquidity providing
Speculation
Fractality Yield Vault product uses the first 3 categories to source yield, while for pure speculation, we believe users can do it themselves effectively after research.
Methodology
Fractality targets to deliver high yield with low risk and low cost. We work to effectively address the trade off between:
DEX and Liquidity providing: this category gives higher yield ( like~20% or more), but comes with high market risk or impermanent loss.
Borrowing/Lending: this category generally gets lower yield (~5% to 10%), and with low risk and higher liquidity (support real-time withdrawal).
Our method includes both analysis at both macro and micro level on choosing the most suitable chain/protocol, plus quantitative analysis to hedge off the downside risk. Chart below describes our method.
We then give more explanation on each component.
BTC Cycle Estimation
BTC (or other crypto currencies) is a highly speculative asset, with its value strongly linked to Central Bank monetary policy (interest rate, QE, โฆ), especially US Federal reserve. Estimating where we are in the cycle can help both boost yield and reduce risk.
Note that we believe mainly BTC (and to a lesser extent, ETH) is driven by monetary policy, while other assets are mainly by speculation. Those other alter coins assets tend to have shorter and more volatile up/downs (which may be 1 off instead of cycle). Therefore, this section focuses on the BTC cycle.
Cycle estimation is an art, depending on many factors (can be conflicting to each other). We choose factors in 3 categories and evaluate them qualitatively:
Monetary policy, where lower interest rate or QE tends to increase btc value.
Amount of resources like stablecoins: it can measure the level of real intention to participate. (effective demand)
Leverage or price volatility: catalyst of bull/bear cycle.
At this stage, we are using the factors below to estimate the Cyble:
US Interest Rate (3M, 2Y, 10Y)
Stablecoins total circulation amount
BTC dominance ratio
BTC price volatility
AAVE USDT/USDC borrowing rate
Crypto market liquidation amt (as estimate of leverage in system)
Below is an example on 2024 Sep, where interest rate is down, (combined with other factors) suggesting we can have higher exposure to LP (like 50%) vs lending. Examples related to other factors can be found at end of this article.
Quantitative analysis and Hedge
Quantitative analysis is used to decide on % of LP allocation, its range, and amount of hedge needed. The factor we consider includes:
The Market is bull/bear (result from previous analysis)
The target yield we want to get (like 20% or 15%). Higher yield needs a larger LP %.
The maximum drawdown risk. This is controlled mainly by
Direct hedge, by shorting the underlying market), and
Statistical hedge, by allocating to protocols that tend to gain when the market is down).
Below is a chart on hedge we use when the market expectation is bull.
We under hedge in this case, to ride on the potential bull cycle.
The hedge reduce the drawdown from 15% to 10% when underlying token drops 20%
Consider 50% allocation, drawdown further reduce to 5%.
A wider range will further reduce it to 2.5%.
Protocol Fundamental Analysis
The analysis is on protocol safety and their economics.
On Safety
The biggest risk of our strategy are:
Defi protocols get hacked or rug pulled.
The tokens we provide liquidity reduce to zero.
Detailed protocol evaluations are not provided here. We protect our userโs asset by:
Only use top protocols: AAVE, Uniswap, GMX, Pendle, Hyperliquid (for hedge). And we are evaluating Jupiter Kaminos, and Aerodrome
Only deal with strongest tokens, and not Meme or pure speculation tokens. We currently only have exposure to BTC, ETH, SOL, USDT, USDC, PYUSD.
We cap the allocation to risky protocols by 5% each.
On Protocol Economics
This analysis is to find out blockchain/protocols with real yield. Through our study,
Ethereum (L1/L2), Tron and Solana are the top chains with fee income.
Within Ethereum, DEX is the top DeFI producing ~32% of all fees, with Uniswap at the top (see an example table below).
Derivative exchange protocols fees are way lower than spot DEX (~1/10th). However, they provide needed hedges.
As of Aug 2024, Fractality uses DEX, and derivatives Dex, lending/Staking to achieve balance between high yield and high liquidity.
Example: Fractality Analysis on Aug 2024
Macro analysis - BTC Cycle
BTC cycle estimate: Bull.
Details are:
US interest rate change in Aug 2024. Chart already given in section BTC Cycle Estimation.
Stablecoin circulation amount (USDT, USDC, DAI) also indicates the bull market.
BTC dominance ratio: we are at middle level, meaning the bubble in the market is not at a high level.
BTC price volatility,
AAVE USDT borrowing interest rate. The rate is only around 4%, below the 1 year average of 9%. This indicates that the leverage in the cryptoin crypto market is not high.
Crypto liquidation amount reported. There have beenare periodic high liquidation loss in past a few months.
Fundamental Analysis - Chain/Protocol returns
Note that smart contract safety is done separately. Here we focus on potential returns.
Chain fee income of past 1 year. We can see only Ethereum and Solana have meaningful income. (We focus on Defi hence removing the Bitcoin and Tron chain).
Top Dex protocols by fee. Top protocols includes Uniswap (and it forks), Raydium and Aerodrome for now.
The end. Enjoy. Keep growing.
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