An In-Depth Look into Our Methodology

Our approach includes both macro and micro-level analysis to select the most suitable chain and protocol, along with quantitative analysis to hedge downside risks. The chart below illustrates our method.

Investment menthodology

BTC Cycle Estimation

BTC (or other cryptocurrencies) is a highly speculative asset, with its value strongly linked to central bank monetary policy (interest rates, QE, etc.), especially the policies of the US Federal Reserve. Estimating where we are in the cycle can help boost yield and reduce risk.

We believe that BTC (and, to a lesser extent, ETH) is primarily driven by monetary policy, while other assets are mainly driven by speculation. These altcoins tend to experience shorter and more volatile fluctuations—often one-off events rather than part of a broader cycle. Therefore, this section focuses on the BTC cycle.

Cycle estimation is an art that depends on many, sometimes conflicting, factors. We choose factors in three categories and evaluate them qualitatively:

• Monetary Policy: Lower interest rates or QE tend to increase BTC's value.

• Resources (Stablecoins): The total circulation of stablecoins can measure the level of genuine participation (effective demand).

• Leverage/Price Volatility: These act as catalysts for bull/bear cycles.

At this stage, we are using the following factors to estimate the cycle:

• US Interest Rates (3M, 2Y, 10Y)

• Total circulation of stablecoins

• BTC dominance ratio

• BTC price volatility

• AAVE USDT/USDC borrowing rates

• Crypto market liquidation amount (as an estimate of leverage in the system)

Below is an example from September 2024, when interest rates were low. Combined with other factors, this suggests that we can have higher exposure to LP (around 50%) versus lending. Examples related to other factors can be found at the end of this article.

US Treasury Yield/Date

Quantitative analysis and Hedge

Quantitative Analysis and Hedge

Quantitative analysis is used to determine the percentage of LP allocation, its range, and the amount of hedge needed. The factors we consider include:

• The market condition (bull/bear), as determined by previous analysis.

• The target yield we want to achieve: higher yield requires a larger LP percentage.

• The maximum drawdown risk, which is primarily controlled by:

  • A direct hedge by shorting the underlying market, and

  • A statistical hedge by allocating to protocols that tend to gain when the market is down.

Below is a chart on Below is a chart illustrating the hedge we use when market expectations are bullish.

• We under-hedge in this case to capitalize on the potential bull cycle.

• The hedge reduces the drawdown from 15% to 10% when the underlying token drops 20%.

• With a 50% allocation, the drawdown is further reduced to 5%.

• A wider range further reduces it to 2.5%.

Hedge to reduce the impairment loss

Wider range reduces the impairment loss (it comes with a trade off against capital efficiency or fee yield)

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 value &/or liquidity.

Detailed protocol evaluations are not provided here. We protect our users’ 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, derivatives DEX, and lending/Staking to achieve balance between high yield and high liquidity.

Ethereum top apps by fees (source)

Example: Fractality Analysis on Aug 2024

Macro analysis - BTC Cycle

BTC cycle estimate: Bull.

Cycle parameters and their indication

Details are:

• US interest rate change in August 2024. Chart already given in section BTC cycle edstimation.

• Stablecoin circulation amount (USDT, USDC, DAI) also indicates the bull market.

Top three stable assets per market cap & their total circulation over time

• BTC dominance ratio: We are at middle level, meaning the bubble in the market is not at a high level.

BTC dominance ratio

• BTC price volatility:

Bitcoin price volatility over time

• 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 crypto market is not high.

AAVE USDT borrowing interest rate over time

• Crypto liquidation amount reported. There have been periodic high liquidation loss in past a few months.

Liquidations over time in crypto market

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).

Fees per chain

• Top DEX protocols by fee. Top protocols includes Uniswap (and it forks), Raydium and Aerodrome for now.

Fees per protocol

The end. Enjoy. Keep growing.