The vault’s mandate is to double down on the amount of base asset it holds (going into USDC debt), while hedging away the excess exposure via short perps to remain delta-1.
As such, the vault depositors should expect the vault’s share price to be close to 1 unit of their deposit asset (e.g. 1 LBTC) at all times, which further grows at a rate of (base asset APY + perp funding APY - USDC borrow APY). This strategy is ideal for people who have LBTC, want to hold LBTC, and want more LBTC (or other LRT/LST).
Lifecycle
The vault’s lifecycle flow is very straightforward:
The vault will launch with some amount of the base asset deposited into it (e.g. TVL of 100 LBTC)
The vault sends bids to buy more base asset in small sizes (e.g. if the vault aims to buy a total of extra 100 LBTC, it will send orders with size 1 LBTC and price equal to fair value of LBTC)
Whenever a fill is detected, the vault will hedge by selling perps (in case base asset was bought) or buying perps (in case base asset was sold) to keep the delta at 1.0
The target leverage is tentatively set to 2.0 (i.e. the vault with TVL of 100 LBTC will aim to hold 200 LBTC as base and hedge with an amount of BTC perps to keep the net delta at 1.0). However, as LBTC yields, funding, and USDC borrow rate shift unfavourably, the vault may adjust it’s target leverage to a lower number to stop further accumulation, or start exiting the trade. In that case the vault will sell some base asset, and will keep hedging to keep delta at 1.0 at all times.
Spot Trading
Vault’s spot trades will be executed on Derive’s orderbook. The vault will aim at minimizing execution losses and slippage by continuously posting bids at fair value of LBTC. In other words, the vault will act as a market maker of the spot asset.
The vault expects retail users to sell their LBTC into it when those users need to close USDC debt. Liquidators who take on LBTC from liquidated users would also be able to offload this asset into the vault. Finally, traders running algorithmic arbitrage strategies will be able to fill the vault as part of their strategies.
Pricing
Fair value of the spot asset will be calculated via:
A ratio of LRT/LST to the base asset (e.g. LBTC/BTC) from chainlink
and a base price implied from live orderbook subscriptions (e.g. Binance mid-prices).
Extra guardrails will be in place in case of large deviations of price ratios - the vault will avoid trading during volatile times.
Then the price the vault will bid at is simply the fair_value * (1 + spread), where spread can be zero, or sometimes a slightly larger number (e.g. 5bp) to incentivize sellers.
When asking instead, the spread can be slightly negative to incentivize buyers.
Additionally, the vault must satisfy on-chain guardrails, such as not selling too cheaply or not buying too expensive, relative to the mark price on the derive chain. The vault will cap / floor its prices at e.g. +/- 1% of the mark price.
Finally, the vault has to comply with an additional pricing guardrail that prevents the vault from doing too many bad trades over a short time period. On-chain, the vault tracks an exponentially-weighted average mark loss over the last hour, and reverts a transaction if the loss exceeds a limit of e.g. 20bp of TVL. The loss is calculated simply as +/- (limit_price - mark_price) x amount , sign being determined by it being a buy or a sell.
Sizing
The vault will be placing bids as long as it’s current leverage is below target leverage. The maximum size the vault can bid is limited by the on-chain guardrails on the delta of the vault.
For example, if the vault’s TVL is 10 LBTC and its positions are 15 LBTC base, -$500,000 USDC (1.5x leverage), and -5 BTC perps, the vault has a delta of 1.0, calculated as (15 - 5) / 10, i.e. (base_delta + perp_delta) / tvl. If delta limit is set to 1.01, then the maximum size the vault can bid is the x that satisfies 1.01 ≤ (15 + x - 5) / 10, i.e. 0.1 LBTC. The vault’s delta limit will typically be set a bit more conservatively than the on-chain limit (e.g. on-chain limit could be 1.02 and vault will trade as if it is 1.01).
Target leverage will also be checked by the vault in determining size, e.g. in the above example and assuming 2.0 target leverage, the maximum additional spot position the vault would want is the y that satisfies 2.0 ≤ (15 + y) / 10, i.e. 5 LBTC. Note that the vault defines leverage as purely the spot leverage, namely spot_position / tvl, e.g. owning 20 LBTC while having 10 LBTC TVL corresponds to 2.0 leverage.
Perp Trading
Vault’s perp trades will also be executed on Derive’s orderbook. Similarly, the vault will try to minimize execution losses and slippage by continuously posting orders at mid-market, however since perp liquidity tends to be much more reliable than spot liquidity, market orders might also be acceptable.
Pricing
Unlike the spot asset, pricing is easier for perps due to much better liquidity. The vault will be using a combination of derive’s orderbook and an external source (e.g. Binance live orderbook feed) to determine far value of the perps.
Similar to spot, the vault needs to comply with equivalent guardrails of
Not exceeding price limits
Not exceeding EMA of the mark loss
Sizing
The vault will trade perps when the delta limit is reached from trading spot assets. For example, if the current delta is 1.01 with 15.1 LBTC, -5 BTC perps and 10 LBTC TVL, the vault will calculate the desired perp delta as x that satisfies 1 = (15.1 - 5 + x) / 10, i.e. -0.1 BTC. Note that this yields the delta that the vault aims to close, to get to the actual perp position that the vault wants to enter, the delta will be adjusted by the LBTC/BTC ratio, but it is assumed to be 1.0 in this example.
Since leverage is unaffected by the perp trades, it does not need to be checked.
Smart Contract Guardrails
To summarize, there are a few on-chain smart contract guardrails that ensure that the vault behaves as mandated. Those are:
Leverage bounds that make sure the vault does not exceed e.g. 2x leverage (or goes below 0.9 leverage) in the spot asset.
Delta bounds that ensure that the vault mimics the price performance of holding exactly 1.0 unit of the base asset, within +/- 2% tolerance
Price bounds that make sure the vault does not sell spot or perps too cheaply or buy too expensively.
Loss bounds that make sure that the vault does not lose some % of TVL due to bad trades, on a per-hour basis.