Neutral market exposure
Single token exposure in a two tokens pool
Last updated
Single token exposure in a two tokens pool
Last updated
Under normal circumstances, an investment in a liquidity pool needs two deposit tokens to operate. This double exposure is very complicated to master for most DeFi investors. This is why, at Lobster, we have found a solution to cancel exposure to one of the two tokens in the pool. This is the concept of a neutral market strategy.
In order to cancel exposure to one of the two tokens, Lobster uses a lending protocol. By collateralising part of the deposit token, we can borrow the second token.
This second borrowed token is not part of the exposure of your position. As the loan is made in the currency of the second token, if its dollar value rises, you will also have a higher dollar debt on the lending protocol. Therefore, this will cancel out the benefit of the price rise. On the other hand, if the dollar value of this loan token falls, you will have to repay less on the lending protocol (in dollars) because your debt will be lower. In the end, this will not cause you any loss of funds.
Here is the general workflow of Lobster strategies, in the case of an ETH strategy using an underlying BTC/ETH liquidity pool :
Having borrowed this second token, we now own two. We can now participate in a liquidity pool requiring two deposit tokens.
Even if the above workflow allows Lobster to control a different exposure than the one of the deposit token, the strategy itself is not always neutral due to the nature of an investment linked to market making.
Indeed, if you try to be 100% neutral on the deposit token, you will ultimately underperform a flexible strategy. Our backtests and all our mathematical studies have proven that many times. In fact, a strategy that anticipates changes in the relative intrinsic price of the two assets within a liquidity-providing strategy is much more effective. To benefit from these market variations, the position should not be totally neutral.
The second reason is obviously impermanent loss. When the intrinsic price of the two tokens in the pool varies, your exposure to them will also vary over time. In order to remain neutral, you will have to carry out an incalculable number of swaps to recover your initial exposure, and this is not always profitable. The best way to handle this situation is to compose with these variations and avoid excessive swaps.