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V2 Skew Farming

Guide to Skew Farming on Perpetual Pools V2

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Introduction to Skew Farming

If you are completely new to Tracer’s Perpetual Pools, we highly recommend you check out our Perpetual Pools ELi5 article before you attempt to understand skew farming.

Tracer’s Perpetual Pools let users take leveraged directional positions on the performance of an asset by pooling their collateral. The payoffs for the parties taking the long position come out of the proportion of the pool owed to the parties taking the short position, and vice versa. When the proportion of collateral is not 50/50 (evenly split between long and short), the pool is said to be skewed.

When a pool is skewed, the under-collateralized (less popular) side of the pool will experience a leverage on gains which is above the leverage they experience on losses. This imbalance between risk and reward creates an opportunity for traders who know how to take advantage of it - this is known as skew farming.

Profit from skew by playing the odds

To assess the best opportunities, look for those Pools with the largest (positive) difference between effective leverage and advertised leverage. On Tracer’s interface, this difference is observed as the “Effective Leverage” on “Gains” and “Losses”. The leverage on gains floats in accordance with skew, whereas the leverage on losses is always as advertised.

The image below shows a large skew farming opportunity for users willing to take the long side of the pool. They will experience leverage of 8.2x while only risking a 5x leverage on losses.

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By maintaining an offsetting position on another platform you can even hedge away most of the downside risks of your position and generate a return on your capital.

Advanced topics and further details

To reiterate, skewed pools present an opportunity to generate excess risk-adjusted returns. In particular, the strategy involves entering the ‘under-collateralised’ position (taking the side of the contract with the smaller pool share).

Yield

The yield earned from skew farming is a function of the differential between the leverage on gains and the leverage on losses, normalised by the leverage multiplier:

Skew farming ranking = (leverage on gains - leverage on losses)/leverage on losses

To be even more accurate, yield also depends on the volatility of the price feed. If the price data is twice as volatile, the yield will be twice as much given the same skew. For example, BTC/USD is about 80% as volatile as ETH/USD, so a BTC based token with 3.08 gains leverage will be earning less interest than an ETH based market with 3.07 gains leverage, despite having a slightly higher effective leverage.

Impact of SMA pricing

The V2 iteration of Perpetual Pools contracts uses Simple Moving Average (SMA) pricing to dampen data volatility. Despite the benefits to product usability, the new pricing function impacts previous skew-farming strategies. Importantly, it is no longer possible to perform the trade with an exact hedge.

Strategy 1: Delta Minimised

This strategy exploits the skew with an offsetting position (delta-minimised). It involves taking a Perpetual Pools position that benefits from skew, and a position elsewhere that roughly hedges your Pools position. The delta-minimised strategy earns a reliable yield while being almost impervious to capital losses (e.g. it is close to delta neutral).

Strategy 2: Directional Strategy

This strategy exploits the skew with a directional position. It involves offsetting a portion of already held assets for the skew-benefiting position in a Pool. The directional strategy generates yield while the skew is favourable, but reduces exposure to a portfolio asset.


Strategies in Practice

Strategy 1: Delta-Minimised Strategy

Step 1: Get the information

Go to https://pools.tracer.finance/

Step 2: Find the best yield

Calculate the skew farming ranking for each of the pools and assess the best yield option. Also consider the price feed volatility and collateral owed to each party. A large investment in a low TVL pool can have a drastic effect on yield.

Step 3: Check you can access the underlying

You cannot perform this strategy without the ability to enter an offsetting position. Check that the cost of acquiring the opposite position (e.g. buying spot, selling a perpetual swap) is not prohibitive.

Creative ways to trade the underlying and minimise delta will be the avenues through which sophisticated actors generate the most alpha.

Step 4: Acquire the token benefitting from skew

Immediately buy the leveraged token which benefits from the skew from Balancer or another secondary market. For large orders, this option may be more expensive than minting (slippage plus token premium). In this case, you can mint new tokens with Perpetual Pools. There is an 8-hour wait before you receive the new tokens, so ensure you consider the time until your exposure begins.

Step 5: Exposure while waiting to mint

This applies only to traders who mint new tokens. Exposure begins when your collateral is processed (at the end of the 8 hour commit window). Do not hedge your position until your tokens are created and show up on the interface in the Portfolio tab.

Step 6: Hedge after receiving tokens

Calculate the trade needed to offset the Perpetual Pools position. The hedging trade will be the value of the position multiplied by the market’s leverage e.g. $1000 of 3S-BTC requires a $3000 long position to hedge.

Step 7: Rebalance regularly

Your position size will change over time. Repeat step number 6 to offset any additional exposure you take on. Rebalancing frequently is advised (once a day in most market conditions) but is up to the trader. Higher leveraged markets may require more observation.

Step 8: Consider exiting

Be aware that skew changes. When it is no longer profitable for you to continue using this strategy, you may want to exit. However, you do not need to sell pool tokens every time the skew flips. As polarised leverage is a form of in-kind funding, it is reasonable to expect that the long party will typically pay the short party. It may be worth waiting for the skew to become favourable once more.

Step 9: Exit

You can exit in 3 ways.

Sell on the Secondary Market:

The secondary market is usually more expensive for traders selling a position, but they can exit immediately.

Hedged Burn (high effort):

Like the minting window, Perpetual Pool positions have an 8 hour exit time. However, rather than maintaining your entire exposure during this period, the position instead transitions linearly into the collateral asset. To remain appropriately hedged during the burn, you are required to incrementally reduce the size of your offsetting position.

Unhedged Burn:

A hedged burn is time and effort intensive. Either closing your hedge at the beginning of the burn window or at the end will leave you with exposure, but is a more simple trade. Exiting half when you commit to burn and the other half after 8 hours may be a suitable alternative that is closer to a delta-hedge.


Strategy 2: Directional Strategy

Step 1: Get the information

Go to pools.tracer.finance/pools/.

Step 2: Select a token

Calculate the skew farming ranking for each of the pools and assess the best yield option. Also consider the price feed volatility and collateral owed to each party. A large investment in a low TVL pool can have a drastic effect on yield.

Option 1 - Hedge some of an existing position:

You may hold a market’s underlying asset and observe the skew favours a short position. Choose an amount of your existing position to offset in exchange for the yield opportunity.

Option 2 - Hold a long position instead of the underlying:

The skew may favour the long party at a time when you also desire exposure to the underlying asset. Enter a long position to exploit the polarised leverage and gain exposure at the same time.

Note: Before you mint the token that appears to have the highest yield, consider the difference in collateral owing to each party. Your investment, especially if large, can impact the opportunity.


Disclaimer: 'Skew Farming' is a conceptual model and the above overview of the mechanics does not constitute financial, tax or legal advice. All decentralised trading strategies present high and various forms of risk, including, but not limited to smart contract risk. It is recommended that you obtain your own financial, legal and tax advice before using this product.

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