🏛️ How to make over 26% per year and operate like a mini hedge fund (in a good way!)
In this guide I will show you in three steps how to use the UST you deposited with Anchor (explained in my previous article two weeks ago) to add extra layers of yield to your investment.
This strategy will allow you to make over 26% APY (at the time of writing) without having to speculate on whether the stock or crypto markets will go up or down. By doing this you will be utilising one of the main techniques hedge funds use to minimise their risk - namely going both long and short to hedge your position.
What is Mirror?
Mirror is a crypto app on the Terra blockchain which allows anyone in the world to invest in synthetic assets which track or “mirror” the value and price movements of “real” financial assets. These assets include a variety of stocks, ETFs (exchange traded funds), crypto assets and commodities like gold and silver.
Synthetic assets are also called derivatives as they “derive” their value from an underlying asset, such as Microsoft stock for example. But unlike owning Microsoft stock outright through a traditional broker, with a derivative you aren’t entitled to shareholder or other ownership rights.
The Mirror protocol is a fairly large and well-established crypto app with over $579 million in TVL (as seen in the rankings below). This level of TVL places Mirror in the top 6 of all DeFi applications on the Terra blockchain.
Anchor → Mirror
This guide assumes you already know how to start earning over 19% on Anchor and have deposited some money into the Anchor app. If you are unsure of this step or need a recap, you can take a look at my previous article on DeFi and stablecoins.
Understanding aUST as a liquid yield-bearing asset:
After depositing on the Anchor earn page you should receive aUST in your wallet. You can think of aUST like a receipt which is needed to reclaim the UST you just deposited. This aUST is also a yield-bearing asset, meaning it appreciates in value at 19% and is not “static” like normal dollars sitting in your bank account.
But the really powerful and special characteristic of aUST is that it is liquid and transferrable. This means aUST can be used outside of Anchor as collateral with other apps in the Terra blockchain ecosystem. This is where Mirror comes in.
To make things simple, let’s assume we start our short/long strategy with $10,000 in UST.
Step 1 - Select your short farm asset on Mirror:
Short farming in crypto is similar to short selling in traditional markets except with Mirror you can also earn yield for taking this position. When you go short you borrow the asset and then immediately sell it. This borrowing and selling mechanism is automatically taken care of by Mirror’s smart contract code.
Short selling is normally used by traders who are bearish on a specific asset, hoping to buy the asset back for less money at a later date. As you will see, in our situation we don’t have to take a bullish or bearish view as we will immediately cover (hedge) this short by going long on the same asset in step 2.
First we will go to the farm page on Mirror and select the synthetic “mAsset” we want to short farm. In this example I will select the Invesco QQQ Trust, an ETF which tracks the companies traded on the tech-heavy Nasdaq 100 index.
There are a few reasons why I think this mQQQ is a good short farming candidate (disclaimer: please don’t taken this as formal financial advice). First, the short farming APY on Mirror looks good at over 23%. Second, while the markets are volatile right now due to both macroeconomic and geopolitical factors, an ETF which tracks an index is likely to be more stable than a single stock or cryptocurrency.
We will see later in this guide why price stability is important. Mirror also provides an mAsset which tracks the S&P 500 which would be more stable than the Nasdaq but it only offers 0.16% APY for short farming.
Next we select aUST from the dropdown menu as our collateral asset. In the previous step we said we are starting with the round figure of $10,000. Let’s take $5,000 of that to go short here:
Now, the really important part - set the collateral ratio. Mirror suggests that the safe collateral ratio is 200%. This means that if we use $5,000 worth of collateral, the app will allow us to borrow slightly more than $3,000 of mQQQ which is then immediately sold for UST.
Mirror also shows that if our collateral ratio goes below the minimum level of 150% we will get liquidated - ie. lose all our capital. We really don’t want this to happen! So we have to research and quantify this risk quite thoroughly. Mirror says that 200% is safe but we don’t want to blindly take their word for it.
If we look at the screenshot below showing the calculations from one of Taiki Maeda’s recent YouTube videos, we can see that at the collateral ratio of 200%, we will get liquidated if the asset appreciates by 33.33%. Sure, over a certain period of time, mQQQ could gradually increase towards that percentage but remember our aUST is also appreciating by 19% over the year as well which will partly cover the 33% and reduce our risk.
You can also run the calculation yourself with this simple formula to check Taiki’s results:
Liquidation Price = UST collateral amount / (UST value of short assets * 1.5)
In order to get liquidated by the increasing value of mQQQ, the asset will have to suddenly shoot up by 33.33% overnight, taking us completely by surprise. Of course extreme volatility can happen in moments of crisis, however this is very rare. For example even at the very start of the corona crisis when the markets were at maximum fear and uncertainty, the BBC reported that the Nasdaq index only went down by 9.4% over a 24 hour period.
If we want to be really, really safe from liquidation we can even increase the collateral ratio on Mirror using the slider to 220% which will mean the Nasdaq will have to go up even more to 46.47% for us to face the possibility of liquidation. (NB: there will be some slight variance here based on the exact collateral amounts you use etc, always do your own research and calculations).
Step 2 - Take out a long position on Mirror:
The next big step is to go long on mQQQ in order to hedge our short position. Professional traders call this strategy “delta neutral”. This hedging strategy is important - going short is a high risk decision as in theory there is no limit to how high stocks can go. This means there is no theoretical limit to how high your losses can go which can far exceed your initial investment capital.
There are two ways to go long with Mirror:
First, you can enter a “long yield farm” by deploying 50% UST and 50% mQQQ to Mirror’s liquidity pool. This works in a similar way to normal crypto yield farming, but is not the main subject of this guide.
Long yield farming also exposes you to the risk of impermanent loss which means you can lose some of your initial capital if the two assets you use fluctuate in price relative to each other. This is an added complex risk for no real extra gain which we can be easily avoided in this case. But if you want to learn more about yield farming and impermanent loss, the Binance academy series is a good place to start.
Second, the way I would suggest to go long on Mirror is to simply use the $5,000 remaining from our total of $10,000 in UST capital to buy mQQQ on Mirror’s trade page. It is important we do this immediately to ensure we get the same price as we did when we went short. This also give us the flexibility and peace-of-mind to always have mQQQ available to pay off some or all of our loan from the short position if we see the price going against us.
Step 3 - Using the short sale proceeds to deposit into Anchor Earn (again).
Now for the really clever bit! - Remember in Step 1, we shorted mQQQ by borrowing and then selling it immediately. Mirror only releases the UST proceeds from the short sale after 2 weeks to prevent users from gaming the system. But after the two weeks is up we can then use this UST to deposit in Anchor Earn again to make an additional 19%.
In my view re-depositing to Anchor Earn is also a better approach as we will receive this layer of the yield in UST stablecoins on Anchor. If we were to wait two weeks to receive our UST and deploy it to a yield farm we will receive the income in Mirror’s native token ($MIR). This token is unlikely to hold value over the long-term. In general tokens received from yield farms are often disparagingly referred to as “farm and dump” tokens. This is because the tokens usually have limited utility beyond basic crypto governance and as the phrase implies are merely farmed to then be sold straight away.
Summing up: How much money did we make with this strategy?
The spreadsheet below shows how much we made with our $10,000 of initial capital:
Hopefully you found this guide helpful and interesting!
What did I miss? - These reports are a learning process for me and I’m very open to constructive feedback and suggestions.
What stock or crypto asset should I cover next? You can contact me by email: hellorobostox@gmail.com or feel free to leave your response in the comments below. You can also follow me on Twitter: @daneasterman.
Disclaimer: I am not a financial advisor, none of this report should be taken as financial advice. Instead this should be viewed as starting point to conduct your own research. At the time of writing I did not hold any positions in the QQQ Nasdaq ETF or the crypto assets mentioned in this report.