Key Facts:

• Go-live Date: 4/29/2024
• Blockchain: Arbitrum One
• Deposit Currency: USDC
• Strategist: Rudy Capital GmbH

The „GMX Delta Neutral Strategy – ETH/USDC “ is based on the decentralized perpetual exchange GMX that operates on the Arbitrum and Avalanche networks. The platform has undergone an update to V2 in 2023 and since then has been one of the most used platforms for traders and liquidity providers in the DeFi space.

 

Liquidity providing on GMX

To generate a return, the strategy provides liquidity in the deposit currency USDC to the GMX liquidity pool ETH-USDC which facilitates various activities for traders including long/short positions and swap trades. Providing liquidity generates returns from several streams such as trading & swap fees, trader liquidations and borrowing fees that traders pay for using the provided liquidity. The annual return generated by the pool is dynamic and dependent on the trading activity within the GMX ecosystem. The more trading volume generated by traders, the higher the return of the strategy.

 

Hedging on Aave

By providing liquidity to the ETH-USDC pool on GMX, part of the deposit currency USDC gets automatically swapped to ETH as the pool is composed of both assets. As the strategy is deltaneutral with regards to USDC, it's imperative to neutralize any value fluctuations within the ETHUSDC pool. This means that the strategy should be isolated from any direct exposure to the Ethereum price. The strategy achieves this through a hedging mechanism utilizing the decentralized lending platform Aave, where ETH is borrowed and sold against USDC provided as collateral, effectively creating a short position for ETH. While this procedure is a capital-efficient way to eliminate the Ethereum price exposure of the strategy, there is one more aspect that needs to be considered to achieve delta-neutrality. The liquidity pools serve as counterparty for users on GMX trading the respective market pairs (in this case ETH-USDC). This means that liquidity providers stand to gain when traders incur losses and vice versa. As the positions of traders and hence their wins and losses continuously change, the strategy constantly monitors the open interest of the trading pair which is a clear sign if traders are currently long or short on the trading pair. The net effect of the open interest on the liquidity pool is included in the hedging mechanism, effectively reducing or increasing it depending on the net positions of traders.

 

Risk Management & Optimization

To ensure the delta-neutrality of the strategy and the effectiveness of the hedge mechanism, the strategy has two distinct rebalancing mechanics and triggers. The strategy constantly monitors the effective exposure to the Ethereum price (which is intended to be 0%). Should that ETH exposure become >2% of the total strategy value, the rebalancing mechanism is triggered, the hedge adjusted, and the ETH exposure neutralized. The second rebalancing mechanic concerns the hedge mechanism itself. The efficiency of the hedge position on Aave can be tracked using their so-called Health Factor. The Health Factor measures the relation between provided collateral and loans that are borrowed against that collateral. The Health Factor has a lower limit where positions with a Health Factor <1 are subject to liquidation. The strategy has a defined target Health Factor of 1.5. The rebalancing of the strategy will trigger should the Health Factor fall below the value of 1.2 to avoid liquidation. On the upper side, the strategy will also rebalance should the Health Factor rise above 1.7 to ensure maximum capital efficiency.