Introducing AutoHedge: A Safer Way to Provide Liquidity with Greater APY

Over the past few months, the Autonomy team has been hard at work on different tools and applications that showcase the protocol’s use cases. From stop-losses on DEXes to an entirely new game genre coming soon, automation is unlocking a diverse range of new decentralized applications that were previously unheard of in Web3.

We’d like to introduce a new tool that goes beyond degens and gamers and helps more conservative participants in the Web3 economy. AutoHedge is a decentralized application for liquidity providers who look to maximize their profit potential while effectively hedging against volatility in a seamless, easy-to-use way. It leverages the Autonomy protocol to create positions that are delta-neutral.

For example you can LP on the ETH-DAI pair on Uniswap with $100, and no matter what happens to the price of ETH, your position’s value will never go above or below $100. More so, over time you’ll accumulate the trading fees on top.

The Problem

For existing LPers, LPing in a bull market is fine because, even with impermanent loss (IL), their position still grows in value even without the trading fees. But in a bear market, the loss in value of the position from price decreases of the tokens could be more than the fees, and therefore they lose money overall.

Institutional investors sit on large pools of idle funds that could be put to work in the DeFi markets and provide game-changing amounts of liquidity, but regulations and internal policies don’t allow them to be exposed to the price volatility risk that's inherent to holding volatile assets like ETH. Since most DEX volume is not in stablecoin-stablecoin pairs, that means they’re missing out on most of the profit and better yield opportunities that exist. Likewise, the markets are missing out on more liquidity.

The Solution

A way to provide the security that more risk-averse investors seek to participate in the DeFi markets is to design a mechanism that creates delta-neutrality. In simple terms, an investment strategy is delta neutral when the dollar value of the position doesn’t change over time.

While this has been impossible to achieve in DeFi, Autonomy’s smart contract automation layer is able to support such a mechanism. This means that even positions taken on volatile assets would always retain their same dollar value and accrue trading fees on top over time.

How AutoHedge Works

All this can happen with one click using AutoHedge. Assume you want to participate in an ETH-DAI liquidity pool on Uniswap with $8,000 in DAI. 4,000 would be swapped to ETH at a price of $2,000 for a total of 2 ETH and 4,000 DAI.

  1. AutoHedge would take those 4,000 DAI and 2 ETH and deposit them into Uniswap’s liquidity pool.
  2. All of the LP tokens it receives back, worth $8,000, would be used as collateral to borrow an amount of ETH equal to the ETH that’s deposited in the liquidity pool (2 ETH). Since this collateral is being lent out, you’d be receiving a return on it.
  3. That amount of 2 ETH would be sold for a stablecoin like DAI, essentially shorting ETH. This means you're now fully hedged against ETH’s price volatility and can even get an additional revenue stream from lending out that DAI again. However, the issue at this point is that the amount of ETH that you can claim back by redeeming the LP token changes as the price of ETH changes and people add or remove ETH from the pool by trading in it.
  4. This is where AutoHedge’s automation capabilities come in: we then need to regularly update the debt position to reflect the amount of ETH we have represented by the DEX’s LP token. Thanks to Autonomy Network, AutoHedge is able to automatically keep the debt in sync with the amount of ETH in the pool. It borrows or pays back some ETH depending on how the balance of the Uniswap pool is changing. It does this every time the debt and the ETH amounts have a difference of 1%.
  5. In this way, AutoHedge is able to offer a meta-LP token, known as AH LP (AutoHedge LP), that wraps the DEXs LP token and the debt. This token represents a delta-neutral position that also receives LP yields.

A Solution for Delta Neutrality and Impermanent Loss

The AH LP token has some interesting properties:

  • It would be essentially zero risk (no risk of liquidation when borrowing) because it's always backed by 2x the value of the debt, since there is an equal dollar value of stable coins and the other asset in the LP token.
  • If the price of ETH goes to zero, the collateral ratio is still 100%, and the user makes as much from shorting ETH as they lost from the ETH they held in the Uniswap LP.
  • If the price of ETH goes up, then the value in both the LP token and the debt would increase accordingly, canceling each other out. In this way, the position is still fully collateralized.
  • On the other hand, the investment would always accrue value because it's generating trading fees despite not being exposed to the underlying price volatility.
  • Another interesting result to note is that AH LP token would make impermanent loss irrelevant, and therefore represents the first ever true prevention solution to impermanent loss.
  • Finally, given that the AH LP token has essentially zero-risk as explained above, it has the property of a low collateral ratio which would mean that you could borrow against it for more AH LP tokens to generate more fees. Basically, you can leverage this yield bearing stablecoin. For example if you’re able to borrow $90 with $100 of AH LP tokens, then with $10 of initial capital you can leverage LP with $100 of capital, essentially 10x’ing the APY.

Altogether, this provides all the risk mitigation of a delta-neutral investment strategy while participating in the opportunities of the DeFi markets without the common threats associated with them. The possibilities created by AutoHedge can even solve overall market problems like riskless liquidity provision for new and illiquid assets.

Try AutoHedge for yourself!

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