Stability & Hedging
USDca Stability and Hedges
Last updated
USDca Stability and Hedges
Last updated
USDca aims to retain its peg to a dollar by being both fully backed by protocol backing assets as well as being "delta neutral" on the collateral provided. A portfolio of assets and positions can be considered "delta neutral" if there is zero net exposure to the underlying change in price (changing the valuation of the portfolio in constant terms). In effect, by taking out a derivative position to hedge the supplied backing asset at the same notional size, mathematically the volatility for the collateral asset is reduced to near zero.
CAMP achieves this by holding corresponding short derivatives position to offset the delta of users' deposited collateral. As such, this results in the backing asset and the derivatives positions offsetting each other from a PnL perspective as the prices change. In effect, CAMP has created a "synthetic dollar". CAMP does not use any material leverage to margin the delta hedging derivatives positions. There is limited liquidation risk given the protocol's resulting insensitivity in the changing valuation of the underlying collateral assets and the absence of leverage. More information on liquidation risk is provided .
The peg stability mechanism relies upon CAMP offsetting the change in the valuation of the backing assets. The delta-hedging derivatives positions directly offset the PnL changes in the valuation of backing assets, aiming to ensure the relatively stable value of the protocol's assets.
Yes, different futures contracts (linear vs inverse) differ in terms of convexity, meaning the gain/loss can vary between contracts for a given change in price of the underlying. The internal Portfolio Management System (PMS) continuously calculates the delta of the position and if need be adjusts the position towards risk neutrality and only thereafter optimize the deployment of capital to deliver the best possible return on backing assets.
CAMP systems are continuously running and maintaining delta neutrality, when mint and redeems are requested they get added to a queue and netted out if possible.
When a delta is detected, CAMP seeks optimal execution among venues using multiple metrics:
Synthetic price Calculating the fair value of a given asset is the cornerstone of good execution, when a perpetual is trading at a temporary premium/discount this is taken into account.
Funding rate Projection of future yield and its persistence is used to adjust the synthetic price, given current and recent historical funding rates as well as platform native futures premium.
Risk limits The overall “portfolio” needs to be balanced, with exposure on each venue being maintained at optimal levels of the total portfolio size according to venue specific contribution to total open interest. Position on a single venue must have a percentage of open interest cap.
The hedge is either executed in full or partially distributed over connected exchanges. Market impact is always taken into account to ensure a high execution quality.
An aggregated orderbook with synthetic price offsets is maintained, making it possible to identify where the liquidity is located and how to route it.
When liquidity is sourced from multiple venues, latencies between CAMP systems and the venue are taken into account and hitting orders are sent in such a way that they hit simultaneously.
Large mint/redeem requests that can’t be automatically performed within 10bps of fair value, enter CAMP’s “manual” flow, where the request is fulfilled at a future price found according to a TWAP plus a risk markup. In practice, due to per-block mint and redeem limits, this is rarely implicated.
Linear perpetuals and inverse perpetuals are two types of perpetual contracts commonly used in cryptocurrency trading.
In a linear perpetual, the contract value is directly proportional to the underlying asset's price. This means that if the price of the underlying asset goes up, the contract value also goes up, and vice versa.
Inverse perpetuals, on the other hand, are contracts where the contract value is inversely proportional to the underlying asset's price. This means that if the price of the underlying asset goes up, the contract value goes down, and vice versa.
Both linear and inverse perpetuals are settled in the same way, using the funding rate. The funding rate is a mechanism that balances the contract value with the underlying asset's spot price. If the contract value is higher than the spot price, long positions pay short positions, and vice versa. This is meant to ensure that the contract price stays close to the underlying asset's spot price.
Convexity (also known as Gamma) refers to the second derivative of a contract's value with respect to price, and in the case of inverse perpetual futures, it can differ to the relationship suggested by a linear move in price.
While the payoff for a linear contract is:
the payoff for an inverse contract is:
hence introducing convexity.
đź’ˇ Example: A trader goes long 50,000 contracts of ETHUSD at a price of 10,000. A few days later the price of the contract increases to 11,000.
The trader’s profit will be:
50,000 * 1 * (1/10,000 - 1/11,000) = 0.4545ETH
If the price had in fact dropped to 9,000, the trader’s loss would have been:
50,000 * 1 * (1/10,000 - 1/9,000) = -0.5556 ETH
The loss is greater because of the inverse and non-linear nature of the contract. Conversely, if the trader was short then the trader’s profit would be greater if the price moved down than the loss if it moved up.
Inverse perpetual futures enable shorts to make more as the ETH price falls, and lose less as prices rise, making the inverse contract suitable for hedgers like CAMP. CAMP will be short ETH and BTC futures with no leverage, benefitting from convexity and resulting in limited liquidation risk.
No, not materially at the portfolio level. CAMP may very temporarily, within very tight risk parameters, use leverage to manage deltas across different exchanges if an exchange shuts down and the system needs to deploy the same collateral on other venues to hedge the delta of the whole backing.
Many exchanges offer both COIN-margined and USDT/C-margined derivative contracts. The differences between the two relate to the quote currency of the contracts (“USD” vs “USDT/C”) and principally the settlement currency of the contracts (base currency vs “USDT”).
As a result of CAMP trading using both COIN-margined and USDT/C margined contracts, the internal trading system must be aware of the spot of the markets being traded, but also the intermediate markets. The trading system assesses in real time capacity and ability to meet margin and settlement requirements as well as incorporates the value of all collateral & positions CAMP is holding in different market scenarios.
Practically this involves ensuring any basis risk on asset currency denomination is matched with liabilities on a frequent basis.
The most dramatic example of open interest building alongside deeply negative funding, indicating heavy demand for new futures positions to the short side, was in September 2022 when investors could avail of an arbitrage opportunity thanks to the Ethereum Merge.
The ETH Proof of Work trade, as it became known, involved investors holding spot ETH as ETH transitioned to proof of stake, while hedging their exposure via short ETH futures. By holding spot ETH, investors were eligible for an ETH PoW airdrop on a forked version of the old chain - so by shorting ETH futures they could arbitrage the airdrop with no price exposure.
This resulted in open interest rising by over $1bn in a matter of days as funding rates started to dip extremely negative, as low as -360% annualized at one point. As the Merge was successfully completed and the ETH PoW airdrop took place, the huge buildup of positions to the short side were closed as open interest fell back below $7bn and funding moved positive again.
The nature of the large swings during this trading opportunity gives us an ideal stress test scenario event in the ETH futures market. Deeply negative funding persisted for no longer than one day before snapping back to positive thanks to funding rates' mean-reverting characteristics. Open interest built up by over $1bn in an extremely short time period before dropping by the same amount in a similar timeframe. In a matter of days, ETH futures markets reverted to their normal structure and the final outcome of the volatile swings was one day of negative funding rates, indicating ETH futures markets can handle dramatic flows in the billions of dollars.
It is also expected that ETH open interest as a % of market cap may rise significantly from <5% today as more derivative products are built around ETH staking cash flows, and once a new bull market emerges and system leverage rises. This should help alleviate any size concerns USDca will have on the futures market vis-a-vis utilizing ETH and ETH assets as protocol backing.
Another example of a sharp dip in funding rates was during the USDC depeg in March 2023. Open interest dipped sharply by $1bn while funding dipped to annualized rates of nearly -40%. Open interest falling indicates that this might not have been a build up in short positions, but rather a liquidation of the long side which was a different scenario to the ETH PoW trade but had a similar effect on funding.
Here, funding rates persisted negative for two or three days as the SVB crisis unfolded but snapped back positive soon after, again displaying funding rates’ mean-reverting characteristics. While the funding rates here weren’t as negative as the ETH PoW trade, the size of the open interest move was similar at $1bn, this time in the opposite direction - giving us another example that ETH futures markets can handle dramatic flows and revert back to mean in the days after.
