The Backd Cookbook — Seeking alpha with Backd
Over the last year the cryptocurrency market has experienced a parabolic increase in the demand for leverage. Many traders and institutions want to maximize their exposure to speculative cryptocurrency assets. Although difficult to measure, the notional value of the cryptocurrency derivatives market is estimated to be around 5 times that of spot. This is miniscule in comparison to the traditional finance derivatives market which is estimated to be greater than 50 times (in notional value) that of spot equity markets.
Why isn’t the derivatives or leveraged cryptocurrency market larger?
This mainly comes down to access to leverage. The majority of leveraged or margin trading still occurs on centralized, or permissioned, exchanges. Many of which are unavailable to citizens of specific countries (such as the U.S.), are limited in the number of available assets, and are questionable in their legitimacy. This limited access to leverage has played a significant role in the growth of DeFi. The total value locked in DeFi is currently estimated to be between 80 (DeFi Pulse) and 130 (CoinGecko) Billion. A major contribution to this growth has been the development of Protocols for loanable funds (PLFs), such as Aave and Compound. PLFs are among the foundation of DeFi and demonstrate the demand for permissionless leverage (or access to leverage that isn’t restrained by KYC or other forms of access).
As the demand for leverage increases so will the utility of Backd as a protocol. Backd compliments or optimizes the leverage offered by PLFs through its reactive liquidity pools. As described in previous blog posts, liquidity providers on Backd can earn yield and Backd rewards while simultaneously protecting their loans from liquidation. While Backd’s reactive liquidity provides DeFi users with an effortless way of managing their DeFi assets, it also enables them to leverage or hedge assets in a sophisticated manner.
👨🍳Introducing the Backd Cookbook™
The Backd Cookbook is a community lead resource that explores the possibilities of Backd as a financial instrument. The Cookbook is made up of “recipes” that showcase different theoretical investment strategies through a simple spreadsheet. The goal of each recipe is to provide the framework for earning above market returns (alpha) with the Backd protocol. Any member of the Backd community can create and submit a recipe. Submissions are reviewed by the Backd team and (possibly) other community members. Recipes that are accepted, following review, will be added to the official cookbook. Users who successfully get their recipe added will have their username (e.g. Twitter, Telegram, etc.) engraved into the Cookbook forever.
- Only uses decentralized protocols (no centralized exchanges)
- Must be conceivable and similar in format to existing recipes
- Recipe must have a name and brief summary (or explanation)
- Submission must include an excel (or Google sheets) spreadsheet that breaks down the recipe into numbered steps and calculates excess return (return with Backd — return without Backd)
Recipes are not required to consider transaction fees
Each cookbook recipe is accompanied by a summary located in the docs. Here you can find details on how each recipe works.
Recipe 001: Interest-bearing protective short
In order to fully understand what each recipe should encompass, lets go over an example. In this recipe we are shown how users can build an “interest-bearing protective short” position. This position takes advantage of Backd’s reactive liquidity pools to accomplish the following:
- Short sell ETH while being protected from liquidation
- Generate excess return (higher return with Backd than without)
In a normal situation a user looking to short an asset utilizing a PLF would most likely borrow the asset they want to short against stable coins. Then, they would immediately sell the borrowed assets for stable coins so they can repurchase them at a lower price, repay the number of tokens owed, and keep the difference. While shorting is a very popular and effective method of gaining downside exposure, it is not always optimized for capital efficiency.
What if while shorting an asset you were able to earn interest and be protected from liquidation? This model explores how this may be possible by utilizing Backd. In this recipe the user borrows ETH against DAI or USDC as collateral. Just like in a normal short, the user immediately sells the borrowed ETH for DAI or USDC. However, rather than simply letting the DAI or USDC sit stable in their wallet, they deposit it into a Backd liquidity pool. Now their DAI is working for them and generating yield instead of just sitting idle. Further, the user registers their deposited DAI for collateral top ups on their initial loan. Now they have a short position that is both protected from liquidation and also earning interest.
This recipe only accounts for a successful short, one in which the shorted asset decreases in price as intended.
When the shorted asset has decreased in price and the user is ready to close their position, they must unregister and remove their Backd liquidity. They now have the initial DAI they deposited plus the interest it accrued. This DAI is then used to purchase and repay the amount of ETH owed.
👉For access to the full Backd Cookbook, additional details on how to submit your recipe, and recipe excel files please refer to the Backd docs.