Simulating SMART Alpha

This post was originally published on Barnbridge

We’re a week removed from the start of the first SMART Alpha epoch, and we couldn’t be more excited to share deeper insights into the default model we’ll be shipping. The current plan is to launch with BTC/USD, ETH/USD, BOND/USD, and ETH/BTC pools and to roll out prioritized pools over the coming month. You can expect deposits to open this week in anticipation of the first epoch advancement on Monday, September 13th at 9:30 AM EDT.

This article will walk through the epoch simulator which we launched today. It will also highlight how senior and junior positions would have performed under certain conditions during historical market periods. You can find the simulator here.

Please note: each SMART Alpha pool is able to calibrate its own or shared rate model. We have optimized the default one for senior downside protection and junior leverage, but anticipate that different assets will benefit from different optimizations. So, if you’re not impressed, please share your thoughts with the community on our forum or in our Discord!

The Simulator

Every SMART Alpha epoch has two independent variables:

  • The percentage of junior dominance upon epoch start
  • The underlying asset’s price performance upon epoch end
To simulate a SMART Alpha epoch, you will need to provide the expected price performance and junior dominance.

Once you provide the two variables and run the simulator, you’ll be presented with the following visualization:

Junior and senior performance are compared against one another and that of the underlying asset.

To better understand these outputs, you will also be presented with a table of the various parameters that inform the given outcome:

biswap
Senior upside exposure and downside protection determine junior position outcomes.
  • Senior Downside Protection: The threshold percentage decline before which senior positions do not incur losses during a down epoch for the underlying asset. Put another way, this is how much yield in the underlying asset could be earned by the senior position in such a scenario.
  • Senior Upside Exposure: How much of every 1% gain in the underlying asset the senior position would participate in
  • Junior Upside Leverage: The leverage on every 1% gain in the underlying asset the junior position would receive
  • Junior Downside Leverage: The leverage on every 1% decline in the underlying asset the junior position would be exposed to up until the senior protection threshold is met

Users will be able to get a sense for the junior dominance variable in the lead up to epoch advancement via the application interface. Because deposits into SMART Alpha pools currently remain inert, one should expect the majority of new deposits to be made in the hours immediately before the new epoch’s start.

The SMART Alpha UI will support real-time updates of expected parameters for the upcoming epoch.

The Model

The default template model the initial SMART Alpha pools will be shipping with offers senior positions up to 35% absolute downside protection and juniors up to 19.8x upside leverage. At the same time, senior upside exposure will be capped at 65% and junior downside leverage will be uncapped.

A note on junior downside leverage: the multiple shown in the simulator only holds for the amount required to cover senior downside protection. In a scenario where junior downside leverage is 2.00x and senior downside protection is 35%, for example, the junior position would have levered exposure until 70% of its value is drawn down, at which point any further decline in the underlying asset price would be applied unlevered.

For BarnBridge community members interested in contributing new models or perhaps even building out a matrix of models for different asset profiles, we’ll be launching a new forum section for such discussion.

Historical Counterfactuals

As you mull over whether SMART Alpha makes sense for your needs, we’ve provided a few examples below of how junior and senior positions would have performed under different junior dominance conditions in various scenarios. Note, we’ll just be referencing the market opening prices for the respective epoch start and end dates.

May 17–24, 2021: Musk Forsakes Crypto

Remember when you didn’t think dog coins represented a local top? Good times.

  • Price of Ether, Beginning of Epoch: $3,602
  • Price of Ether, End of Epoch: $2,120
  • Percentage Drawdown: 41.1%

As you’ll see, seniors would have been happy under most junior dominance scenarios, but never entirely protected due to the cap on senior protection:

  • Neutral (50%):
Assumes -41.1% price performance and 50% junior dominance
  • Bearish (25%):
Assumes -41.1% price performance and 25% junior dominance
  • Bullish (75%):
Assumes -41.1% price performance and 75% junior dominance

November 5–12, 2020: ySqueeze

The bottom of the first DeFi bear market (in dollar terms, h/t DegenSpartan).

  • Price of YFI, Beginning of Epoch: $8,521
  • Price of YFI, End of Epoch: $16,693
  • Percentage Increase: 95.9%

Contrarian junior position bottom-callers would have been well rewarded.

  • Neutral (50%):
Assumes 95.9% price performance and 50% junior dominance
  • Bearish (25%):
Assumes 95.9% price performance and 25% junior dominance
  • Bullish (75%):
Assumes 95.9% price performance and 75% junior dominance

March 9–16, 2020: “Hell is Coming”

Everyone hates on the Federal Reserve until Powell saves our retirements.

  • Price of Bitcoin, Beginning of Epoch: $8,041
  • Price of Bitcoin, End of Epoch: $5,397
  • Percentage Drawdown: 32.9%

As the drawdown came in under 35%, senior positions would have gone unscathed in certain scenarios:

  • Neutral (50%):
Assumes -32.9% price performance and 50% junior dominance
  • Bearish(25%):
Assumes -32.9% price performance and 25% junior dominance
  • Bullish (75%):
Assumes -32.9% price performance and 75% junior dominance

October 21–28, 2019: Xi Jinping Announcement

Blockchain = Bitcoin, good times.

  • Price of Bitcoin, Beginning of Epoch: $8,208
  • Price of Bitcoin, End of Epoch: $9,502
  • Percentage Increase: 15.8%

While the move was more pronounced intraweek, the market sentiment leading into this period suggests it would have been relatively low junior dominance, which would have led to outsized leverage on junior positions.

  • Neutral (50%):
Assumes 15.8% price performance and 50% junior dominance
  • Bearish(25%):
Assumes 15.8% price performance and 25% junior dominance
  • Bullish (75%):
Assumes 15.8% price performance and 75% junior dominance

Looking Ahead

As mentioned, SMART Alpha’s first epoch advances next week. We’re currently working on the following efforts in parallel to strengthen the product:

  • UMA KPI options template for per-pool reward programs
  • Custom Balancer pools for SMART Alpha position secondary liquidity
  • Rari Capital Fuse pool liquidity for eventually borrowing against positions

You can find our previous pieces detailing SMART Alpha here:

On BarnBridge

BarnBridge is a suite of risk tokenization protocols for DeFi. Its applications allow users to select from opposing pools and take positions on risk factors like interest rates or asset prices. Its first application, SMART Yield, offers fixed and levered variable yields on stablecoins deposited into underlying lending markets like Aave, Compound, and C.R.E.A.M. Finance. Its application suite has expanded to include SMART Exposure, a position rebalancing solution, as well as SMART Alpha soon, which will allow users to calibrate their exposure to price movements in an underlying digital asset. BarnBridge is currently live on Ethereum and the Polygon Network.

Keep up to date with the BarnBridge community via the following channels:


Simulating SMART Alpha was originally published in BarnBridge on Medium, where people are continuing the conversation by highlighting and responding to this story.

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