Pseudo-Delta Neutral Hedging

I had been dabbling in crypto for a few years now but was mainly just hodling. In the last few months, I started to explore decentralized finance (DeFi) in earnest and is somewhat fascinated by the many new possibilities made possible by various Decentralized Applications (dApps).

Disclaimer: This is not investment or financial advice, but a sharing of my adventures and learnings in crypto space, where I conduct various experiments with different tokens and protocols across different blockchains.

One of the strategies that I have taken quite a bit of liking to is Pseudo-Delta Neutral (PDN) hedging. In a nutshell, PDN is a strategy that is gaining in popularity where a Leveraged Yield Farming (LYF) position with at least 2 times leverage is deployed such that the quantity of the underlying asset (usually the non-stable token in a non-stable/stable pair such ETH-USDC) in the share (long position) of the Liquidity Pool (LP) balances with its debt (short position). This allows one to capture the profit from yield farming while “ignoring” the price movement of the underlying non-stable token since the long and short positions are equalized. It is typically deployed as a strategy to grow stablecoins like USDC or USDT.

A popular example to set up a PDN position relying on 3x LYF for ETH-USDC farms will be something like this:

1. Set up 3x LYF with US$100 of USDC, borrowing USDC. The net position value is 3x of the initial capital or US$300. US$200 worth of USDC will be borrowed (that is the leverage) and of this initial US$300 of USDC, half of it will be converted to ETH. This means for this trade, it will be long US$150 of ETH + US$150 of USDC in the LP and short US$200 of USDC as debt.
2. Set up 3x LYF with US$300 of USDC, borrowing ETH. The net position value is 3x of the initial capital or US$900. US$600 worth of ETH will be borrowed and of this initial US$300 of USDC + US$600 of ETH, US$150 of ETH will be converted to USDC. This means for this trade, one will be long US$450 of ETH + US$450 of USDC in the LP and short US$600 of ETH as debt.

Adding up the 2 positions, the final long positions are US$600 (US$150 + US$450) worth of ETH and US$600 (US$150 + US$450) worth of USDC, and the final short positions are US$200 of USDC + US$600 of ETH. This is summarized in this table:

Setting up a PDN Position using 3x LYF