MEV Capital, a DeFi-focused institutional investment manager, is rolling out a new impermanent loss hedging product designed to provide downside protection on Uniswap yields — and its exact structure is said to be the first of its kind.
MEV’s offering has been introduced to potential limited partners via separately managed accounts (SMAs), according to a source familiar with the matter and marketing materials obtained by Blockworks.
Its core strategy consists of exotic, short-dated crypto options that are designed to provide downside protection, while generating returns on DeFi yields via Uni v3. MEV has tapped Singapore-headquartered OrBit Markets, which specializes in sector derivatives and structured products, as a counterparty, the source said.
Impermanent loss in a DeFi context: risking the cost of running a Uniswap pool that slips below total fees generated in doing so. Scores of MEV competitors have launched their own impermanent launch strategies.
The firm’s thinking, according to the source, is that and to its knowledge, other traders have done so via perpetual swaps. These differ in that customers rely on perps on those to cover DeFi yield-farming downside by taking a short position.
“That’s not a complete hedge,” one source said. “It’s not a full cover.”
MEV has one additional and undisclosed counterparty, the source said, who categorized the service provider as an established commodities market maker with growing digital assets interest. The source was granted anonymity to discuss sensitive business dealings.
How MEV hedges impermanent loss in DeFi
The Lithuania-based MEV has $32 million of assets under management. Its trading is led by Chief Investment Officer Laurent Bourquin, a veteran of French bank Societe General’s investment banking division, where he worked on leveraged finance products, as well as additional asset classes.
Bourquin co-founded MEV in 2020 — which now has nine full-time staffers — with fellow general partner Gytis Trilikauskis, the asset manager’s chief operating officer.
Trilikauskis confirmed the formation of MEV’s latest strategy in a Blockworks’ interview on Friday. He declined to comment on his firm’s marketing materials or investor communications.
Here’s how it works:
- Limited partners buy in to the strategy via SMAs, and their positions are held on decentralized exchange (DEX) Uniswap.
- MEV with LP assets acts as a market neutral liquidity provider for Uni crypto pools, such as WETH/USDC. The firm is on the lookout for pricing discrepancies that may trigger a higher payout on fee payouts for providing that liquidity.
- Investor yield, meanwhile, is designed to be generated from capturing “organic trading volume” on the DEX, according to MEV’s investor documents.
- The idea is to lock down initial returns from that yield, then deploying hedges on those assets via options designed to proffer downside protection against impermanent loss.
- Options contracts are settled with Orbit and the under wraps commodities market maker, and capital is dispersed accordingly.
The crypto options are settled over the counter, a result of digital asset derivatives liquidity remaining hard to come by at any sort of institutional scale. They’re held open for a week or two.
It’s incumbent on MEV to carefully manage its risk on its open options, given rapid market swings in the cost of carrying derivatives that act as a hedge.
Not to mention the volatility of their underlying cryptoassets.
Traditional financiers can and do structure their own options via OTC methods. But they have at their disposal far more possibilities to open and settle options without them. Not to mention far more derivative market makers to choose from — and their associated cost of carry.
Options market makers have developed a great deal in crypto since they hit the market, but industry participants say there’s still a long way to go in terms of their ability to maintain the prerequisite, voluminous balance sheet needed to ensure liquidity by keeping an abundance of options open on their books.
MEV has previously launched crypto structured products, as well as additional strategies that rely on sector products that are far from established and normative within the industry.
From buy siders to trading desks to limited partner pockets, Wall Street takes for granted the ease of slapping down a trade on a complex, synthetic exposure to commodities and structured products, Trilikauskis told Blockworks.
Trilikauskis and his counterpart general partner, Bourquin, have been designing DeFi plays since the summer of 2020, when MEV first started allocating capital. The firm’s flagship fund focuses on stablecoin yields, and the operation in May of last year introduced an Ethereum strategy.
There have since been sector structured product plays rolled out. MEV since its inception has really been in the business of “yield generating strategies on DeFi exclusively,” Trilikauskis said, “not dealing with centralized exchanges, not dealing with centralized lenders.”
As to the “why now” behind the Uniswap product, a number of factors are, in MEV’s estimation, in play, according to Trilikauskis: increasingly inflationary DEX governance tokens that power Uniswap and its competitors; decentralized market making volumes evaporating, dragging the governance tokens that power DEXes down with the liquidity ship.
That said, DEX market making payouts are still hovering “on the very low end of its historical range,” according to the marketing materials, even if volumes are still chasing historic highs.
What that boils down to is that MEV will have to raise — then deploy — a good chunk of limited partner capital to profit off of fees alone, even with vDEX volumes where they are.
Uniswap pool opportunity set
In the WETH/USDC example, MEV has told investors it expects it to generate $20 to $60 billion in volume early this year. The Uniswap pool’s payout is a puny 0.05%. Generating yield from those fees relies heavily on traders pushing cryptoassets into decentralized pools.
The firm’s view is that crypto options markets have yet to properly price the potential fees that can be earned from DEXes’ resulting in arbitrage plays between on-chain assets and options exercised on them.
Over the long haul, MEX is telling current and potential investors that the dislocation will lessen eventually. The firm in its marketing materials said “we see opportunity” in the “short-to-medium-term” in terms of cashing in on dislocations as off-chain options “become more competitively priced.”
SMAs — as opposed to liquid crypto hedge funds that lock up investor capital — generally function with instantaneous liquidity measures. The setup was pioneered in traditional finance, though blockchains may add additional visibility into a strategy’s book in terms of tracking trades.
The setup has been favored by both crypto native limited and general partners, as well as their Wall Street counterparts, and the sentiment has been only heightened by volatility that’s rocked just about every corner of crypto since the fourth quarter.
MEV is betting on those perceived benefits and others in marketing its hedging strategy settled by OrBit Markets.
“What we saw was unique: to be a mercenary in DeFi now,” Trilikauskis said. “Until now, you needed to fund from opportunities [on the market]. Usually, you stay in a liquid position or a [yield] farming position for two to three weeks under the APR, which is slowly grinding down to something that is not attractive.”
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