When I was at university, an acquaintance in my hall showed me his scheme for making money on eBay--which was then a new phenomenon. He would search the site for misspelt items, such as a chandelier spelt as “chandeleer.” He then would buy those items and resell them with the right spelling for a profit.
I don’t know how much he earned that way, but I suspect it was enough to cover his cannabis and alcohol consumption. I also doubt he knew that his strategy had a fancy-sounding name: “arbitrage.” But that’s just what he was doing, namely exploiting a difference in price between one market and another.
This lesson will develop three ways to do arbitrage with crypto yield farming.
More specifically, we’re going to cover how to do that with leverage--which is like adding fertilizer to the soil of your money tree. I’ll cover a way to introduce 10x leverage into your yield farming in a smart way.
I’m also going to ruin the suspense in advance: there is no magic bullet here. The Art of the Bubble is an art, in the Latin sense of ars, a craft. The strategy has principles, but it also requires experience to do it well. Just like a sport, you can read a book and get the idea of what you’re supposed to do, but without practice, you won’t realize the results you want.
That’s why we have a Discord server, where you can ask me questions. It’s why we have a subscription service, where you can learn exactly what my trades are, and how I interpret the signals from my algorithms. You’re basically paying for tuition, and I am a university professor.
Some of you are the self-reliant type, so I’ve introduced a new tier for Patreon subscribers called the Do It Yourself-er (DIY-er) tier, where you do not get access to my algorithms or my portfolio, but you do get Live Chat on Discord--there’s a specific channel devoted to that--about lessons or trading principles along with access to AMA’s.
Finally, through July, you can still pick up the transition package that requires two steps--one here on Substack and another on Patreon (the link explains in detail).
So far, in this series, the principles that we’ve covered concern the need to distinguish between traditional financial risk, and the newer platform risk that cryptocurrencies pose. In this lesson, we’ll develop two related principles: using leverage and spotting arbitrage opportunities.
Let’s start with the unique problem in the cryptocurrency world.
The problem
I ended the last lesson with a note: 15% yield might not seem like much, but if you can add 10x leverage, that becomes a 150% yield, which is amazing.
Immediately afterwards people contacted me about how to do that. It’s a smart question because you can’t use leverage in the cryptocurrency world. There is no credit system because there is no way to build a credit profile in a decentralized and anonymous blockchain ecosystem.
Moreover, if you are going to force people to pay debt on more than they originally had, then you will need the coercive power of the state to do that. You need police, not smart contract code. This isn’t a problem that smart math can fix, even in principle.
So what are you to do?
One of my favorite folk philosophers, Ryan Holiday, wrote a wonderful little book titled The Obstacle is the Way. I teach it to my students in my Global Ancient Philosophy course. The basic idea is that when you face a real problem, try to reframe that obstacle as the solution. It’s a Stoic idea (a philosophy from ancient Greece born about 350 BCE).
In this case, if you can’t get leverage in the cryptocurrency world, then whoever is able to reliably secure leverage outside the cryptoworld will have an advantage in it. If you take that path, you’ll find that there are three widely available ways to do that.
1 Basic Recursive Farming, 2x
This is just a fancy name for depositing your money somewhere, to earn a little yield. Then borrowing against that deposit. And then redepositing what you borrowed for more yield.
Recursive yield farming, then, is a way to introduce leverage into the system of cryptocurrencies by making exchanges and protocols bear the burden of lending you credit. Here’s an example.
Step1 - Got to Aave, switch to the Polygon protocol, and deposit some DAI. It looks like this.
This only gives me 2.88% annual percentage yield (that’s continuously re-invested for me), but it also gives me an additional 4.41% annual percentage rate (that’s not continually re-invested for me) worth of Polygon tokens (MATIC).
If the price of Polygon tokens stays flat, I’ll earn 7.29% on my deposit … which is disappointing, especially since MATIC tokens can be guaranteed to move all over the place. So, let’s add some leverage by doing this again.
Step 2 - Click “Borrow” to take a loan out against your own deposit.
You’ll notice that I can’t borrow against my whole deposit. The reason is that otherwise the whole system would be put at risk. All borrowing in the cryptocurrency world is over-collateralized because the blockchain tech can’t send police to your house to collect.
You’ll also notice that for borrowing, I’ll be charged 4% APR, but MATIC will pay me 5.52%. If prices stay the same, then I am getting paid to take out a loan.
That difference - 1.52% - is arbitrage. So, this approach uses leverage + arbitrage.
After you complete that, your screen should look like this (taking out a $500 loan and not the maximum to be safe).
Step 3 - Deposit You Loan and Reborrow
After you click the deposit button and put your newly borrowed $500 into Aave, you should get a screen that looks like this.
Now I’m making that 7.29% on $1500, rather than $1000, and I’m getting that additional 1.52% arbitrage payment for borrowing. Basically, I’m making money for making money.
Let’s finish this off and borrow another $500 against that new $1500 sum.
So, there you go. I’m now earning 7.29% on $2000, rather than $1000 = 2x my original yield. I’m additionally making 1.52% for borrowing $1000. So, I’m actually at 16.1% of my original investment.
If Polygon loses a lot of value and never recovers, then I’ll be on the hook for those 4% APY loans. If Polygon returns to its all-time high, then my return will probably be better than 40%.
Considered in strictly financial terms (bracketing platform risk), that’s a 10 to 1 reward to risk ratio. I only need to have 9% confidence that this will work out for this to be a rational bet.
One main limitation to this approach is the cost of depositing, loaning, redepositing, etc. Each of those will incur a transaction cost, so that if you try this on the Ethereum network, you will eat away all possible gains in fees. That’s why this was done on the Polygon network.
If you don’t know how to do that, just ask on Discord and I’ll either answer in Live Chat or during the AMA session.
A second main limitation is that these opportunities are limited. When I checked this morning, those rates weren’t as good.
Third, since this is primarily a bet on MATIC tokens, why not just buy MATIC tokens. If they go up 300% in the next run (likely), then you’ll make 300% rather than 40%. Of course, you expose yourself to a lot more risk that way. This approach has only a 4% loss as a possibility.
But all of this might seem rather excessive, so let’s look at a couple of simpler methods.
2 Exchange Leverage, “3x”
If you have access to exchanges outside the US, then you have the option to use leverage on stable coins.
Here is what Kraken offers (Binance and FTX offer more exotic leveraged options, but let’s keep this simple).
You’ll notice that if you deposit Euros, you can get greater leverage options than US dollars. So, scroll down their page, and you’ll see this.
For Euros, you can get 3x that amount in Tether (USDT) and 3x in USD Coin (USDC). You have to look for the fees, but you’ll pay 21.9% APR for that kind of leverage.
You can’t just take those tokens and stake them for extra returns, as a result, because you’ll be losing to your borrowing costs. The Aave plan described above would work, if MATC makes a bundle. Otherwise, you’re on the hook for a bunch.
So, maybe the best way to do this would be to switch your stable coins for UST, and then go stake that on Anchor. They still give about 19.41% with 5% fees …. So, 14.41% APR.
If you used $10,000 initially, and took out a loan on that for 3x leverage, giving you $30,000, your after fee return on Anchor would be $4323 and your cost would be $2190, for a net gain of $2133. That’s better than just staking your $10k on anchor (giving you $1441), but not astronomically better.
So, this is simpler, but your 3x leverage doesn’t result in 3x returns, because the cost for that borrowing is so high. This point will hold for Binance or FTX too. Let’s look at a final option then.
3 Interest-Free Options, 10x
If you’re like me, then you probably get offers like this all the time. This is from American Express and it was sent to my email.
Yes, they’ll let me borrow $20,000 for 12 months without paying interest.
If I take that $20k to Anchor, I’d make $2882 after a year for free. That’s a lot better than using margin from Kraken.
I could also try the Aave process, but I’d have to hope that MATIC took off in time to repay the loan. There are also hidden fees in this sort of cycle, and I’d have to finish it after 11 months, just to make sure everything was repaid on time. So, this isn’t really free money, but probably better than 10x (meaning I’d incur a $280 set of fees along the way).
The most obvious drawback here is that this approach does not scale well. It’s free money, just not very much of it.
Concluding Thoughts
These are three ways to introduce leverage into your yield-farming strategies that are widely available. Only one of them can take a 15% yield strategy and transmute that into 150%—but probably not at the scale that you want.
I did find some ways to do that, but they are peculiar to me or what I can do. That all follows from the point that cryptocurrencies have no internal credit systems.
The better way to get those returns is just to move away from stablecoin farming and into investments. That means that you’ll be taking on financial (or investment) risk. The recursive approach already did that--you have to bet on MATIC for that to be successful.
So, we’ve already waded into the waters of the Art of the Bubble as an investment strategy. We might as well do it intelligently.
In the next lesson, we’ll look at yield farming proper--where we decide to chase huge 2000%+ yields and figure out what the drawbacks are in each case. That will set us up for my favorite approach in this area: yield farm investing.
Ask me any questions on Discord.
Happy Trading!
Disclaimers
General financial disclaimer: This post is provided for entertainment purposes only. I am not giving you financial advice and I am not a financial advisor. You should expect no financial returns one way or another based on my statements. These points hold equally for any statements that could be attributed to The Art of The Bubble or any related business entities. If you decide to buy or invest in anything, then your returns and potential losses are your own. No statements about taxation are taxable advice and you are encouraged to consult your own tax professional. You are also encouraged to do your own due diligence before investing in anything.