Strategies: Buying, Minting, LP
There are four general ways to play Kvadrat: Long, Short, Buy+LP, Mint+LP.
Before we describe them in detail and compare them, we need to establish what "LP" means here.
LP is a shorthand for "Liquidity Pool" and denotes an activity similar to Tezos Liquidity Baking. The main difference is that you are contributing liquidity to tzBTC/Kvadrat(tzBTC²) trading pair instead of tzBTC/XTZ pair. Naturally, you get rewards for that (in the form of LP tokens) while bearing the additional impermanent loss risk.
Payoff Profile | tzBTC² |
|---|---|
Income/Cost | Daily premium (i.e. in-kind funding) |
Max Gain | Unlimited |
Max Loss | Limited (amount deposited to buy Kvadrat token) |
Liquidation risk | Longs can not be liquidated |
What you are betting on when Long Kvadrat:
- The best time to bet long on Kvadrat is when you believe in the upward price movement of Bitcoin (and tzBTC in effect) in short to medium term. Kvadrat will then supercharge this move via its quadratic payoff formula, granting you an enormous upside.
- You will have to pay the funding rate for holding this long position; thus, it is better not to hold the long for too long.
- Naturally, it is better to buy kvBTC when the implied volatility is at historically low levels. This way, you are paying a lower funding rate and can benefit from the upwards repricing of the token if IV rises.
Risks:
Again, you have to pay attention to Kvadrat funding throughout the period you plan to hold it. Holding a Long position for an extended period (> 6-12 months), during which tzBTC (Bitcoin) trades sideways or goes down in value, will cause a loss in tzBTC² exposure due to in-kind funding paid to kvBTC sellers.
This is fair compared to a 2x leveraged position; KVADRAT will make more when BTC goes up and lose less when it goes down. Thus funding rates are expected to be high due to Kvadrat's desirable exposure to pure convexity.
Payoff Profile | Varies based on the collateralization ratio |
|---|---|
Income | Daily premium paid by Long Kvadrat holders (i.e. in-kind funding) |
Max Gain | Limited (amount of debt from short Kvadrat token) |
Max Loss | Limited (amount deposited to short Kvadrat token) |
Liquidation risk | Short Kvadrat positions can be partially or fully liquidated (liquidation price is based on collateralization ratio) |
What you are betting on as a Kvadrat Short:
At the recommended collateralization ratio of 200%, the ideal market condition to be short Kvadrat is when there is a conviction that the market is overpricing volatility (i.e. current Kvadrat implied volatility is too high - see the paragraphs above on being long Kvadrat) and you expect the price of Bitcoin to trade sideways. More specifically, during periods when Kvadrat realized volatility is less than Kvadrat implied volatility (this is again very similar to how shorting options works except you don't need to worry about strikes, deltas, maturities and all the other stuff and focus on Gamma).
The cumulative short Kvadrat return is thus a function of:
- Daily premium paid by Long Kvadrat holders (reduction of kvBTC token debt size that you need to repay through in-kind funding)
- BTC collateral
- Short (∆ tzBTC)² return
Risks:
The most significant risk to a short Kvadrart position is a quick, large move up in the price of (tzBTC) Bitcoin due to the possibility of being liquidated in this case. If the price of tzBTC continues to increase, short sellers will need to add collateral to avoid being liquidated.
On the other hand, if the BTC price decreases, the value of the short Kvadrat position’s collateral will decrease. However, this will be partially offset by the gain from being short tzBTC² (the quadratic effect will be dominated by the linear one here).
Since selling Kvadrat short exposes you to a liquidation risk, it’s important to monitor the liquidation price set by the minimum collateralization threshold (150%) and strive to have a higher initial collateral ratio (like 200%)
Payoff Profile | tzBTC^1,5 |
|---|---|
Income/Cost | You pay: Daily Premium of the Kvadrat token portion of LP (i.e. in-kind funding, you have less exposure to funding than holding 100% Kvadrat.) You receive: Kvadrat-tzBTC Liquidity Pool Fees |
Max Gain | Unlimited |
Max Loss | Limited (amount deposited to buy + LP) |
Liquidation risk | Buy + LP positions CANNOT be liquidated |
What you are betting on with Buy + LP Kvadrat:
The best setup for Buy + LP is when tzBTC price appreciation exceeds funding paid for the long Kvadrat portion of your LP. In short, you want the price of tzBTC to go up with high volatility and high trading volume in the Kvadrat-tzBTC liquidity pool. Buy + LP positions do well even if BTC (tzBTC) increases prices significantly.
A full-range Buy + LP position is similar to a tzBTC^1.5 payoff, excluding funding and trading fees. You have less funding exposure than holding 100% Kvadrat long and thus need to worry less about the cost of carrying for your long position.
The Buy + LP position accumulates more tzBTC as its price increases (due to the impermanent loss on the LP effect). Alternatively, if the price of tzBTC decreases, the LP position accumulates more kvBTC tokens and reduces its % holding of tzBTC.
When does it make sense to Buy + LP Kvadrat?
- High trading volume in the Kvadrat-tzBTC pool and, thus, high liquidity pool fees
- Price increases of BTC outperform funding on Kvadrat token (similar to being just long Kvadrat, but you don't need to be as bullish in this case)
- You desire a convex exposure to tzBTC
- You consider a moderate funding rate acceptable cost for having above 1x tzBTC long exposure.
Risks:
You still need to pay special attention to Kvadrat funding cost throughout the period you plan to Buy + LP Kvadrat. If the price of tzBTC decreases, the LP position will accumulate more Kvadrat tokens, thus leading to higher amounts of funding paid.
Payoff Profile | Acts like a covered call (your initial exposure is similar to a long 1x BTC) |
|---|---|
Income/Cost | You receive: Kvadrat-tzBTC Liquidity Pool Fees |
Max Gain | Limited, dependent on LP range, collateralization ratio, and trading fees |
Max Loss | Limited, dependent on LP range, collateralization ratio, and trading fees |
Liquidation risk | Mint + LP Kvadrat positions can be partially or fully liquidated if the price of tzBTC increases too much (liquidation price depends on LP range) |
What you are betting on with Mint + LP Kvadrat::
The ideal market condition for Mint + LP is when there is Bitcoin (tzBTC) price appreciation and high trading volume in the Kvadrat-tzBTC pool. You ideally want the impact of tzBTC price increases to exceed funding slightly, but you may not be as bullish as someone who chooses to Buy +LP.
Mint + LP positions give up some tzBTC (compared to long and buy + LP cases) upside and take on more tzBTC downside in exchange for earning trading fees generated from the Kvadrat-tzBTC pool.
When does it make sense to Mint + LP Kvadrat?
- Want to be long but are not very bullish compared to Buy + LP Kvadrat (BTC^1.5 payoff)
- You observe high Kvadrat-tzBTC pool trading volumes and, thus, high returns from LP activity.
- Don’t want to be initially paying the funding costs
- You are ok with a lower upside from being long tzBTC in exchange for earning trading fees from the Kvadrat-tzBTC liquidity pool
Risks:
The most significant risk to a Mint + LP position is a quick, large increase in the price of tzBTC (Bitcoin). You will need to provide additional collateral to avoid being liquidated if the price of Bitcoin continues to rise.
If the Bitcoin price falls, the value of the Mint + LP position’s collateral will decrease, which will be aided by increased funding earned by the short Kvadrat position within the LP. Thus, this scenario is less negative for the Mint+LP case.
