Anatomy of a Trade: How ReFi thinks about risk
Written by our lead farmer, Ξ huf
ReFi’s treasury has grown rapidly over the past week. We now manage a farming portfolio worth over $1,300,000, and so it’s a good time to go under the bonnet in terms of how we think about risk.
As outlined in our first few articles, we currently give each position a risk rating of either “Low”, “Medium” or “High Risk”. But how exactly do we determine what goes where?
Let’s take a deeper look at Beefy Finance, a yield aggregrator where we currently hold our largest single position.
- Assessing Platform/Smart contract risk
For any DeFi protocol, our first place we look at is rugdoc.io and check their expert review of the protocol. For beefy.finance they determine this as “low risk”, and there are links to both the Certik audit and the DefiYield Audit
We recommend any investors do the same when exploring any of the newer protocols.
2. Portfolio risk
Vaults are vulnerable to exploits at any given time, as witnessed recently by some over at grim.finance (we were not exposed).
In order to mitigate this risk, ReFi has a policy to not have more than 12% of it’s exposure in any one vault or position. As of today, we have not breached this threshold, nor do we intend to do so. Our top 4 positions are as below.
The reasoning is that if there was ever to be an unfortunate event, the absolute max downside would be 10–12% of the portfolio. All these policies are soon to be formalised in an investment mandate document that I am working with our advisors on.
Volatility is a statistical measure of how “dispersed” the daily returns are for a given crypto asset. I.e. take daily closing prices of say, $ETH, compare it to the mean, and then work out how far from the mean each daily close price is.
I highly recommend this article if you’d like to work out how to calculate volatility yourself.
Not following? No worries, put it this way, the higher the volatility, the riskier the security. The riskiest the security, the less allocation we put to it.
So let’s take a look at USDC, the asset we have deposited in beefy.finance. The blue line shows you annualised volatility for USDC. It looks scary right, but look closer. The blue line range of volatility is 0.04% —0.35%.
So USDC moves like 0.35% in a year (historical volatility). Not much at all. For riskier plays, this volatility statistic can be north of 50%, as reflected in the portfolio weightings of the higher risk plays (sub 5%).
Another key way to mitigate our risk is to not invest when things are “expensive”. One way to look at this on a protocol level is to compare Total Value Locked (TVL) to the market cap of the protocol.
Indeed this is one metric we used to make our bullish call on Fantom at $1.50 (see left).
The TVL has since risen from $4.72bn to $5.69bn and Fantom’s market cap has risen from sub $4.72bn to $7.49bn.
That’s why we put many of our initial trades against FTM pairs.
So, coming back to our big USDC deposit. The back-end infrastructure for that is using a protocol called Scream (https://scream.sh/).
One reason we are bullish on $SCREAM is because it has a market cap of around $12m, but a TVL of nearly $500m.
Indeed, even though beefy.finance uses SCREAM, we decided to get ourselves some more exposure to the ecosystem as outlined in this tweet:
The rationale is that by buying at a “cheaper” valuation, we offset some of the downside risk by being early.
This is not a formal risk metric, but it’s an important part of our due diligence. Nothing beats getting close to the founders of the protocols that we are investing in. For example, we have a sizeable bentCVX position on https://app.bentfinance.com/.
To get comfortable with the risk, one of our advisors (Pablo Treff) introduced us to the founding team. Since then, we’ve been in discussions with them about adding bespoke curve and convex pools that might best suit ReFi’s needs. That level of innovation and communication gave us the confidence to invest your capital there.
Going back to Fantom for a sec, we also have built a relationship with the team at reaper.farm and like the way they think about risk.
We feel a lot more comfortable knowing we have a direct line of communication with the founders.
Finally, we are actively trimming positions when they have performed very well (e.g. FTM/TOMB LP) and rotating them into positions with much more upside (e.g. we used profits to buy and stake $LQDR at $7, now $22).
I am working with our advisors in formalising our investment mandate and putting many of these policies into a document so that going forward we have stricter criteria for new purchases. This helps ensure the stability of the Reimagined Finance project. To summarise:
- Assess platform risk
- Portfolio level risk
Peace out, huf.