What is a pairs trade?
A pairs trade is a strategy used when two related assets that typically move in the same direction. When one asset starts to perform better than the other, you sell the outperforming asset and buy the underperforming one. This is done with the expectation that they will eventually return to their usual relationship, allowing you to make a profit when that happens.
If a user believes that an asset will decline in market cap (example - Asset A), but the crypto market as a whole will continue to grow - using a pairs-trade to open a position would be an optimal strategy.
How does the position work?
The trade utilizes AAVE, which is a permissionless lending market. AAVE enables users to borrow an asset by depositing collateral at a variable interest rate. To initiate a bearish position against an asset in the index, the user would do the following:
Bearish Pairs-swap
- Deposit USDC or an equivalent stablecoin into AAVE as collateral.
- Borrow asset that the user is bearish on (e.g. ETH, wBTC).
- Sell borrowed asset and purchase AMKT.
When a position is closed, the AMKT is sold back for stablecoins or the bearish asset and the debt is settled. If users are unable to repay the loan, their position will be liquidated and the position will be closed out automatically.
Monitoring an open position
Positions can be monitored at https://app.aave.com/.
It is important to make sure that your loan health does not go below 1. If it is below this number, your loan is at risk of liquidation which will result in a loss of collateral.
It is important to make sure that your loan health does not go below 1. If it is below this number, your loan is at risk of liquidation which will result in a loss of collateral.
How do I close my position?
You can close your position by going to https://app.aave.com/,and repaying your open borrows. After all borrowed assets have been repaid, supplied collateral will be available for withdrawal.
What are the risks involved?
There are several risks associated with this strategy, including liquidation risk, market risk, and smart contract risk and interest rates. Liquidation risk arises if positions are not adequately maintained, leading to liquidation in the event that the value of the borrowed collateral falls below the liquidation threshold. In addition, users may be charged an interest rate for taking out a position. Market risk stems from the inherent volatility and unpredictability of the cryptocurrency market, which could negatively impact the performance of pair-trading strategies. Lastly, smart contract risk is a concern, as potential vulnerabilities in the lending market could be exploited, resulting in a total loss of funds. It’s essential to be aware of these risks when engaging in pair-trading strategies and to take appropriate measures to mitigate them.