Crypto Market Commentary
1 December 2019
Doc's Daily Commentary
The 11/29 ReadySetLive Trade School with Doc is listed below.
The Open Finance (ex-DeFi) ecosystem is burgeoning on the Ethereum platform and is certainly the most evolved and mature application layer we have seen for smart contracts to date. The real value proposition for Open Finance comes from the ability to build one protocol on-top of another creating a composable system.
In Ethereum, many refer to this as ‘money lego’ where different pieces of the open finance stack can call upon others to enhance their functionality and create new possibilities for what can be achieved with blockchains. It is a fascinating concept to be watching unfold, despite some regulatory hurdles and teething problems such as smart contract risk and ‘house of cards’ style systems.
One project which is very interesting is Set Protocol and today I want to look at some interesting features and products available that might help us gain edge and manage risk in the market.
Set Protocol Basics
The general overview of set protocol is that the team has written smart contracts that link into decentralised exchanges (Uniswap and Kyber Network) undertake automatic rebalancing, buying and selling of various tokens on Ethereum when a set of conditions are met.
Think of it like an automated portfolio manager that is managed by a smart contract. The concept itself is pretty neat and it makes it possible to leverage many of the interesting composability dynamics available within the Open Finance ecosystem.
At the moment, the project has a few different types of Sets available:
Buy and Hold – These sets usually have a weighting of ETH and WBTC that varies between 25%-75% and is intended to simulate a portfolio rebalancing. If you are more bullish on Bitcoin but want exposure to Eth, these sets will essentially take profits with the project that outperforms and converts it into the other token.
In my opinion, the set that is heavier weighted to ETH (75% ETH, 25%WBTC) makes more sense. If you want more exposure to BTC, just hold BTC. If you want exposure to ETH but want to automatically take profits in BTC, this is the kind of set for you. It maintains full exposure to crypto and thus will fluctuate in price relative to changes in the underlying.
Volatility Range Bound Sets – These sets are designed to accumulate during choppy, sideways markets. They are available for both BTC and ETH and range in expected volatility ranging from low (25% moves) to high volatility (40%). Essentially, if you expect sideways trading, these sets will automatically sell when BTC or ETH rallies into USDC or DAI (stable coins) and then ‘buy the dip’ when price falls back down.
To be honest, I don’t think these are very good plays as crypto markets are likely to trend in the medium to long term and these sets will likely be in DAI at the exact time you want to be in BTC or ETH. This is reflected in the new Market Cap rankings on Set Protocol website where these sets have attracted some of the least investment attention.
Inverse Sets – these are basically the opposite of a bullish 20SMA cross over strategy. Instead of BUYING ETH when it breaks above the 20SMA, it SELLS it to USDC in anticipation of a bearish reversal. This is a bearish trending strategy and hopefully is something that is not useful in the medium term.
Even so, I feel there are better strategies than buying and selling on a 20 and 50SMA crossover during a bear market which is often volatile and trending and I suspect will have a lot of false signals. I suspect these sets will get the most use by people hedging risk but likely not much by retail investors bullish on the space. It would be better if they used short tokens rather than cash at the bottom, ETH at the top…seems confused.
The Trending Strategies
The final category of Sets is where I see a lot of potential for us to hedge risk and capitalise on market movements.
Any of you who have been following my learning process with respect to the value proposition and longevity of Ethereum know that I have my doubts long term. The project continues to baffle me as realistically speaking, it should have died along time ago. It has serious technical, governance and mechanical issues….and yet it continues to attract developers, users and investment use cases. I will gladly be proven wrong as it will be a great learning experience.
Set protocol now provides us with the ability to hold ETH with automated stop losses in place.
These sets are usually some kind of moving average (simple or exponential) cross over and can be thought of as an automated Turtle trading strategy. In fact, one could reasonably buy a portion of both a 20DMA and 50DMA crossover strategies and have a fully functioning turtle trading strategy in action. How well it performs in these markets would need back-testing to properly understand.
What is important is that in the event of a cataclysmic event (that doesn’t kill the network), these sets will have an automated stop loss built in. If you are unsure of ETH’s price stability, instead of selling to USDC, you could buy a moving average cross-over Set that will do this automatically in a dump but hold ETH if it keeps going up. It is a smart stablecoin in this instance.
There are three sets in particular that are of interest 1) The ETH 20D and 50D Moving Average crossovers and the new 2) ETH/BTC 20D EMA cross over strategy. We can see that the 20DMA cross over strategy currently has the greatest investment on the Set platform and the volatility (purple) and inverse sets (red) have very limited open interest.
The Turtle Strategy
For those not familiar with the story of the turtle traders, they were a legendary group of individuals in the 1980’s who were brought in by Richard Dennis and William Eckhardt to be taught how to trade a very strict and specific strategy. The whole experiment was to settle a bet as to whether traders are born or made, a classic nature vs nurture test.
The strategy was simple, buy a portion of a commodity on a confirmed 20DMA cross over (the fast signal) and then buy with more conviction on a 50DMA cross over (the slow signal). Coupled with strict position sizing and entry/exit criteria, the strategy was so simple yet so many of the traders could not stomach the pull backs and chop. Those who deviated from the strategy invariably underperformed and those who stayed strong and executed every single rule outperformed almost the entire market.
At the end of the day, more of the turtles made money selling guides and books on the turtle trading strategy than actually executing it themselves. Those who actually mastered the strategy retired early as very wealthy individuals.
Now these Sets allow you to automate this process. If you were to buy say a 50/50 split of the 20DMA and 50DMA crossover strategy, you have effectively employed the turtle trader strategy without the human constraint of emotions.
When price drops below the 20 or 50DMA, it will sell ETH into USDC. When it crosses back above it will rebalance into ETH. Simple right? Now in sideways and choppy markets, there is a risk it will consume some profit potential as it buys and sells multiple times losing to slippage and false signals. However when the trending market kicks in and over the long term, I strongly suspect these sets will outperform the market.
These sets will be capable of selling local tops and buying the dip to capture the most meat from the trend.
As an added bonus, in the event Vitalik does something stupid and price dumps, your set will rebalance into USDC, ideally with minimal slippage. For a Bull market, if there is ever market wide uncertainty in the viability of the Ethereum project, you could hedge this risk with the purchase of an Ethereum based product.
Seems kind of ironic but at the same time provides an actual use case for this technology. Perhaps that reduces the risk…it also makes my head hurt.
BTC is my stablecoin
If you are like me, BTC is my stablecoin and I think about profits in sats not dollars. My conviction with BTC success far outweighs my conviction for ETH. Thus, in a risk off scenario, I want to be in sats not gwei.
In a very similar manner to the ETH/USDC trend strategies, the ETH/BTC trend strategy uses the 26D EMA of the ETH to BTC ratio to buy and sell whilst remaining completely exposed to Crypto price fluctuations. You could select this set where you are have a high conviction in BTC price appreciation but are not so sure ETH will perform as strongly.
When ETH performs poorly against BTC, this Set will have 100% WBTC exposure. If ETH starts to trend against BTC, you will have full ETH exposure. If Vitalik does something questionable, you will be rebalanced automatically into WBTC. It is an automatic sats-stop.
This could be a viable strategy in the run up to the halving. There is a moderate likelihood that everything will underperform BTC in the immediate run-up as people accumulate sats as much as possible. Conversely, if the BTC rally raises all boats, you will benefit from ETH appreciation. This Set may also form a sane component in a portfolio in conjunction with the turtle strategy to maintain some exposure to crypto at all times.
Nothing is without risks so I will list the key ones below for further discussion.
Composability and smart contracts – All Open Finance systems are built on-top of others. Set protocol is generally pretty isolated and only really draws on the ERC-20 WBTC, DAI and USDC for the sets of interest. There may also be bugs in the smart contracts however so far so good. Therefore I see this as the lowest risk in the stack.
Liquidity risk – There is a risk that when your set goes to rebalance, there is not enough liquidity in the DEX. I do not fully understand the mechanics of how Set goes about it but as more and more people buy the Set, the slippage will increase. If Vitalik does something stupid and everyone exist at the same time, unlikely you will get the best price. That said, if you caught the bulk of the move long term, this risk may remain palatable.
Chop – The sets have some rebalancing criteria such as a cross-over. Usually, price needs to remain above the MA of interest for 6hours before a rebalance occurs to avoid getting wiped out because of a single wick. Sets then have a 12-48hr window where no additional rebalance can occur to avoid getting chopped up and losing to slippage. Overall, this is a good system if you are in it for the long haul (6+ month minimum) as it will even out. However short term, you may get rebalanced to USDC in the short term and if price strongly reverses, you may end up with a little less ETH than you started with. A lot can happen in 12 hours in crypto. This works both ways.
Tax – I have no idea what this means for taxable events. It is possible that buying the Set is your ‘investment’ as it has a defined price that moves with the underlying and on rebalances. It could be that every rebalance is a taxable event. This one is in your court as it will no doubt vary based on jurisdiction. Something to be aware of.
I like Set protocol, it is a valid use of smart contracts and Open Finance. Holding a combination of the 20DMA, 50DMA and ETHBTC 26EMA Sets are in my world the most intelligent way to get ETH exposure whilst also managing existential risk. It is like buying a smart stablecoin that will protect the bulk of your profits in the event of an Ethpocalypse. I am currently experimenting with the ETHBTC ratio as a way to get ETH exposure, just in case the project grows legs and starts running…Let’s see how it goes.
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