Algorithm Design
Purpose
The purpose of the rebalancing strategy is to accumulate the token of choice (aka target token or deposit token, as it is the token that the user deposits into the vault). The return profile and user experience is similar to a staking product, but instead of earning additional tokens that contribute to value dilution, Yield IQ depositors earn token rewards in the form of trading fees from liquidity pools.
With this design, the depositor’s return can be calculated elegantly and effortlessly, represented as deposit token denominated IRR.
State Archetypes
The rebalancing strategy uses the token composition and volatility to categorize the vault into 5 states:
Healthy State
Over Inventory State
Under Inventory State
High Volatility State
Extreme Volatility State
Depending on the state, the rebalancing strategy will allocate the token and designate token concentration accordingly.
Healthy State: This is the state the rebalancing strategy is trying to keep the vault in for as long as possible. This means the price is moving within the price range where we position the concentrated liquidity, and thus efficiently accumulate the deposit token through earning concentrated trading fees.
In a healthy state, this is how the tokens are allocated and concentrated:
Over Inventory State:
This state (and corresponding concentrated liquidity provision) is triggered when there are too many deposit tokens. When the vault is in the over inventory state, the rebalancing strategy will position the vault in a way that it prioritizes the sale of the deposit token to get it back to the healthy state.
As illustrated, when the paired token spot FX increases by a small %, the concentrated position will sell a much larger size of the deposit token when compared to a similar move of the spot FX to the other side.
Under Inventory State
This state (and corresponding concentrated liquidity provision) is triggered when there are too few deposit tokens. When the vault is in the under inventory state, the rebalancing strategy will position the vault in a way that it optimizes for buying the deposit token to get it back to the healthy state.
As illustrated, when the paired token spot FX decreases by a small %, the concentrated position will buy a much larger size of the deposit token when compared to a similar move of the spot FX to the other side.
High Volatility State
Differences between fast 5 mim and slow 60 min TWAPs as well as between current price and fast TWAP will be used to detect such price movements. By default, a 6% difference triggers the high volatility state.
In the high volatility state, the liquidity will be spread out into full range for both tokens.
Extreme Volatility State
Difference between fast and slow TWAPs as well as between current price and fast TWAP will be used to detect such price movements. By default, a 25% difference triggers the extreme volatility state.
In the extreme volatility state, the strategy will lock itself and prevent further deposits into the vault. Note that in this case the vault is not rebalanced at all - human intervention is needed to assess the situation and decide when and how to rebalance.
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