Let’s Make It Interesting

One of the fun things about working for a DeFi protocol is counter-trading the protocol’s founder.

….Wait what?

Am I crazy? I hope not.

Is he wrong? I hope so.

The Trade

Honestly, it’s super simple — Long ETH, with some juice.

Hear me out:

I’m bullish crypto on a macro level for at least the next 3-6 months. I feel like I have a strong rationale, but that part really isn’t important. What’s important is that I have a high-conviction bullish bias. HIGH. The kind of conviction that makes a guy look for leverage on large caps as a proxy for the whole crypto sector. I can feel it in my bones. But that’s just me.

So what are my choices?

Option 1: Perps & Options (EXPENSIVE)

I am absolutely no stranger to perpetual swaps; I cut my crypto-trading teeth on Bitmex back in 2016 originally—then expanded to Deribit, Binance, Bybit, OKX, and everything else under the sun. The reasonable part of me still cannot believe these venues offer up to 100x leverage. But an even more reasonable part of me simply cannot justify the funding rates and what it costs to hold a long perp position at these venues during a bull, or really for any meaningful amount of time.

I’ll take only a moment to touch on options because my Greek is less than conversational. In my opinion, options are an incredible instrument to still be wrong despite being right. I can attest that you only need to experience this so many times before you stop using options for speculation. My duration for this trade isn’t explicitly short term and it isn’t explicitly long term, and that’s about as certain as I can be on it. Options aren’t the right way to play that kind of duration thesis so let’s get back to perps and one of their various and sundry “gotcha” mechanisms.

The typical “baseline” funding rate for large cap perpetual swaps at any given stable moment in the market is 0.01%. This accrues every 8 hours, so I’d expect to pay 10.95% per year to be in a long position. But remember I said I want leverage — I’m thinking 3-4x. The (not) fun thing about funding rates is that they’re subject to these leverage mechanics; so that juicy 100x long you’re thinking about taking? A standard 0.01% funding rate means that all else equal, including price, you’d get 100% liquidated in a month due to your cost of capital.

Let’s run that math back again real quick: Funding has longs paying 0.03%/day, but at 100x that’s 3%/day. At that rate, only 34 days until you’re down 102% on the funding rate alone — AKA “cooked” to speak technically. At only 3-4x leverage it’s certainly not that egregious, but we’re still talking 30-40% interest to go long on ETH. If I was insane and therefore comfortable with that I’d just open a new AmEx card and max it out on Coinbase.

Not to mention that in bull markets this funding rate generally skews further against longs as their trade becomes crowded; earlier this year funding on ETH was annualizing for over 20% for well over a month. Suffice to say that for a “medium or longer” duration trade with leverage, this kind of funding is a non-starter. And all this makes no mention of having to get comfortable with handing my assets over into CeFi custody, so let’s move on.

Option 2: Aave, or Moonwell/Compound, etc.

Here we go, a DeFi option! I love the self custody, I am no stranger to Aave, and with $10B+ in assets surely this will be a super cheap and easy option to use right?

Wrong.

Borrowing on Aave (and most other borrow/lend protocols) at a variable rate subjects me to rate spikes; rate spikes that were as high as 45% just a day ago. Naturally these rate spikes get more frequent in a bull market when more traders are borrowing stables to get leverage against long positions, and naturally that behavior tends to pull the baseline rates higher — like the 10-15% baseline borrow rates we saw earlier this year for extended periods of time. Keep in mind if I want leverage that means these rates would get levered too… suddenly that crazy AmEx approach is starting to seem competitive.

Option 3: Size Credit

Time to toot our own horn here. At first pass you might assume Size is yet another Aave or Compound fork—transparent, onchain, permissionless borrowing and lending is not uncommon in DeFi. But an incredibly important difference between Size and Aave (or any other borrow/lend protocol) is the unique Size fixed-term loan structure and order book.

Dramatically unlike Aave, I can pick any specific loan duration and any future maturity date, and then lock in an interest rate to borrow USDC against my ETH over that duration. Funding rates, utilization rates, CeFi exchange collapses, and general price volatility be damned—if I lock in 6% for a year on Size, I’m paying 6% if I hold that loan for a year, end of story. This means that I can get my leverage for a reasonable cost, and more importantly, I can sleep easy at night knowing this cost cannot change for any reason whatsoever.

Maybe if I’m clever I can use some of that leverage to specifically to earn a yield on the borrowed USDC. It will take some creativity but I think I could earn a healthy yield premium over that 6% borrow cost, discounting my cost of leverage even further. Can I build a yield spread that pays for my leverage making it basically free? Only one way to find out.

The nice thing about this duration structure is that I don’t need to be specific and perfect in my timing like I would have to be trading options or using other set-maturity protocols like Notional, Term, or Pendle. If the trade plays our sooner than I expect, or if I’m totally wrong, I can exit my loan early using the Size Credit order book. If this is the beginning of a 2-3 year giga-super-cycle, I can continuously roll my my Size position across different maturities, potentially trade my credit position at specific moments to lock in even better rates, borrow more to squeeze more yield out the trade—or again, just exit early whenever is ideal or necessary.

The Trade, Continued

I mentioned earlier I am ultra-giga-bullish; the founder of the protocol I work for is not. And while I’m looking for leverage on crypto writ large, our founder is certainly not. He’d rather be looking for dollar-collateralized yields—and in light of multiple rate cuts expected around the corner, if anything he’d love to lock in higher yields now. So he’ll gladly lock in a rate for 6 months at least, and I get a fixed cost of capital on this trade. If I lock in 6% against him and use it to lever up, even at 3x I’m only looking at 18% annualized as opposed to 30-40%. Not only is my cost of capital predictable, I also just cut it in half—and that feels pretty smart.

Are we taking a trade against one another? Essentially. But it’s a win-win-win:

I get the cheapest leverage in town (perhaps free?) to put on a trade, our founder gets to lock in a solid rate now knowing that the cuts right around the corner make for ideal timing, and you get to watch what happens as the trade plays out.

To keep things interesting we’re doing this all publicly — you can track my wallet here: 0x278f48c486f8b71facbfdee9a34ff2d4ebfb7ace

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