Effectively, the article conveys nothing new. Nothing other than cash is (or has been) legal tender, not real estate, not even gold. Banning, controlling and regulating are three very different things. Also, if the Government wants to launch its own CBDC
(crypto-backed digital Rupee), it cannot at the same time also ban cryptocurrencies. It might, as Iran is currently doing, put in a regime for tracking and tracing cryptocurrency ownership. As we have always said, regulatory clarity will be welcomed not just in India, but by the global crypto community looking at the India opportunity. You can price risk, but you cannot price uncertainty.
Another piece in Quartz
by Nupur Anand was far more balanced, and spoke about a leading law firm advising a governmental panel set up to probe cryptocurrencies, advising the panel to take a constructive, progressive view on cryptocurrencies. We think this is probably far closer to reality. A common view in various crypto forums is that there is going to be regulatory clarity in the next few months, after the national elections that are due in Q2.
By the way, the piece we wrote on FactorDaily on crypto and geopolitics
was timely and continues to drive debate, aided also by the fact that in the interim, multiple governments have been making progress on crypto-versions of their fiat currencies. Iran’s crypto rial is making progress, the UAE and Saudi Arabia are planning one, and going above the news article above, India is also apparently planning one!
Using the DAI stablecoin to gain leveraged ETH exposure
TLDR; Today’s core post is a detailed exploration of how one might use the DAI, a decentralized, crypto-collateralized stablecoin, to gain leverage exposure to ETH. It is an interesting post in that it portends the type of financial instruments that will characterize the emerging DeFi (distributed finance) era over the next few years. We are using a completely decentralized cryptocurrency, that is theoretically pegged to the US Dollar, to gain exposure to Ethereum, another decentralized cryptocurrency. In a few years, such structures will likely be commonplace across desks at most investment banks. To coincide with the launch of Fordex, the world’s first stablecoin DEX with a fiat on-ramp, we will be periodically looking at analyzing investing and trading strategies that are actionable, for those that are so inclined.
Most of the trading activity that we are witnessing in stablecoins currently is as a result of speculators chasing ephemeral arbitrage opportunities that stem from price discrepancies of various stablecoins, against the base currency, such as the US Dollar, and amongst themselves.
To see how arbitrage works in stablecoins, let’s see how fiat-collateralized stablecoins work. In fiat-collateralized stablecoins, every stablecoin that is issued ( or minted, technically speaking) is backed by a dollar that is deposited in a bank account. The price stability of stablecoins stems from the fact that each token can be redeemed for a dollar minus any service fees. So, in theory, every stablecoin should be priced at a very slight discount to a dollar. However, the ebb and flow of markets creates arbitrage opportunities for traders through price discrepancies where stablecoins trade at a premium or a discount to their ideal price of $1 per token.
Consider two cases where the price of a stablecoin is above $1 in case and below $1 in another. For the purposes of illustration, we shall refer to two popular stablecoins, USDC and PAX. Note that this is a pair that is available to trade on Fordex
Case 1 (price of a stablecoin is above $1, say $1.02):
- Send $1 to USDC/PAX to get 1 USDC/PAX token in return
- Sell the USDC/PAX token on the exchange for $1.02 and make a risk-free profit of $0.02
Case 2 (price of a stablecoin is below $1, say $0.98):
- Buy 1 USDC/PAX token on the exchange for $0.98
- Send 1 USDC/PAX token to USDC/PAX and get $1 in return, effectively making a profit of $0.02
The possibility of a zero-risk profit due to price discrepancies is driving up the issuance of fiat-collateralized stablecoins in general.
In the case of crypto-collateralized stablecoins such as DAI, where the stablecoins are overcollateralized with ETH, arbitrage trading becomes much harder. For every $1 in ETH as collateral, only $0.66 worth DAI tokens are issued. In order to profitably arbitrage DAI, the price of the DAI token should be above $1.5 (which is unlikely). That said, crypto-collateralized stablecoins such as DAI have a nuanced feature that allows users to gain leveraged exposure to the underlying collateral. Let’s take a step-by-step look at how that can be achieved with a $100 investment.
- Buy $100 worth of Ether on any exchange and transfer it to a CDP to get DAI tokens
- Assuming a minimum collateralization ratio of 150% (CDPs with <150% collateralization are liquidated to cover the DAI outstanding), the CDP will issue 66.67 tokens of DAI (100/150). At this point, the user owns the underlying $100 in ETH and also has access to 66.67 DAI tokens that the CDP minted
- Using the DAI tokens, roughly $66.67 worth of Ether can be purchased on an exchange
- The new Ether that is purchased can be used to create a new CDP with 150% collateralization ratio again. The new DAI tokens issued by the CDP with $66.67 worth of Ether as collateral would be 44.44 (66.67/150%). So, the total exposure to Ether a user has after opening a second CDP would be worth $166.67 ($100 from the first CDP and $66.67 from the second one)
- This process can be repeated ad infinitum until theoretically the DAI issued drops to close to zero
- The theoretical limit for the maximum leverage that you can get is the summation of an infinite GP series with (1/r) as the multiplying factor, where r is the minimum collateralization ratio (r = 150% in this case).
L = 1 + 1/r + 1/r^2 + 1/r^3 + 1/r^4 + ………..
Solving the infinite geometric progression leads to a maximum theoretical value of L = 3, or 3x leverage is the maximum one can get after a large number of iterations.
The table below shows the amount of leverage to Ether that a user gets after ‘n’ rounds of CDP creation.