Verified by the Sharp Labs Team

Introduction

Amidst the ever-fluctuating cryptocurrency markets, characterized by systemic events like the Terra Luna debacle, FTX blow-up, and a recent regional banking crisis, price swings have been nothing short of dramatic. Although the markets have impressively recovered from their lows at the start of the year, periodic knee-jerk events continue to spook traders, causing occasional price dips. In this dynamic landscape, delta neutral strategies have emerged as a prudent alternative for astute investors, effectively neutralizing directional risk, mitigating the impact of market swings, and retaining exposure to potential opportunities.

Gone are the glory days of DeFi Summer in 2020 when yield farming peaked. Today, the landscape has shifted, and the once unsustainable and lucrative yields on major DeFi protocols have dwindled. Investors are no longer enticed solely by token incentives; instead, they seek the allure of “real yield” in tangible earnings, be it in stablecoins or the coveted ETH.

These days, investors are increasingly drawn to well-established platforms offering conservative investment options, ensuring steady returns ranging from 1 to 10% by focusing on secure, low-volatility, blue-chip assets. Amidst these familiar choices, GLP stands out as an exceptional performer, earning yield by providing trading liquidity on GMX primarily through stablecoins, BTC, and ETH, with other assets like UNI and LINK representing a much lower proportion. Thanks to its unique ability to generate stable yields north of 10% in ETH, GLP has attracted various protocols to build upon it, resulting in a wide range of new structured products and yield-enhancing vaults.

Sharp Labs: A Web 3.0 Asset Management Platform

As we prepare for a crypto market recovery, these real yield income strategies play a crucial role in diversifying portfolios and ensuring we have dry powder and cash flow to seize emerging opportunities. In partnership with Sharp Labs, a Web3 Asset Management Platform, we delve into their Delta Neutral Strategy Vaults, designed to maximize GLP yield while protecting capital from crypto market volatility. Sharp Labs provides Web 3.0 users access to institutional-style asset management, employing proprietary trading strategies to enhance yield while mitigating price fluctuation risks. Here’s a short summary of what we’ll cover in this article:  

  • Sharp Labs provides Web 3.0 users with access to institutional-style asset management strategies.
  • The Junior and Senior Delta Neutral Vaults boast historical performances of 16.7% and 7.9% Annual Percentage Yield (APY), respectively.
  • These vaults earn a yield by providing liquidity to GMX while mitigating exposure to underlying asset price volatility through proprietary trading strategies.
  • The Delta Neutral Strategy vault stands out among other DeFi alternatives, offering impressive risk-adjusted returns, with a Sharpe ratio of 10+, and a 0.5% max drawdown. 

In short, Sharp Labs is paving the way to democratize institutional-grade trading strategies for DeFi users. With a team of Ph.D. researchers boasting impressive backgrounds in hedge funds and high-frequency trading, they are dedicated to providing market participants with easy access to higher returns from top DeFi protocols like GMX, Lido stETH, and more. By abstracting away complexities and breaking down barriers to entry, Sharp Labs aims to empower users to enjoy higher DeFi yields with ease.

Earn Trading Fees On GMX Without The Underlying Volatility

Sharp Labs’ Delta Neutral Vaults allow users to directly provide liquidity to GMX, which does not heavily rely on inflationary rewards, as liquidity providers (LPs) on GMX earn sustainable real yields from trading fees, funding rate interest, and liquidations. 

However, liquidity providers (GLP token holders) are exposed to the price volatility of the underlying assets, and impermanent loss betting against traders/takers (Figure 1). Sharp Labs’ Delta Neutral Vault steps in as a solution, significantly reducing this exposure while maximizing yield generation in a delta neutral manner.

Vault Strategy Overview

Let’s take a closer look at the mechanics of Sharp Labs’ Delta Neutral Vaults. The vaults are divided into two levels of risk: Senior and Junior. Each tranche caters to investors with different investment objectives as follows:

Senior Vaults: Stable Yields With Seniority Claiming Rights

In the senior risk-off vault, your USDC deposits are lent to the junior vault at a stable interest rate. This yield is then contingent on the vault utilization, with the loan fully collateralized by the underlying assets in GLP. This collateralization ensures depositors a priority claim on both interest earned and principal invested, even in the event of losses incurred in the junior vault. 

To illustrate, in the extreme scenario that GMX gets fully exploited with the entire GLP pool drained, the NAV of the entire Delta Neutral Vault (Risk-on and Risk-off combined) will be 30% of the junior vault’s NAV (the portion that was deposited into OKX for hedging). In such a case, the remaining positions held on OKX will be closed, and funds will be transferred to the risk-off vault until 100% of the deposit is withdrawable before junior vault depositors can claim the rest. Assuming the current market condition holds true, the scenario will play out as follows:

In the rapidly evolving world of DeFi, protocols across the board are susceptible to pool-draining risks, whether due to market anomalies or malicious actors. It’s crucial to note that while Sharp Labs, like other protocols, isn’t immune to these risks, its exposure is considerably mitigated. The security measures provided by OKX and Copper play a pivotal role in ensuring that the risks remain low for Sharp Labs.

The aforementioned scenario highlights the potential risks associated with Sharp Labs in extreme market conditions. However, it’s worth emphasizing that such events are outliers, and the robust security infrastructure in place, especially with the involvement of OKX and Copper, acts as a formidable line of defense against such adversities. 

Junior Vault: Enhanced Yields and Minimized Price Fluctuations

On the other hand, user deposits in the Junior vault are directly converted into GLP (mainly composed of USDC, BTC, and ETH), earning liquidity provider fees. This yield is further boosted through a loan from the Senior Vault, effectively entering a leveraged farm position on GLP. 

Additionally, 30% of the funds deposited in the Junior vault are allocated to OKX, where short perpetual future positions are systematically initiated to hedge against price fluctuations while simultaneously earning funding rates. These positions are rebalanced constantly using a proprietary trading algorithm to account for the changes in the weights of each GLP component. If the market volatility is high, the algorithm could trade more than 100 times daily based on trading activities on GMX and price fluctuations. The vault also automatically hedges against impermanent losses by rebalancing liquidity to GLP. With this mechanism, price fluctuations and portfolio drawdowns are minimized, reducing them to as low as 0.5%.

As GLP rewards its holders with both esGMX and ETH, the vault enhances yield by automatically compounding ETH rewards into GLP and restaking the earned esGMX and multiplier points ensuring maximum efficiency and yield generation within the vault.

Mitigating Centralisation Risk

As previously mentioned, 30% of the USDC risk-on deposits are allocated to centralized exchanges for effective price volatility hedging. These exchanges provide high execution speeds and cost-effective hedging options. However, this introduces some level of trust for correct reporting and custody from the third party, deviating from the trustless nature of DeFi protocols. To address this concern, the following measures have been implemented:

  1. Real-Time Reporting: The vaults can be verified on-chain, ensuring that at least 70% of the Total Value Locked (TVL) is accounted for. Currently undergoing periodic independent verification by a third-party reporting service, NAV Fund Administrator Group, live trading performance, and portfolio balances on the centralized exchanges are reported in real-time by Treehouse.
  2. Restricted Withdrawals by Smart Contract: Funds in the treasury contract can only be withdrawn with the team’s multi-signature wallet, which enforces a restriction allowing withdrawals of up to 30% of the total value locked (TVL) for risk-on vaults.  
  3. Counterparty Insurance  Sharp Labs will be utilizing ClearLoop, Copper’s off-exchange settlement service, revolutionizing how institutional clients trade and manage their digital assets. With its integration with Copper’s award-winning multi-party computation (MPC) custody, ClearLoop will enable Sharp Labs to trade securely on OKX, while mitigating exchange counterparty risk and increasing capital efficiency.

Performance Benchmark 

In this section, we’ll assess how Sharp Labs’ vaults stand out among alternatives in yield farming, considering factors such as yield, Sharpe ratio, and protocol risks. For a comprehensive comparison, please refer to the Appendices.

Comparison to Sharp Labs’ Senior Vault

We benchmarked Sharp Labs’ Senior Vault alongside gamma neutral vaults, stablecoin lending farms, and bridge farms, where lending is the primary yield component. Overall, Sharp Labs offers a highly competitive yield, which is on par with Jones DAO’s jUSDC Gamma Neutral Vault, as both employ similar strategies to generate yield. 

Compared to Sharp Labs, which provides a transparent holdings breakdown using Treehouse’s Proof of Reserves powered by Hyperion, Jones DAO provides transparency on-chain and allows depositors to exit their positions immediately, rather than waiting for 9 AM UTC+8 for vault withdrawals. Investors can also pair jUSDC-ETH for liquidity, further earning yield. For investors with a lower risk appetite seeking to minimize protocol and execution risk, money markets lending on Compound or Bridge Staking on Hop Exchange may also be appealing options despite their slightly lower APRs in comparison.

However, Sharp Labs’ senior vault mitigates some of its centralization risks through over-collateralization and priority payout claims. To compensate for these risks, the vault offers a risk premium that results in a superior return compared to similar vaults.

Comparison to Sharp Labs’ Junior Vault

On the other hand, we benchmarked Sharp Labs’ junior risk-on vault with a plethora of protocols built upon GMX/GLP.

Before the exploit, Steadefi was the only delta neutral GLP vault that offered a similar yield to Sharp Labs, which can be further boosted through their native token emissions. However, compared to Sharp Labs’ vault capacity of $50M, the Steadefi GLP vault could only take $300K in deposits and had a 2/20 fee structure, making Sharp Labs the superior option for large investors. Since its inception, the Steadefi vault has also experienced a max drawdown of 1.4% prior to the exploit, noticeably higher than Sharp Labs’ historical drawdowns of below 0.5%.

On a similar note, Flynt Finance also offers its delta neutral GLP vault in a nearly identical setup through a long position on GLP hedged by perpetual shorts of the risky asset components of GLP on Binance. However, it’s worth noting that historically, the strategy has encountered a significantly higher drawdown of nearly 4%, despite the absence of leverage in their approach.

On the other hand, for investors who want to maintain price exposure to the underlying risk assets for capital appreciation, there are plenty of other options in the market. Jones DAO’s Leveraged GLP Vaults and Olive Finance’s GLP Amplified Vault are the two established platforms that act as good alternative optimizers for GLP with a decent amount of TVL and high APRs. 

Looking back at Sharp Labs, the risk-on vault has displayed APRs generally superior to its competitors in a delta neutral manner without significant leverage (since the current TVL of the risk-off vault is minimal). This is because Sharp Labs’ risk-on strategy is not only earning yields from GLP but also the funding rates on OKX through all of the hedging perp positions. This marks ample growth potential for Sharp Labs’ junior vault APR as more people deposit into the senior risk-off vault, effectively providing more leverage to the risk-on vault.

In addition, since the staking and withdrawing requests are only processed by the protocol every day at 9 PM EDT, the protocol saves a significant amount of gas fee from incoming and outgoing transactions, similar to the concept of net settlement in the world of TradFi, effectively increasing the realized APR potential.

Lastly, by hedging through a CEX, Sharp Labs can hedge for most GLP components while minimizing transaction costs. Unlike most other players who only hedge through BTC, ETH (Rage Trade), and USDC (Steadefi), Sharp Labs hedges for BTC, ETH, UNI, LINK, and even USDC through USDT perp pairs, effectively creating a near-perfect hedge for GLP constituents. This leaves DAI, FRAX, and USDT the only three components not directly hedged. However, all three are well-established stablecoins with an extremely large portion of their reserves backed by either BTC, ETH, or USDC, leaving less concerns about price fluctuations. Due to these superior risk management measures, Sharp Labs also stands as the vault that provides the highest risk-adjusted returns amongst the competitors.

Strategy Drawbacks

Compared to other players that provide similar products, while the Sharp Labs Delta Neutral Vaults provide one of the highest returns in the market alongside effectively minimizing the risks associated with risky asset components of GLP, there are certain drawbacks to its strategy.

  1. The Inclusion Of A CEX in Strategy Execution: Using a CEX, in general, may go against the fundamental DeFi ethos despite its superiority in providing delta neutral instruments in an efficient and cost-effective manner. In addition, this adds an additional layer of risk in terms of execution and the possibilities of a CEX black swan event. To mitigate this risk, Sharp Labs will use Copper ClearLoop, which acts as insurance to such events.
  2. Lower Transparency On Risk-off Vault APR Parameters: While most of the competitors are dynamically adjusting the APRs of the risk-off lending vaults based on formulas that take into account factors such as governance voting and utilization ratio, Sharp Labs’ risk-off vault APR is determined by the team based on the perceived market conditions.
  3. Lack of Native Token Emissions: Given the current standings of the Sharp Labs protocol, the risk-off senior vault is generating little traction, given the outstanding performance of the risk-on junior vault in terms of drawdown. As a result, the junior vault’s leverage is limited, which impacts its potential appeal. To illustrate this, let’s consider Steadefi, which successfully encouraged users to deposit into its lending vault by offering generous native token rewards, significantly enhancing the vault’s appeal before the hack. Native token rewards on its USDC lending vault boosted the APR from 1.24% to an impressive 15.31%. Although there are no token incentives at the moment, the Sharp Labs team has confirmed plans to launch a native token in the near future, which will be airdropped to early participants of the vaults.
  4. No Time Lock Imposed On The Vault Smart Contract: While the protocol has undergone a comprehensive audit by Certik, not all identified issues were effectively resolved. One of the main outstanding items is the lack of a 48-hour time lock on privileged accounts and operations which may lead to centralized controls of specific protocol parameters with zero latency. However, the team has argued that the decision was made as GMX operates completely anonymously with only a 24-hour time lock on their smart contracts. A 48-hour timelock will disable the team from saving the assets within GLP if anything unexpected happens to the GMX protocol. To ensure the safety of the depositors’ assets, the Sharp Labs team has also gone through a full KYC with multiple well-known institutions such as OKX and Google Cloud.

Conclusion

In conclusion, Sharp Labs’ Delta Neutral Vault strategy is a unique income strategy for investors, offering the ability to preserve capital and swiftly seize opportunities during the bear market recovery. The vault’s high-risk adjusted returns make it a competitive choice in the DeFi landscape. Sharp Labs’ vision to democratize institutional-grade trading strategies for DeFi users holds great promise. It is indeed an exciting development to witness the deployment of cutting-edge strategies that parallel traditional finance (TradFi) markets.

Looking ahead, we anticipate introducing more innovative offerings in DeFi, such as algorithmic trading and structured yields, which will further bridge the gap between decentralized and traditional financial markets. Sharp Labs is also developing multiple other vaults across different chains to potentially provide the best alpha-generating strategy coverage in the Web 3.0 space. We invite you to stay tuned with us as we delve into more of such insights, exploring a world of TradFi-type products within the DeFi space. Let us know which other projects you would like Treehouse Research to deep dive into by tagging @TreehouseFi on Twitter, and follow us for our daily market insights on both Email and Telegram!

(The End)

At Treehouse, we want to empower people to navigate DeFi confidently. In case you missed it, check out our other articles on Delta Neutral Strategies and our GMX piece to learn more about this decentralized perpetual futures trading platform!

Appendices

Appendix D: Sharp Labs Risk-on Junior Vault APR Calculation

NAV06/08/2022 = 1.094339

NAV05/08/2022 = 1.093948

APR = (1.094339/1.093948)365 – 1 = 13.93%

Appendix E: How does Copper’s ClearLoop safeguard Sharp Labs funds?

  • Copper’s Role as Trustee and Custodian: Copper establishes a trust over client-delegated assets and exchange margin. As the trustee and custodian, Copper holds and manages these funds on behalf of the beneficiaries, which include both the exchanges and Copper’s clients.
  • ClearLoop Portal: With the integration of ClearLoop, Copper allows users to execute trades securely across various execution venues, including centralized exchanges like OKX. This off-exchange settlement service is designed to revolutionize the way institutional clients trade and manage their digital assets.
  • Insolvency Protection: One of the primary features of ClearLoop is its protection against insolvency risks. The trust structure ensures that in the event of Copper’s insolvency, client assets and exchange margins are protected and not available to general creditors. Additionally, collateral agreements are in place to protect clients against the insolvency of an exchange and vice versa.

This solves 4 specific problems for Sharp Labs:

  1. Mitigate Counterparty Risk: ClearLoop enables clients to trade on centralised exchanges without funds leaving Copper’s secure MPC custody
  2. Off-exchange Settlement: Settlements occur on the Copper platform between the client and the exchange.
  3. Collateral Monitoring: Copper’s risk engine performs ongoing monitoring of ClearLoop trading activity vs. respective exchange collateral
  4. Bankruptcy Remote: To address the insolvency risk of any ClearLoop participant, Copper has established an account structure dedicated to ClearLoop, over which an English Law Trust is created.

Disclaimer

This publication is provided for informational and entertainment purposes only. Nothing contained in this publication constitutes financial advice, trading advice, or any other advice, nor does it constitute an offer to buy or sell securities or any other assets or participate in any particular trading strategy. This publication does not take into account your personal investment objectives, financial situation, or needs. Treehouse does not warrant that the information provided in this publication is up-to-date or accurate.

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