Aug 2 | 3 min read
The Market Neutral Yield ETH (MNYe) token from the Index Coop automates a continuous basis trading strategy that returns a price-neutral yield to token holders. Built using Set’s integration with Perpetual Protocol on Optimism, MNYe contains a fully-hedged ETH position, with equivalent spot exposure and short exposure via perpetuals. Token holders earn a variable USDC return when the funding rate is positive.
Basis trading, also known as cash and carry arbitrage, is an established strategy for achieving price-neutral yield by arbitraging the difference between an asset price on the spot market and the near-term futures markets. In DeFi, perpetual swaps – also called perpetuals or perps – can be used in lieu of futures. First implemented by BitMEX, perpetuals are futures with no settlement date. The yield is derived from a funding payment paid periodically between long and short perpetuals in order to incentivize the peg to the spot price. By convention, when the funding rate is positive, the perpetual market maker makes a payment from the long to the short holders, and vice versa when the funding rate is negative.
MNYe takes simultaneous spot long and short perpetual ETH positions and derives yield from the funding payment to the short position. By taking a fully hedged position, the product has no net asset price exposure. MNYe uses a 1x ETH spot position and a -1x short ETH perpetual settled in USDC. The yield is further enhanced by weekly auto-compounding when the USDC funding balance is positive. The yield is used to maintain a leverage position between -0.95x and -2x.
The main risk is liquidation if the Ethereum price increases dramatically and the short position is not de-levered. The leverage ratio is actively monitored and automatically adopted to mitigate this risk.
A secondary risk is a negative yield if the funding rate is negative for a sustained period. The funding rate will become negative when short interest exceeds long interest in a given perp market, and when this happens, shorts pay the funding rate to those on the other side of the trade. Because MNYe consistently maintains a -1x short perp position, it will pay the negative funding rate alongside the other shorts.
The strategy will be unwound if weekly APR < -1% for 4 consecutive weeks to minimize this risk. Unwinding the entire position anytime there is a negative funding rate is cost prohibitive as it would result in significant NAV decay and erode existing gains, which is why the 4-week window has been established.
The APY is projected to be 10-20% based on backtesting results and current performance. The projected yield based on the past month’s NAV performance can be seen on TokenSets. Additionally, the funding rates and APRs can be seen on r72.fi and perp.fi. Note that the funding rates and APRs do not take into account compounding and the leverage ratio.
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