What Is Volatility Farming? Taming the Turbulence

February 26, 2024

In conclusion

People from the crypto space love volatility. Sitting in front of charts, watching the price of assets dramatically fluctuate, and anticipating the next candlestick color sets in that adrenaline rush. You have to admit that volatility is the name of the game in the crypto market. 

Well, everyone says that they’re “in it for “the tech.” With innovation happening left-right-center at a rapid rate, tech - of course - acts like a magnet to attract folks into the ecosystem. However, the ulterior motive was, has, and will always be to make money somewhere or the other. 

That’s exactly where volatility plays its part. The rules of the game are simple. Playing it right will help you make money. However, if you try to out-smart the market, you’ll end up burning your own fingers, anon. 

Volatility Farming: Yield farming on steroids?

The DeFi space has evolved by leaps and bounds over the past few years. There have been successful projects. There have been failures. The market has seen it all. Some users have become millionaires and billionaires. While at the same time, on the other side of the spectrum, people have lost money and fallen victim to rugpulls and ponzi schemes. 

Despite obstacles and challenges, the spirit of developers continues to remain high. It hasn’t been a plain sailing journey for them to bestow people with the power to lend, borrow, trade, and take part in p2p financial transactions on blockchain networks. 

But well, here we are already! Their efforts have helped DeFi build a credible and compelling narrative for itself. And mind you, experiments, refinements, and mind-boggling releases keep taking place on a daily basis. Rome wasn’t built in a day, and neither was DeFi. I’d bet anything to say that the latter show is just getting started. 

In DeFi, farming is one of the many ways users make money. Just like how OG farmers plow the field, sow the seeds, and then harvest the crop, yield farmers first hunt for attractive farms, then deposit their crypto assets into the protocol and eventually reap returns. 

Volatility farming, in its most basic essence, encashes upon the volatility of the market and helps people like you and me fetch returns. It is basically yield farming on steroids. If you don’t believe me, just tag along - you’ll automatically get the justification you’re looking for. 

Welcome! You have now landed in the world of pods

In the volatility farming empire, Peapods Finance is currently the king. In fact, this protocol is deemed to be the pioneer of the concept of volatility farming. 

Wrapping - or swapping one token for another in the same ratio - holds the key to farming volatility and fetching yields. Interestingly, these wrapped tokens are nicknamed as “pTKNs” in the Peapods kingdom. 

Pod tokens [eg. pTKNs] are backed by their respective underlying tokens [TKNs]. As such, the wrapping process is reversible, meaning, pods can be unwrapped back to the original asset at any time. From the price perspective, TKNs and pTKNs should trade closely with one another.  

Now, you might wonder, how do market participants make money using such a setup? Well, the answer is pretty much a single word - arbitrage.

Few practices never get old. Buying cheap and selling expensive is definitely one such phenomenon. Our whole life, we’ve seen people around us do it. Shopkeepers buy products in bulk [wholesale] from vendors and then sell the same products to customers at higher rates. A football disliker doesn’t hesitate even for a second before buying tickets to the Premier League match just to sell them to hard-core fans at a premium. People see an opportunity, they seize it. 

Even in crypto, that’s what traders do. The price of any asset is never the same on all crypto exchanges. So, traders basically capitalize on the deviations by first buying in the cheaper market and then selling it in the expensive market. In this process, they make profits, and if they’re satisfied with the outcome, they keep repeating the process of buying low and selling high until the prices in both markets are more or less the same. That is what arbitraging is. 

Volatility farming tokens like TKN and pTKN work on this same model, but there's just an extra ‘conversion’ step in the middle that ties it all together. 

Say, pTKN’s [the pod token] price is hovering below TKN [OG asset]. In such a scenario, you will first buy pTKN [from exchanges like Uniswap], then unwrap it to TKN for a fee, and then sell the TKN for profit [again on DEXes like Uniswap]. Contrarily, when TKN is trading at a cheaper value than pTKN, you will first buy TKN, wrap it to pTKN, and then sell pTKN for a profit. Arbitrageurs can take advantage if there’s a price mismatch in either direction.

The architecture of the Peapods protocol has been shrewdly crafted to enable traders to buy and sell the assets simultaneously to profit from the price discrepancy. Arbitrage opportunities open up when the price of TKN and pTKN deviate beyond the cost to wrap and unwrap. In fact, the protocol itself creates arbitrage opportunities for users.

Source: Peapods Finance

Users obviously pay fees to wrap and unwrap tokens. So, from the protocol POV, Peapods Finance earns from the fee generated via wrapping and unwrapping. 

But they say sharing is caring, right? Token holders and liquidity providers are rewarded back by the protocol in retrospect. Thus, the fee paid by traders becomes revenue for the protocol, and that eventually finds its way back to holders via rewards.

PEAS is the reward token of the Peapods ecosystem. Its supply cannot be inflated by minting additional tokens. The maximum amount - 10 million tokens - was minted when the contract was deployed. Tokens are burnt every time someone wraps or unwraps tokens, and thus PEAS is deemed to be deflationary in nature. Owing to this burn-deflationary model, the supply of tokens keeps reducing and theoretically opens the doors for the asset to become scarce and more valuable over the long term.

As far as the numbers are concerned, the protocol has allocated up to 90% of the pod fee to award liquidity providers while the remaining is burnt. The protocol pays the incentives in PEAS tokens by purchasing them from the market using the fees. This process is completely automated and helps keep the ‘decentralized real yield’ wheel rotating simultaneously. 

Win-win, ain’t it?

LPing and staking are two other interesting tangents - users who provide liquidity can also stake their LP position to earn a portion of the fees collected by the pod. Where to provide liquidity? In the incentivized pod's liquidity pool. What tokens to use to provide liquidity: A 1:1 ratio of pTKN and the pre-defined paired asset. You’ll be incentivized based on how much you stake and how much liquidity you provide.

How things work IRL

Literally anyone can create a pod on Peapods Finance. However, there are a few things you need to know before enthusiastically stepping into the arena. The DAI stablecoin is the go-to token to pair the yield-bearing LP with. That being said, there are other options to experiment as well (we’ll get to that in a bit). 

If you hadn’t figured it out already, pTKN and TKN were just random examples used above. But in reality, once the pod-paired LP token is sorted, any ERC-20 token [LINK, SHIB, etc.] can be added to the pod. All you have to do is merely key in the contract address. Be mindful of how many tokens you add because the wrapping and unwrapping fee rises with every new asset added to the pod. Among the added tokens, you could also add weight distributions if you wish. 

When you’re creating a pod, you are basically deploying a smart contract on the blockchain. In hindsight, you will also have to bear the gas fee. 

Before winding up the creation process, you’ll have to quote the fee percentage for the pod, i.e., you will have to assign fees for wrapping, unwrapping, buying, selling, burning, partnering, etc. Peapods has set certain upper caps for fees. So, pay heed to the prompts that pop up on your window while you’re assigning quotes.  

When the pod fee is high, more tokens are burned. The rewards distributed also end up rising accordingly. But, high fees can also narrow the arbitrage opportunities [volume-wise] because the price difference between assets needs to be significant enough to cover the fee and still make a profit.

On the other hand, when the pod fee is low, fewer tokens are burned, and rewards are lower for each arbitrage. Nevertheless, low fees can lead to more arbitrage opportunities because the price difference between assets can be smaller and yet be profitable for traders.

Source: Peapods Finance

Current state of affairs

Source: DeFiLlama

Uses have been constantly adding liquidity to the protocol. As per data from DeFiLlama, close to $50 million is currently locked on Peapods Finance, including staked assets. 

Another parallel dashboard from Dune Analytics revealed that more than 3700 users currently hold PEAS tokens. This indicates that people are jumping onto the bandwagon and are currently testing the Peapods waters. 

You know what’s more interesting? The top 5 PEAS trades so far. They have fetched traders estimated profits in the $50k to $150k range.

Source: Dune Analytics

The Pandora’s Box Pod

Of late, Pandora and its underlying 404 experimental standard has caught people’s attention. Peapods Finance has been able to capitalize on that. Just a day back, the Pandora team added $100k worth of liquidity to enhance community LP rewards. Users can now wrap PANDORA to fetch returns. That being said, it should be noted that while wrapping PANDORA into the pod, the NFTs associated with the tokens will get burnt. Likewise, while unwrapping, NFTs will be minted. At the time of writing, the Pandora Pod [pPDRA] was a part of the top-3 hottest pods on Peapods Finance. 

Several community members took to X (formerly Twitter) to highlight how it’s becoming the norm these days for new protocols to create pods. In fact, they have also been acknowledging that Peapods Finance is becoming a leader in DeFi faster than one can imagine. 

Oh, the Ohmies!

Like highlighted in the ‘How Things Work in IRL’ section above, DAI is the go-to token to pair the yield-bearing LP with. However, OlympusDAO’s OHM and pOHM are a couple of other options that are available for LP pairing. 

Unlike stablecoins, OHM is unpegged. It is basically treasury-backed smart money. Its value typically stays within a moving price range. This is done by adjusting its token supply based on market demand, thanks to the RBS monetary supply policy it follows. 

To boil it down: The project increases and sells supply during periods of high demand. Contrarily, it decreases it during low demand patches, using buybacks funded by treasury reserves. Ultimately, it provides stability and more volatility and growth when compared to stablecoins, making it a good token pick to pair the yield-bearing LP with. 

pOHM is deemed to be an even better option because it is a Green Arrow pod of OHM. This also opens the doors for additional volatility, more arbitrage volume, and wrap/unwrap fees. You can read more about GA pods and why they have an extra edge over others here and here

Vector Reserve 

The Peapods Finance team has been on-boarding new protocols continuously. Vector Reserve launched another new pod a few hours back (at the time of writing). This means sVETH holders can boost their yields by wrapping svETH into psvETH and staking LP.  

Source: X [Formerly Twitter]

In fact, towards the end of January, they also created a psVEC pod and injected $200k liquidity. Context time: sVEC is the governance token of the Vector Reserve. This means holders of sVEC can wrap their assets into psVEC on Peapods Finance and be rewarded with volatility farming yield. 

Source: X [Formerly Twitter]

Beware, all that glitters is not gold! 

Barely Finance was another volatility farming project in the spotlight a few days ago. However, right after it started garnering traction, red flags started unfurling. On January 29, there was a vulnerability attack on the wBARL pod. The attacker stole more than 10% of the total BARL supply in the pod. However, a major chunk of it was collateral from the development team, coming from marketing and development allocations. Thus, the project claimed that the damage caused to users was minimal. The proposed solution was to change the wBARL pod contract to remove the function that caused the vulnerability attack.

Leaving aside the attack, several others kept calling the project a knock-off of Peapods Finance.

Source: Blockchain Security Firm SlowMist

The project did give its users surety that things would get back on-track. However, they failed to live up to their word. The value of the native BARL token registered a freefall a day back. The website went down, and so did the project’s X handle, making it one of the latest rug pull projects.  

It was the well-disguised ponzi: Token lock-ups, compounding rewards, longer and longer green candles, increased social chatter, and then the [un]anticipated monstrous crash. This ain’t the first time when a project has conned users, and it won’t be the last either.

Source: X [Formerly Twitter]

Enter BTC

Moving on, BTC has also been at the tip of everyone’s tongues who’ve been talking about volatility farming. For a change, BTC doesn't refer to Bitcoin. It’s another project that goes by the name Blackrock Trading Currency. 

Source: X [Formerly Twitter]

Even this project operates around the mechanics of volatility arbitrage. Alongside, it also takes a leaf out of the books of bonding and debasing. Blackrock Trading Fund claims to be the premier DeFi hedge fund, where BTC holders are entitled to five actions: Staking, Holding, Bonding, Unstaking Early, and Unstaking Post Consolidation. As per the tokenomics, the project intends to distribute all profits back to BTC holders. 

Blackrock Trading Currency follows the dual token system. aBTC compliments BTC as the arbitrage token. Users can swap their assets between different liquidity pools and encash on the arbitrage. However, the absence of initial yield could play spoilsport and discourage users from converting their BTC to aBTC. In hindsight, the Blackrock Trading Currency team is looking for solutions to integrate an initial reward system to kindle volatility farming activity. 

Recently, smart contract auditor Charles Wang publicly revealed a few concerns pertaining to the project’s code that sparked a debate. Owing to all the loose ends, he affirmed that there’s a cent percent likelihood of the contracts resulting in lost/stuck/stolen funds. The BTC team is, however, working towards resolving the issues, with the founder of the project assuring the community funds are safe and secure. 

Source: X [Formerly Twitter]

Here, it is worth noting that this project has not yet launched completely. Several features are still in the works. The team has identified a couple of challenges and has put forth solutions on the table.

As of press time, the team claimed that its treasury boasted $800k cash. In fact, it is also gearing up to perform more buybacks. Users have been instructed to stack up points and wait for the test snapshot. Thus, we’ll have to hold our horses until other developments take place. 

Final thoughts 

Volatility is the most sought-after renewable resource in the crypto space. So, with the advent of volatility farming in DeFi, you get to make the best of both worlds. 

Peapods Finance seems promising on paper: The green flags have been out-numbering the red flags. It has the first-mover advantage. It’s been raining collabs within the ecosystem and whatnot. However, skepticism still prevails because the project has yet to pass the test of time. 

Experimenting in the DeFi arena is like playing musical chairs. Sometimes you sort of sense who’s gonna get out next, sometimes you save others from getting out, while sometimes you yourself end up becoming the victim. Nevertheless, in all cases, risk is always a part of the equation.   

Volatility farming is still in its infancy. As it starts garnering more appeal and traction, many projects will be launched out of thin air. Only the ones that take setbacks in their stride, improvise, and keep delivering will survive. Others, like Barley Finance, will end up being forgotten even before they are remembered. 

So stay vigilant, but don’t let go of opportunities in that process. Strike a balance. Do thorough assessments. Consume alpha content. Take calculated risks. Your future self will thank you. 

If you’ve read everything in this report word by word and reached this point, GG! It’s time for you to take your eyes off the screen for a while and stare out of the window. I will {hopefully} see you soon with another deep-dive piece. Until then, may the volatility forces be with you!

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