Simple LP hedge strategy

[velhoti]

I’d like to share my simple LP hedge strategy.

LPs typically work like this: suppose I open a position in a liquidity pool (LP) with a total of X bitcoins worth Y USD. If the price rises, I end up with more USD than I originally had, but each bitcoin is more expensive - so if I convert, I’ll end up with fewer bitcoins than originally. If the price falls, I end up with more bitcoins than originally, but bitcoins are cheaper - so if I convert, I’ll have less USD.

If my goal is to preserve my bitcoin amount instead of my USD amount (which is preferable in bull markets), my strategy is:
    1. Open an LP position. If the price falls, convert the excess bitcoins into E USD.
    2. On the next LP position, open a long position on a perpetual contract with a size of E USD. This is the hedge.

If the price falls, I lose my perp position partially or entirely, but that’s okay because I’m preserving my bitcoin balance - that’s my goal. If the price rises, the profit from the perp helps maintain (and possibly increase) my bitcoin balance. It’s not exact math, so my bitcoin balance may increase more or less than expected, but it should help anyway.

Throughout the process, the fees are paid from the LP.

The opposite is also possible, to preserve USD instead of bitcoin, also can be applied in pairs of crypto.

[Alphakilo]

I’d like to share my simple LP hedge strategy.

LPs typically work like this: suppose I open a position in a liquidity pool (LP) with a total of X bitcoins worth Y USD. If the price rises, I end up with more USD than I originally had, but each bitcoin is more expensive - so if I convert, I’ll end up with fewer bitcoins than originally. If the price falls, I end up with more bitcoins than originally, but bitcoins are cheaper - so if I convert, I’ll have less USD.

If my goal is to preserve my bitcoin amount instead of my USD amount (which is preferable in bull markets), my strategy is:
    1. Open an LP position. If the price falls, convert the excess bitcoins into E USD.
    2. On the next LP position, open a long position on a perpetual contract with a size of E USD. This is the hedge.

If the price falls, I lose my perp position partially or entirely, but that’s okay because I’m preserving my bitcoin balance - that’s my goal. If the price rises, the profit from the perp helps maintain (and possibly increase) my bitcoin balance. It’s not exact math, so my bitcoin balance may increase more or less than expected, but it should help anyway.

Throughout the process, the fees are paid from the LP.

The opposite is also possible, to preserve USD instead of bitcoin, also can be applied in pairs of crypto.

I can see a flaw in your hedging strategy in step 2 that might not pan out as you planned if you abide to it, also because your hedging is more reactive and moves in the direction of the market rather than being neutral and proactive in essence.
What a true hedge stands to do by application and deployment, is for protection against wrong decisions about the market movement and direction and that means trying to time the market is a bad decision already mostly with a long contract.

Wouldn't it make more sense to you to open the long perp at same time after deployment of the LP with a modest and reasonable leverage, instead of waiting for the price of Bitcoin to fall before you open the long perp?

[velhoti]

What a true hedge stands to do by application and deployment, is for protection against wrong decisions about the market movement and direction and that means trying to time the market is a bad decision already mostly with a long contract.

Wouldn't it make more sense to you to open the long perp at same time after deployment of the LP with a modest and reasonable leverage, instead of waiting for the price of Bitcoin to fall before you open the long perp?

Yes, that makes sense, but it isn’t simple anymore. The math also depends on the upper price where the LP will be closed. I mean, it’s a good idea, but it’s less flexible and more math-heavy.

I open several short price range LPs (one at a time), and when some reach lower level, I hold the same amount of BTC and use the extra USD to long BTC, I guess, in the long the result is the same.

It is not guaranteed neutral, at least not deterministically.

[slaman29]

Wish I'd thought of this when I was very active! I used to only do LPs in stablecoins and/or shitcoins actually, mainly because I'd keep them in for so long only to lose out when BTC kept going up in price (bad timing). In the end, I only found it useful for stablecoin pairs, then realised I should have kept those in long term. The commissions rarely covered in a bull!