March 16, 2023
Mission briefing:
The voyagers who make the multi-million mile journey to a Martian Outpost can sustain a comfortable life by tapping into the Red Bank. Many come exclusively to deposit assets and earn yield.
Others may borrow tokens to participate in governance votes, unlock the value of their deposits without selling them, or perhaps put those tokens to work elsewhere – hopefully earning higher yields than their borrow rates.
Active traders can even use the Red Bank as a tool to express opinions about the future direction of the market. Specifically, they can create leveraged long or short positions by depositing and borrowing specific combinations of assets. Let’s explore how.
When you borrow a token from the Red Bank, you create virtual smart contract ‘debt’ denominated in the token you’ve borrowed. That’s relatively straightforward (your borrowings = your debt). What’s less obvious is this: that debt is effectively “shorting” the token you’ve borrowed if you swap it for another asset.
Shorting is the inverse of buying or “longing” a token. When you go long, you profit when your tokens rise in value. When you go short, you profit when your tokens fall in value.
Put another way: if the token you’ve borrowed from the Red Bank falls in value, you’ll owe more (at least in dollar terms) than you borrowed.
Let’s look at several examples including:
Imagine you’re bullish ATOM, and you want to maximize your exposure to the token. You visit the Red Bank and deposit 100 ATOM. Now, you borrow the stablecoin axlUSDC against your deposit.
By swapping the stablecoin back to the original asset, ATOM, you are effectively taking a long position. Let’s illustrate it with a specific example.
Assume 100 ATOM is worth $1,000, and you borrowed $500 in axlUSDC. After swapping that axlUSDC for ATOM, you now hold 150 ATOM worth $1,500. If the price of ATOM doubles, you make more money than you would have simply holding 100 ATOM.
In fact, you now hold 150 ATOM worth $3,000. But your ‘debt’ is still just $500 in axlUSDC. You can sell $500 worth of ATOM for axlUSDC, pay off your debt, and walk away with 125 ATOM worth $2,500 (minus any borrowing fees).
Keep in mind, this position could end up costing you more than it would have otherwise if the price of ATOM moves against you (i.e., decreases).
Imagine that instead of doubling, ATOM’s price plunges 25% to $7.50. Your $1,500 worth of ATOM is now worth $1,125, and you owe the Red Bank $500 in axlUSDC. By the time you sell $500 worth of ATOM to pay off your debt, you only hold $625 in ATOM (or ~83 ATOM) – less than your original deposit.
Remember that if the market moves against you, your positions could get liquidated and will incur a loss, so it’s important to keep an eye on your account’s health factor.
Now, imagine you’re bearish ATOM, and you want to actively bet against it. Let's flip the switch and utilize the same mechanic. Instead of depositing ATOM, you deposit 1,000 axlUSDC, borrow 50 ATOM (worth $500) and sell that ATOM for more axlUSDC. This is called short-selling.
If ATOM falls 50%, you can re-buy 50 ATOM for $250. That means that when you pay off your 50 ATOM debt, you walk away with 1,250 axlUSDC (minus any borrowing costs) – a profit of 250 axlUSDC.
Just as in the longing example above, if the trades move against you, you could end up losing money. Let’s say ATOM spikes 25% to $12.50. That means you have to spend $625 to buy back 50 ATOM to pay off your debt. In this case, you’re out $125.
The math is relatively straightforward if you’re lending and borrowing with stablecoins. Using the Red Bank to long or short assets can get much more complex if you mix volatile assets. For example, suppose you’re bullish ATOM and bearish OSMO. You could deposit ATOM and borrow OSMO.
Then, you could sell that OSMO for more ATOM. If the prices of ATOM rises relative to OSMO, you’re in the green. If OSMO rises instead, you’re in the red.
Another tactic advanced traders use is making multiple borrows and deposits in the same account. For example, if you’re extremely bullish ATOM, you could deposit ATOM and use it to borrow axlUSDC.
Then, you could buy more ATOM, deposit it in the Red Bank and use it as collateral to borrow even more axlUSDC, which you also sell for more ATOM. By looping your deposits and borrows multiple times, you can increase your leverage to more than 2x.
It works great if your directional bet is correct. If it’s not, you run an even greater risk of liquidation than in the examples given above. This is an advanced technique that requires even more active management on your part to ensure the market doesn’t move against you.
The Red Bank can be used not just to make directional bets on its supported assets; it can also be used to hedge your existing positions. Suppose, for example, that you hold a large staking position in ATOM.
You believe in Cosmos Hub’s long-term prospects, but you’d like to protect yourself in case there’s a sudden market correction. You can use the Red Bank as a hedging tool. Simply short a fraction of your ATOM holdings using the shorting strategy discussed above.
If ATOM continues to rise in value, you’ll lose some of the upside (since you’ll ‘have to’ pay back more ‘debt’ to the Red Bank). However, if the price of ATOM collapses, you’ll have some downside protection. That means your loss won’t be as big as it might have been otherwise. In effect, this advanced technique dampens some of the volatility in ATOM’s price movement.
ATOM’s 21-day unbonding period means you can’t sell your staked tokens quickly if an unexpected event adversely affects the network. Hedging your stake during the unbonding period can potentially help you minimize losses.
Remember that the deposit and borrow rates in the Red Bank are based on supply and demand and update with every deposit or withdrawal by any astronaut. Learn more about rate calculations, liquidations, and Red Bank’s architecture in the Mars Docs now.
Then, voyage to Mars on Osmosis and explore the Red Bank first hand at osmosis.marsprotocol.io.
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Mars is a novel interchain credit protocol primitive facilitating non-custodial borrowing and lending for the Cosmos ecosystem and beyond. Its hub and outpost architecture allows Mars to operate on any chain in the Cosmoverse, and enables a new primitive: the Rover. Rovers could give their pilots DeFi superpowers to engage in virtually every governance-approved activity they might encounter on a centralized exchange: spot trading, margin trading, lending and borrowing — all in a single decentralized credit account represented by a transferable NFT. Explore the concept now at marsprotocol.io or in the Mars v2 Whitepaper.
Engaging in leveraged transactions may be legally restricted in some jurisdictions–please consult your own legal counsel and adhere to your local laws/regulations. Remember, Cosmos, Osmosis, and Mars are experimental technologies. This article does not constitute investment advice and is subject to and limited by the disclaimers and other information contained or referenced in the Mars FUD Bible which you should review before interacting with the protocol.
