Everything You Need to Know About CVI: Chapter 2 — Trading CVI Volatility: What and how
As we are getting closer to the CVI trading platform launch, we’ll be releasing a series of articles and guides over the next few weeks, detailing the CVI index and trading platform. In the following article, we’ll explain how to trade the CVI volatility, and we’ll present the most common strategies for trading the volatility index.
Trading CVI Volatility: What and how
Traders can use the CVI to hedge their cryptocurrency holdings against volatility. For example, a trader may have a long position on a portfolio of various top currencies and fears adverse market conditions, and as such, takes a LONG position on the CVI, hedging the value of their overall portfolio (in the case of a market drop, the trader may sustain some loss on their cryptocurrency portfolio but will profit from their CVI position). In that way, the trader essentially buys insurance against adverse conditions.
Another very common use case is for traders who provide liquidity on platforms such as Uniswap. The algorithm which such platform use (called AMM) makes the traders expose themself to a risk, called “Impermanent loss.” This type of risk is one of the biggest pain points in DeFi, since it can cause the liquidity provider to suffer losses at times of volatility. For this reason, liquidity providers on Uniswap could find the option of taking a position on CVI to have perfect fit for their risk.
In both cases, a trader that wishes to take a trade on the CVI needs to not only make a deposit on CVI to cover the size of the trade but also pay a small usage fee for doing so.
Traders pay the funding fee according to their positions. They can close their CVI positions at any time.
What should I do if the market goes up?
Keep in mind that the situation for the stock market and crypto market is different. For the classic stock market, the volatility index is always anticorrelated with the market, while cryptocurrency rallies generally result in volatility growth.
There are several possible strategies. Here are three of them:
- When the market goes up moderately, the volatility index generally decreases. It may be reasonable to take a “short position” as a liquidity provider. In the COTI CVI trading model, it can be even more attractive because of the funding fee, leveling the risk for liquidity providers.
- If there is a market rally beginning, it may be reasonable to take a long position because the volatility will grow to reflect concerns of market rollback.
- As a market rally continues and market participants accept the new level, it may be reasonable to take a short position again.
For traders, the amount of $GOVI to be distributed for them is calculated automatically and will be made available for them to claim it. Once they have $GOVI, they can stake it in order to get a share from the collected fees in the central fees pool.
Overheated market — hedging strategy
Unlike the previous trading strategy, this is a much more common situation for all financial markets. Let’s look at the last known one, at the beginning of September. The event is easily distinguishable on the Bitcoin price chart above, and even more so if we examine the Ethereum chart:
The explanation for this market behavior is the overbought state of the market into the “DeFi” tokens — a very promising and quickly developing market segment, but no investment market can be stable being overbought. As a result, when the stock market plunged by approximately 5%, cryptocurrency markets lost much more, and the Defi components which are based on Ethereum, got the most significant drawdown.
The possible strategy of using CVI for this situation is to buy volatility entering the rising market. If a trader starts buying into CVI when it is at 50 entering the market on the last day of August, together with Ethereum or other tokens, then the gain in CVI would have compensated most of his losses in Ethereum all through September.
What should I do if the market goes down?
If the cryptocurrency market is going down moderately, it usually means that market participants are preparing themselves for a new down slip, and waiting for some (any) good news. In this situation, the volatility index should also go down moderately, and liquidity providers are earning both profit and funding fees.
On the other hand, when the cryptocurrency will plunge to a new level or some good news will arrive, the volatility index will surge and the traders in long positions will take a lot of profit. So, if a trader expects something like this, it is reasonable to take a long position.
“Black swan” — hedging strategy
If a trader expects that some large scale shock can affect the whole market, he can buy CVI and, if the market downturn really happens, the trader can make substantial gains from the trade.
For example, if the trader entered the market on some of the first days of February 2020 when the CVI level was at 50, he could have made a 260% profit closing the position when the CVI level was at 180.
What should I do if the market is volatile?
The trader should consider whether there is an expectation for the volatility to increase or decrease and whether it is already fully reflected in the CVI index. If the expectation is for the volatility to further increase, the trader should consider staying or even increasing their position, otherwise, it may be time to close their position and switch to the liquidity providers’ side to take advantage of when the market stabilizes.
What should I do if the market has stagnated?
When the market stagnates the CVI index will go down, the trader should consider whether it is profitable to stay or leave. If the CVI index is below its average value, there is an opportunity to open a new position in expectation of it to increase its value once the market’s volatility bounces back.
There is a multitude of trading strategies using the volatility index. The following describes an additional common strategy for trading the volatility index:
Uniswap liquidity provider — hedging strategy
Liquidity providers on Uniswap and many platforms like it (SushiSwap, Mooniswap, etc.) are advised to have a deep understanding of the concept of “Impermanent loss.”
For example, a liquidity provider for the “USDT-ETH” pair on Uniswap supplies amounts of equal dollar value to the pool, in return he would receive fees from each swap performed on the pair.
The AMM algorithm, which Uniswap uses, would change the ratio of his holding on each swap performed by a trader. As a result of the change, if ETH would jump in value, the liquidity provider would be left with less ETH and more USDT. If ETH drops in value, the liquidity provider would be left with more ETH and less USDT.
In both cases — the liquidity provider loses when there is high volatility — This is what is “Impermanent loss” is.
If a liquidity provider on Uniswap fears the market is going to be turbulent, he can open a position on CVI and hedge his risk with. The CVI position could protect him from both an upwards volatile movement and a downward crash, offsetting his impermanent loss.
Rewards and Fees
- In addition to the change in the CVI index which is reflected in the matching value of the covered positions placed by traders and covered by the liquidity providers, there are additional elements relevant to the traders.
- General fees such as the open \ close positions and deposit \ withdraw liquidity are collected into the fees pool, which is to be distributed between the stakers.
- In addition, there will be as part of the rewards additional $GOVI tokens to be rewarded based on a predefined plan.
How Can I Become a Trader?
- Connect your Metamask or connect with WalletConnect → go to “Platform”
2. Click on “Manage your positions” on the top menu
3. Select the currency you want to buy the CVI index with → insert the amount
4. On the right side of the page you can use the slider in order to check the potential position value
5. Click on “Buy”
6. Please note that you will also get $GOVI tokens each time you buy CVI position. You can claim them to your wallet in the “Manage your positions” → Claim tab
In the next article, we will review and explain how to provide liquidity to the CVI platform. Stay tuned!
For the first article in the series, visit here: