Flipping your Perspective on Alchemix Loans, Part Two

Core Perspectives to guide understanding of Alchemix Loan strategies

Including a comparison between Alchemix and Abracadabra!

This article is a follow-up to “Flipping Your Perspective on Alchemix Loans, Part 1”. Part 1 was focused on clarifying loan repayment time misconceptions, with an example that demonstrated how Alchemix is beneficial even on short timelines. Part 2 expands this concept into four “core perspectives” (i.e. main concepts) that can guide efficient capital allocation through Alchemix, using ETH strategy case studies as supporting examples. In the end, we’ll use the core perspectives to compare Alchemix to Abracadabra — a comparison that is often made but is rarely nuanced. There are some exceptions to the core perspectives (gas fees on small deposits can create some issues, for example) but applying any or all of the core perspectives should lead to more efficient Alchemix usage for most users.

Core Perspective 1 — Your Favorite Yield Strategy, But Better

It’s important to understand that when Alchemix integrates a new yield strategy, anyone currently using that strategy outside of Alchemix can withdraw their funds, deposit them into Alchemix, and then use that same yield strategy to maximize returns. For example — you, a DeFi protocol yield farmer, want to deposit your capital to CoolStrategy because it earns you an acceptable amount of yield. You realize that CoolStrategy is integrated into Alchemix. By depositing to Alchemix, you receive approximately the same yield with the same strategy (if not more due to boosted yield!), but now with the additional functionality of being able to take a self-repaying loan against your collateral. Why would you deposit directly to the strategy when you can use Alchemix to utilize the same underlying strategy and unlock a self-repaying loan? Smart contract risk and debt cap limit aside, you wouldn’t.

Another benefit of using Alchemix is seeing our cool logo more often.

The limitation with Alchemix v1 is that only Yearn vaults are incorporated — and not everyone wants to use Yearn. Alchemix v2 improves this with its modular design, allowing almost any yield strategy to be integrated as an add-on module.

The core idea here is: Any yield strategy you want to use, you can use more effectively with Alchemix.

Core Perspective 2 — You Are Better Off With Alchemix On ANY Timeline

Yep, even this timeline

Most investors don’t know how interest rates will change over time, but Core Perspective 1 and Part 1 of this series taught us that this is not an issue. Choosing the best interest rate at the time (for your risk tolerance) and depositing to a strategy through Alchemix will often yield better results than depositing directly to the strategy, no matter how long you plan to use the strategy for. We can continue to explore this concept with another example, using the alETH vault.

Say you have 100 ETH. You would like to purchase DopeNFT for 25 ETH. You plan to deposit your leftover ETH into DopeStrategy, which yields 5% APR. You notice this strategy is integrated into Alchemix, so you decide to pay for the NFT with an Alchemix loan. After 1 year, a new DoperStrategy emerges that yields 10% APR and isn’t incorporated into Alchemix. You fully withdraw from Alchemix and migrate to DoperStrategy. Let’s look at the two outcomes:

1. Without Alchemix, you purchase your DopeNFT for 25 ETH leaving you 75 ETH to deposit into DopeStrategy. You deposit and recieve 5% APR for a year with DoperStrategy. After one year you have your DopeNFT and 78.75 ETH to deposit to DoperStrategy.
2. With Alchemix, you deposit 100 ETH to Alchemix and set your yield source as DopeStrategy. You take a loan for 25 alETH and use it to buy DopeNFT. After one year, you now have your DopeNFT, 100 ETH collateral, and only 20 alETH of debt (5% of 100 is 5 ETH of debt repayment). You self liquidate (this feature of Alchemix lets you use your deposited collateral to pay off your outstanding debt, and then withdraw the remaining collateral), leaving you with your DopeNFT and 80 ETH to deposit to DoperStrategy.

Even though you took a maximum loan and only held it for 1 year, you still end up with an additional 25% of yield (1.25 ETH) by utilizing Alchemix instead of the base yield strategy.

Separately, let’s say you want to spend 50 ETH total on two DopeNFTs, which is more than Alchemix will let you borrow with 100 ETH collateral. So instead, you deposit 66.67 ETH in Alchemix and take a loan for 16.67 ETH. This allows you to pair the 16.67 ETH loan with your undeposited 33.33 ETH to purchase the NFTs for 50 ETH total. The net result is 66.67 ETH earning yield on Alchemix. If you bought the DopeNFTs outright, you would only have 50 ETH left earning yield. This means as long as you have more ETH than the purchase price of what you wish to buy, Alchemix can be helpful — it does not have to be “all or nothing” when using Alchemix loans! The equation to determine how much ETH to put into Alchemix is:

The core idea defined in Part 1 and demonstrated here is: Alchemix lets you spend some of your money while earning interest on all of your money. This is a useful tool, regardless if you plan to use Alchemix for 1 week, or if you plan on staying for 100 years.

Core Perspective 3 — Alchemix Shouldn’t Change Your Investment Strategy

Alchemix loans can feel like free money is raining down from the sky, but that doesn’t mean you should spend it irrationally.

Alchemix loans can be used to justify a bit more risk but, in my opinion, they should not be used to justify extreme risks. Selling your alETH for anything other than ETH (and selling your alUSD for anything other than DAI) is effectively taking a new position. In other words, selling alETH for DAI can be a way of shorting ETH because if the price of ETH goes down, the cost to repay your loan (in dollar terms) goes down.

As noted in Core Perspective 2, Alchemix will enhance an already planned purchase. However, you do not get the 25 ETH used to purchase the DopeNFT back — Alchemix is not a “free pass” to take large positions in utter trash (sorry DopeNFT). By using Alchemix, you are effectively selling your tokens; the difference is that Alchemix lets you keep the yield those tokens generate until you need full access to your remaining collateral. This is an important differentiator. Without Alchemix, when you sell your collateral you also give up your right to earn yield on this collateral. With Alchemix spending your loan can be viewed as selling your collateral while retaining the right to earn yield on your collateral indefinitely. This is a more certain way to view Alchemix, as indefinite yield doesn’t have a fixed end date like a fixed amount of future yield does. The phrase “future yield today” is catchy but unpredictable because the future is not guaranteed. “Keep your yield indefinitely” is not as cool of a catchphrase but with context is more accurate. In the DopeNFT example, the 25 ETH you spent is your future yield — but you have no idea how long it will take to generate 25 ETH of yield. What you do know is that for as long as you have your Alchemix vault, you will continue to earn yield on that 25 ETH. This is significantly easier to strategize around. At any moment, you can decide if having 75 ETH locked away in Alchemix is worth effectively earning yield on 100 ETH.

So perhaps some additional risk if justified — after all, with Alchemix you just sell the ETH but keep the yield generation. Without Alchemix you sell the ETH as well as your ability to earn yield on it. Because of this, you could consider the cost of anything you buy through Alchemix is a little bit cheaper than buying it normally. In general, the culmination of Core Perspectives 1, 2, and 3 is that Alchemix is a better way to sell ETH if you are already going to sell ETH. The line of reasoning here is, “I want to sell ETH for X reason. Am I better off if I using Alchemix to take out a loan and sell alETH instead?” Generally, the answer is yes. If you weren’t planning to sell ETH for another asset in the first place, then taking a loan and selling alETH for that asset may not be the right strategy for you.

The core idea here is: First figure out your general strategy, then consider how Alchemix can make your strategy more capital-efficient or more viable.

Core Perspective 4 — Max Loans are Best, Continuously

Scrooge McDuck dreaming of max Alchemix Loans (err does this make me Scrooge McDuck?)

With most Alchemix strategies, taking out a max loan is optimal. This follows the adage “money now is better than money later”. Even if you only need to take out a partial loan to fund whatever strategy you are using, a max loan allows you to use the excess for yield farming. This is very different from strategies with protocols that enable liquidations because with those, you are taking on additional risk by taking out a larger loan. With protocols like MakerDAO, taking a 50% DAI loan on your ETH is regarded as high-risk. However, with Alchemix there is no additional risk created by taking out the full 50% loan. Therefore, you should always access as much capital as possible! This is also one factor in why Alchemix’s LTV ratios are lower than protocols with liquidations. If we raise LTVs, then everyone would, in theory, max out their vault which could cause peg stress.

Additionally, if a portion of your loan has been paid off, why wait for the full loan to be paid off? Take another loan and re-up it to the max! Even if you don’t need it, you can farm with it until you do. The point is to access as much of your future yield as possible at all times.

Another benefit of taking a max loan is diversifying risk. You can deposit the excess loan to a separate strategy within Alchemix or a different yield strategy altogether. Let’s say you deposit 100k USD into Alchemix, take a 50K alUSD loan and immediately put the loan back in your bank. If a black swan event happens that results in a total loss of funds in the Alchemix vaults, this would result in a net loss of 50k for you, compared to a net loss of 100k had you not taken a loan.

The core idea here is: Don’t wait for your loan to pay off — any time is a good time to access the full amount of future yield available to you! Max loan ALWAYS.

Strategy Discussion — Abracadabra Comparison

Part 1 compared Alchemix to banks. Now we’re leveling up and comparing Alchemix to Abracadabra. Pepe Mage vs Merlin, who wins? Spoiler: we all win because we’re using DeFi!

Abracadabra and MakerDAO are protocols that are often compared to Alchemix. Many DeFi protocols have a similar general product that offers access to capital without selling collateral, but with various nuanced and important differences.

Stablecoin Farming Comparison

The first comparison is stablecoin yield. With both Abracadabra and Alchemix, you can deposit stablecoins into your vault as collateral and get a loan in another stablecoin (MIM for Abra, alUSD for Alchemix). The MIM or alUSD can then be swapped back to the stablecoin used for collateral, deposited into the same vault, a new loan can be taken, and so on. The result in both scenarios is you leverage up to a larger stablecoin position than you deposited, meaning you are earning yield on more than 100% of your collateral.

With Alchemix’s 50% LTV, you can complete this loop up to a max of 2x your collateral. This means if you deposit 10,000 DAI and loop an infinite number of times, you will converge on yield farming with 20,000 DAI. In other words, you can effectively double your yield on DAI.

With Abracadabra, the most comparable Abra vault to the Alchemix DAI vault would be the deprecated USDT and USDC vaults. The most common rules of thumb appears to be that a “responsible” liquidation price for a stablecoin is between $0.80 and $0.85 (meaning if the stablecoin depegs below this value for any amount of time, you’d be at risk of being liquidated). With Abra, you could leverage your USDT up to 4x to be within that zone (i.e. if USDT were to depeg temporarily to $0.85, you would lose all of your USDT in the Abra vault).

There is also a difference in fee structure when comparing Abra and Alchemix. The Abra vaults charge a fixed interest rate and a borrow fee. On USDC these are quite small, a 0.05% borrow fee and 0.8% interest fee. Still, this means that you are going to immediately sacrifice 0.05% of yield upfront and take a 0.8% hit on your expected rate (this is because the 0.8% applies to your leveraged balance). Alchemix takes 10% of the yield regardless of what the yield is. With established stablecoin yields around 5%, this would only be 0.5%. However, with Alchemix, as long as the alUSD peg is stable, you’ll be earning boosted yield that offsets the fee. For the lifetime of Alchemix, the boosted yield has exceeded the fee; type !boostedkaren in the Alchemix discord to learn more about boosted yield.

If we assume a base interest rate of 5%, then by looping Alchemix you would get a 10%+ yield on your stablecoins with no liquidation risk. With Abra, you would get 16.8% (5% minus 0.8% times 4x leverage). So, when deciding which protocol to use, ask yourself:

1. Does the Alchemix boost yield cause Alchemix stable looping to surpass Abra?
2. Is the extra yield worth the added liquidation risk on Abra?

For number 1, the answer is usually no, but occasionally the Alchemix looped stable yield may surpass that of Abracadabra. For number 2, the answer for many experienced DeFi users is probably yes, the extra risk is worth it. However, for a DAO treasury, a whale, or a crypto newbie who is not used to the threat and risk of liquidations, the answer may very well be “no”, and this is a big reason why Abra and Alchemix can coexist in the stablecoin-for-stablecoin lending space.

ETH Loan Comparison

Many people are very interested in a “never sell” plan for ETH that allows them to perpetually take money out by taking loans against their crypto. This means taking loans against your ETH to pay for expenses while never actually selling the underlying ETH. In general, this is accomplished by taking out loans denominated in USD. This way, if ETH keeps going up the cost of your loan remains the same, and you have more net worth with the same amount of debt. If you want to repay your loan in the future, it costs you less ETH than when you started. If ETH keeps going up, you can maintain the same LTV ratio while taking out even more collateral. Great!

Let’s look at this strategy with Abracadabra (MakerDAO would be similar). Say you have 100 ETH and want to cash some out. ETH is priced at $3,000 and yield is 5%. 100 ETH is everything you have, so you want to be rather conservative. You decide to cash out 10%, or 10 ETH. You deposit all 100 ETH into Abra and take the loan for 10 ETH worth, which is paid out as $30k MIM (note you could also deposit 50 ETH and take a 10 ETH loan, for a greater chance of liquidation but only risking 50 ETH). The Abra yvWETH vault has an interest rate of 2.5% and a borrow fee of 1%. This means you are only actually getting 2.5% interest on top of an initial 1% fee, which drops your effective starting capital down to 99 ETH. Prices can go up, down, or stay the same. Let’s assume 2x, 1x, and 0.5x as the three outcomes for this case study over the timeframe of one year:

1. ETH goes up 2x ($6k) — Your 99 ETH has earned 2.5% interest and is now 101.5 ETH. Your $30k loan (that you spent) now only costs 5 ETH to pay off. You settle the loan and have 96.5 ETH.
2. ETH stays the same ($3k) — You have 101.5 ETH, same as #1. Your $30k loan still costs 10 ETH to pay off, so you’re left with 91.5 ETH.
3. ETH crashes 0.5x ($1.5k) — Your 30k loan costs 20 ETH to pay off, so you’re left with 81.5 ETH.

It is important to note that if ETH were ever to dip in price to $300 just one time the entire year, you would lose all your ETH. It may not be very likely, but the result would be very damaging.

Now let’s compare the above scenario to Alchemix. From Core Perspective 4, we know that taking the max loan is optimal, so we’ll deposit our 100 ETH into an Alchemix vault and take a loan for 50 alETH, assuming v2 will allow 50% LTV on ETH. Taking a 50% loan on Abra would be high-risk, whereas taking it on Alchemix is a responsible and efficient allocation of capital. We still only cash out 10 alETH, but now we have an extra 40 alETH to farm at 5% APR by swapping to ETH and depositing back into Alchemix. Here are the results:

1. ETH goes up 2x ($6k) — The 50 alETH of debt is repaid with 5% interest on 140 ETH of collateral (initial 100 plus the 40 leftover from the loan after selling 10), leaving a total debt of 43 alETH. After repaying the 43 alETH debt with the 140 ETh collateral, you are left with 97 ETH — slightly better than Abra!
2. ETH stays the same ($3k) — Since everything is denominated in ETH, the result is the same — you’re left with 97 ETH. Quite a bit better than Abra.
3. ETH crashes 0.5x ($1.5k) — Since everything is denominated in ETH, the result is the same — you’re left with 97 ETH. A lot better than Abra.

There are many variables that could shift the result to favor Abra or Alchemix:

1. If ETH were to increase in price 4x, Abracadabra would win.
2. If the Alchemix boosted yield were to remain high enough, Alchemix would win even when ETH goes up 4x (assuming they use the same yield strategy)
3. If a user were to take a 20% loan on Abra and not get liquidated, Abra would win.
4. If you take a 20% loan on Abra AND ETH goes up 4x, Abra wins pretty significantly.

The main point here is that on the surface, it would appear that Abra would win in any scenario where ETH goes up. In reality, Alchemix wins in many scenarios where ETH goes up. Additionally, the “winning” is not that excessive on the upside, whereas the “losing” can be quite substantial on the downside. So it once again comes down to whether the downside risk of liquidation on Abra is worth the slightly higher upside. Again, I think that for treasuries, whales, and individuals that are new to the Crypto and DeFi space, the answer will often be “no”. If Alchemix is better in every scenario except an ETH gigamoon, one could potentially hedge that scenario with some gigamoon ETH options, if one were so inclined… Ultimately, finance isn’t just about the movement of money, but rather the movement of money and risk. Alchemix offers many advantages here by mitigating much of the risk while sacrificing a smaller amount of upside than one might expect.

Conclusion

This was a dense article, but I hope you got something out of it. The key path here is to start to develop a crypto strategy or thesis, evaluate the various yield options out there, determine if the strategy you want to use is on Alchemix (or at least one with a similar yield), then evaluate how taking a continuous max loan could help your strategy. Determine if your strategy would be more lucrative by using Abracadabra, MakerDAO, or other lending protocols instead of Alchemix, and if so, determine if the extra risks are worth the extra rewards. If you apply the core perspectives along the way, you’ll find that Alchemix may beat out other options more often than you thought!