Hedging

The Challenge of Hedging FX Exposure in DeFi

Current Difficulties:

On-chain Hedging: Often marred by liquidity issues leading to elevated costs.

Off-chain Hedging: Introduces inefficiencies due to the on-chain asset location and the complexities of managing risk with traditional banks.

A Real-World Example:

Imagine an investor holding 100 USDC wanting to invest in BRZ (BRL stable coin) assets with a yield of 15% p.a.:

1. Trading USDC for BRZ incurs a 0.50% markup, reducing the value to 99.50 USDC-equivalent in BRZ.
2. To hedge against BRL's volatility, he sells BRL futures (NDFs) with a local bank, which costs him around 10.5% p.a. in total.
3. Banks demand real USD as collateral for NDFs, often 10%-20% of the notional amount. This means the investor can only effectively allocate 89.55 USD-equivalent, slashing the yield to 3.5%.
4. On receiving the BRZ investment back, converting to USDC incurs another 0.50% cost. The effective yield is just 3%.

The initial excitement 🤑 quickly turns into disappointment 🤕. This example can be even more challenging for small clients or in case of significant FX movements.

Kona's Solution: Nakō - Revolutionizing On-chain Hedging

Understanding Nakō:

Banks typically match two clients wanting exposure to different currencies for NDFs. They don't always need exact matches due to their cross-border books. Nakō is built upon this model.

Two Core Concepts:

Diverse Risk Appetites: Some users seek risk in various currencies, either for speculation or due to their inherent financial commitments.

Borrowing Dynamics: When you borrow a coin, you owe the borrowed quantity, not its financial value. For example, if you borrow 10 ETH, you owe 10 ETH, regardless of its price.

Nakō's Elegance:

By merging these concepts, Kona introduces a combined AMM and Lending pool. It's a singular pool where:

• Liquidity providers with an inherent need for currency X lend to investors.
• Investors wanting strategies exposed to currency X provide collateral in their native currency Y.
• LPs embrace the volatility and receive payment for their loans.
• The pool retains collateral until the loan's settlement.
• Investors get a pure yield.

Applications:

• Nakō can function within a closed loop in the protocol, with a 100% LTV.
• It can be a service for other protocols.
• It can operate as a standalone solution, though different risk parameters would be necessary.