HODL, Perp DEX or ILM — What’s right for you?
Currently the crypto markets have over 10,000+ DeFi apps. It is hard to make an investment choice, and even harder to get in-depth knowledge of multiple apps before making one.
In this article, the pros and cons of three different options are compared; minimal effort of just holding a token, high effort of depositing in a Perp DEX and low/medium effort of depositing in an ILM.
If you are new to ILMs, ILMs are vault strategies that run on auto-pilot, and use ERC20 tokens to represent shares. ILMs make it easy for users to increase exposure by abstracting away time consuming transactions, whilst magnifying exposure to market effects. Learn more about ILMs from Seamless Protocol here.
Holding, Perp DEXs and ILMs
To compare these options meaningfully, we must understand what each of these options entails at a high level.
Holding a token is just that — purchasing and waiting. HODLing. It is extremely simple and easy to do, and just requires deciding when to purchase more or sell the position. This option has the lowest barrier to entry and the lowest monitoring requirements, hence it is by far the most accessible to users.
A Perp DEX is on the other end of the spectrum; it is a highly nuanced, highly complex ecosystem which requires intimate knowledge of the financial instrument known as Perpetual Futures so that a position can be managed effectively.
In essence, Perp DEXs operate like future contracts without an expiration date. This means that an investor can select a price, purchase a future contract, and keep it active indefinitely by paying a funding rate. On top of that, leverage is often used to amplify the effects of market movements, sometimes upwards of 100x leverage!
Finally an ILM is an automated vault strategy which also incorporates leverage to amplify the effects of market movements, but consistently stays within a targeted leverage band. Regarding access to leverage, Perp DEXs and ILMs are similar.
Comparison
The table below indicates where the large differences for most users appear between the three options of simply holding a token, depositing in a Perp DEX or depositing in an ILM.
Even so, it is prudent to understand how these differences arise, and what option is most suited to you.
Holding a token has the benefit of being simple. The risks are just the same as the market movements, and no fees need to be paid. As a consequence, the losses are limited to market movement however so are the profits.
On the other hand, both Perp DEXs and ILMs offer leverage. At its core leveraging just amplifies the effects of a market movement. If leverage is at 2x, this means that a drop or a rise in the market will affect the position twice as much as it would normally (minus a slight percentage when accounting for fees).
Leverage is achieved via borrowing other assets. In the case of crypto, leverage is obtained when borrowing tokens to achieve a larger position. Just like any borrowing activity, taking out a loan to amplify exposure comes with the cost of paying back interest. Both ILMs and Perp DEXs have to pay back the interest incurred on these loans.
Due to the price movements of the assets being borrowed or collateralized, the leverage of a position changes, as does its exposure. To maintain leverage, and to ensure a healthy loan, tokens must be swapped and part of the debt must be repaid, or additional collateral must be provided. This results in DEX fees being incurred. Both Perp DEXs and ILMs are burdened with this operation cost. It is worth noting that when a user participates in an ILM strategy, their only costs are 3rd party DEX costs, no ILM specific fee. This is different from Perp DEXs which add entry fees in most cases.
The key difference is that maintaining loan health, and leverage, is done manually on Perp DEXs whereas ILMs do it automatically. This means that maintaining a position is far simpler in an ILM, as it abstracts the complexity of ensuring leverage and also greatly reduces chances of liquidation due to bad loan health.
Another similarity is that leverage exposes the investor to volatility decay. In Perp DEXs the investor is burdened with the protection against this risk. In contrast, in the ILMs, the exposure being kept within a certain margin means the effects of volatility decay are kept to a minimum.
Finally, a unique element of Perp DEXs is the requirement that the position holder pays a funding rate, to maintain the future they have purchased. This value fluctuates based on market conditions, and as a result can impact the position tremendously.
To sum it up in a table:
Conclusion
Token holding is the lowest effort, lowest risk and lowest return options.
Perpetual DEXs are advanced tools that can yield amplified results but require a lot of monitoring and diligent accounting to ensure a position is and will remain profitable.
ILMs are simple tools which can yield amplified results and require very little effort to manage.
So which would you pick?
To learn more about ILMs, and how they work under the hood, check out this article on rebalancing and compounding.
Seamless Protocol is the first decentralized, native lending and borrowing protocol on Base. Seamless lays the foundation for Modern DeFi, focusing on lower-collateral borrowing and a better user experience to inspire the masses.
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