Managing Backing Asset Portfolio

The backing assets utilized by Arcana are managed through a series of delta-neutral strategies, which aim to maintain the stability of arcUSD's value in USD despite the market volatility of the underlying collateral. This approach is not limited to BTC but can extend to other high-capitalization assets such as ETH and SOL, depending on the specific strategy employed, such as Liquidity Pool Hedging or potential future strategies.

Specifically, to create 1 arcUSD, Arcana allocates $1 of a backing asset and delegates it as margin with a derivatives centralized exchange to short the related perpetual contract. This way, the value in USD remains constant regardless of changes in the spot price of the underlying. Should the value of the backing assets portfolio double or crash 50%, the losses from either side of the position are offset by the profits earned on the other hand.

Delta-Neutral Stability Across Market Conditions

Below are few examples to show how the delta-neutral stability holds in different market conditions.

Assume for simplicity that the price of a generic backing asset (e.g. BTC) starts at $100.

Price Increase Scenario:

  1. Arcana delegates 1 BTC as margin with the exchange, and opens a BTCUSD perpetual short position.

  2. BTC price rises from $100 to $1,000

  3. The value of BTCUSD perpetual in BTC is 0.1 BTC ($100 / $1,000)

  4. The PNL of BTCUSD perpetual is -0.9 BTC [0.1 BTC (current value) – 1 BTC (initial value)]

  5. Arcana's total balance with the exchange is now 0.1 BTC [1 BTC (initial margin) – 0.9 BTC (loss from BTCUSD perpetual position)]

  6. Since Arcana still holds 0.1 BTC and the price of BTC is now $1,000, the USD value of the total position remains unchanged at $100 ($1,000 * 0.1 BTC)

Price Decrease Scenario:

  1. Arcana delegates 1 BTC as margin with the exchange, and opens a BTCUSD perpetual short position.

  2. BTC price falls from $100 to $10

  3. The value of BTCUSD perpetual in BTC is 10 BTC ($100 / $10)

  4. The PNL of BTCUSD perpetual is +9 BTC [10 BTC (current value) – 1 BTC (initial value)]

  5. Arcana's total balance with the exchange is now 10 BTC [1 BTC (initial margin) + 9 BTC (profit from BTCUSD perpetual position)]

  6. Since Arcana now holds 10 BTC and the price of BTC is $10, the USD value of the total position remains unchanged at $100 ($10 * 10 BTC)

In certain market conditions these examples may not hold, as described in more detail in the “Risks” section.

Portfolio Management and Strategies Allocations

Arcana's management of its backing asset portfolio takes into account various risk profiles associated with each delta-neutral strategy, as well as fundamental principles of standard portfolio management, such as liquidity risk and concentration risk.

Recognizing the additional risks associated with DeFi protocols, such as impermanent loss and smart contract risk, Arcana strategically allocates a smaller portion of its total portfolio to the Liquidity Pool Hedging strategy. This approach ensures that while this strategy can offer higher yields, it does not disproportionately expose the portfolio to potential losses.

Most of the portfolio remains anchored in the bitcoin cash and carry trade, reflecting the relatively lower risk profile and substantial liquidity of BTC markets. It's important to note that this percentage is not fixed and may fluctuate based on varying market conditions, changes in the risk profile of strategies, and other dynamic factors.

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