How to make money from RAI arbitrage

A walkthrough on how you can make money by watching the price of RAI

Bankless DAO released its first NFT! There is no floor is based on this epic meme. Bid now!

Buy "There is No Floor" NFT


Dear Bankless Nation,

DeFi needs an asset that’s trustless and stable—we’ve said before that this is the holy grail for collateral. This is what RAI is looking to achieve.

We’ve covered RAI before (see here, here, and here) because we love the concept.

RAI is possibly the first true stablecoin in DeFi. It’s not backed by dollars. It’s not even pegged to dollars. In fact…it’s not pegged to any outside asset. It’s a DeFi money backed by ETH with code + incentive mechanisms to maintain a stable price.

Even Rohan Grey would approve.

And these incentive mechanisms present an opportunity to make money while also helping maintain the asset stability.

So how do you make money?

Pretty simple: if RAI is above or below the redemption price, there’s an opportunity to profit via arbitrage.

A Reflexer community writer walks us through how this works in today’s tactic.

Here’s how you can make money by making RAI more stable.

- RSA


🙏 Sponsor: Aave—Experience DeFi: Deposit, Earn, & Borrow with Aave


📺 Watch Episode 46 of State of the Nation

📺 Watch State of the Nation #46: The ETH Trade| Su Zhu & Kyle Davies of 3AC

Su Zhu and Kyle Davies are legendary crypto investors & founders of crypto hedge fund Three Arrows Capital. They join the State of the Nation to discuss the bullish case for ETH.

We premiere State of the Nation on YouTube every Tuesday at 2pm EST—join us!


Tactic Tuesday

Guest Writer: Anonymous, Reflexer Community Member

Serving the Money God for Fun & Profit: RAI Arbitrage Tactics

RAI is a stablecoin with an algorithmically controlled floating peg that maintains price stability by creating market incentives for traders to counter any sudden market movements in order to restore RAI to equilibrium.

Savvy arbitrageurs serving the RAI Money God should find themselves handsomely rewarded. This tactic will dive into the different opportunities available and how you can capitalize on RAI arbitrage to earn a profit.

  • Goal: Make money by arb’ing RAI

  • Skill: Intermediate

  • Effort: Understand RAI and execute trades

  • ROI: A few % on your capital for each trade


RAI: A New Money God

The RAI “reflex index” built by Reflexer Labs is an algorithmic stable asset backed by only ETH, which tries to maintain its USD price in response to market fluctuations. RAI is minted by depositing ETH in a Safe (similar to a MakerDAO Vault) and incurring an equivalent amount of debt against the ETH collateral. 

RAI maintains its price stability by setting up incentives for market participants to arbitrage price fluctuations between the market price (what it is trading for according to oracles) and the redemption price (the dollar value of RAI debt, per RAI)

Unlike other stable assets on blockchains, it is not pegged to a specific USD price. Instead, RAI is pegged to its own previous redemption price. On each update, the system adjusts its redemption rate, the rate at which the redemption price is updated, using an on-chain PID controller. 

A full description of the mechanism is outside the scope of this article (read this for more info), but a PID controller pushes a system back towards its set point harder with a larger measured deviation from the set point.

In other words, the more the market price deviates from the redemption price, the stronger the system makes the incentives to push it back—just like a spring.

The thesis behind RAI is that by minimizing governance and human intervention, we can actually create a more stable and socially scalable system. As a technology, crypto is all about removing the need for trusted 3rd parties. 

When they are removed from the equation, you are left with a credibly neutral system. Neutral systems can be trusted by parties that don’t know each other, and are socially scalable—as demonstrated by Bitcoin, faith in machines can outpace faith in human organizations.

Rai intends to bring this philosophy to the very core of money, using ETH to create the ultimate trust minimized stable money. ETH is Money. RAI is ETH. RAI is Money.


Want to learn more about RAI? Check out these Bankless resources:


How to make money by watching RAI’s price

Market participants are critical to maintaining RAI’s price stability, especially with the currently deployed automated market maker (AMM) technologies on decentralized exchanges.  

Arbitrage opportunities arise whenever the RAI market price deviates sufficiently far from the redemption price to cover slippage and fees. Given the market behavior of RAI so far, generally the best opportunities will occur when ETH/USD is rapidly rising or falling. Unfortunately, due to the large ETH/RAI LP pool, on short time scales RAI and ETH are still somewhat correlated. This means that the greatest advantage can be had by using a pegged stablecoin like DAI as an intermediary.

In order to execute RAI arbitrage trades, one must acquire RAI at some point. There are two ways to do that; minting RAI against ETH collateral, or buying RAI on the market. What one chooses to do depends upon one’s preferences, as the price swings of RAI alone mean that simple arb against fiat-pegged assets is possible. However, this strategy means that you are dependent upon other arbitrageurs to eventually bring the market price back in line with the redemption price. If you employ a RAI safe as part of the cycle, you help keep RAI stable and have greater security in the trade.

A few examples should help illustrate the process.


💼 Case 1: RAI is above the redemption price

This typically happens when ETH is trending strongly upward.

If you do not already have RAI, you can get it at the redemption price by minting it against ETH in a Reflexer Safe. Deposit ETH and mint RAI, then sell RAI on the open market to a pegged stablecoin such as DAI.

You will eventually have to repurchase the RAI to repay your debt—you depend upon the market to drive the price back down so that you can do that. If you already have RAI, simply sell it to a pegged asset and wait. Note that if RAI market price is above the redemption price, your debt will devalue (you will owe less in dollar terms) while you wait because the redemption rate will soon be negative if it is not already. In this way, you are incentivized to generate more debt and sell RAI on the open market in this situation, which helps drive market price back down.

For example, if the RAI redemption price is $3.01 and the market price is $3.10, you can incur a debt of $3.01/RAI and immediately sell for a net profit of $0.09/RAI. If you purchased on a downswing at $2.90, you can sell for a net profit of $0.20/RAI.

💼 Case 2: RAI is below the redemption price

This typically happens when ETH is trending strongly downward.

This is the time to purchase RAI. If you are not employing a Safe in your strategy, you will merely wait until the RAI price is higher and sell it back to a pegged stablecoin.

If you are employing a Safe, and already have debt, this will allow you to pay back your debt more cheaply. As above, but conversely, note that if RAI market price is below the redemption price, your debt will increase in value (you will owe more in dollar terms) while you wait because the redemption rate will soon be positive if it is not already.

In this way, you are incentivized to buy RAI on the open market and repay your debt, which helps drive market price back up.

For example, if the RAI redemption price is $3.01 and the market price is $2.90, you can repay your RAI debt at a discount of $0.11/RAI. As mentioned above, if you purchase RAI merely to hold until the next upswing and it reaches $3.10, you can sell for a net profit of $0.20!


A Note About Redemption Rate

On short time frames, the redemption rate does not much affect this trade. However, over time the redemption rate will affect the redemption price enough to devalue the RAI you hold, and to make cheaper the debt you owe in a Safe.

Therefore, if you’re looking to execute these trades on a longer time scale, it is important to remember that a high market price means it is preferable to incur debt and sell RAI, while a low market price means that it is preferable to repay debt and hold RAI. This is further affected by the value of the ETH collateral.


Conclusion

Thanks for reading this brief RAI arbitrage strategy guide. With a little help from the community of arbitrageurs, RAI is able to maintain stability and serve as a new reserve asset for DeFi.

These opportunities are key to the long term success of RAI—so if you see it and it’s profitable, execute on the trade! You’re helping RAI become more stable, and a more effective, trust-minimized reserve asset for the world.


Action steps


Author Bio

This article was written by a Reflexer Community Member who elected to remain anonymous. They’re a DeFi Degen and RAI Money God Worshipper!


Subscribe to Bankless. $22 per mo. Includes archive accessInner Circle & Badge.


🙏Thanks to our sponsor

Aave

👉 Experience DeFi: Deposit, Earn, & Borrow with Aave

Aave is a decentralised, open source and non-custodial liquidity protocol enabling users to earn interest on deposits and borrow assets. Aave Protocol is unique in that it tokenizes deposits as aTokens, which accrue interest in real time. It also pioneered Flash Loans and Credit Delegation as innovative DeFi building blocks. The Aave Protocol V2 makes the DeFi experience more seamless with features that allow you to swap your assets for the best yields on the market, and more. Check it out here.


Want to get featured on Bankless? Send your article to submissions@banklesshq.com

Write for Bankless


Not financial or tax advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This newsletter is not tax advice. Talk to your accountant. Do your own research.


Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Bankless writers hold crypto assets. See our investment disclosures here.