COVES-XX: Country-Oriented Volatility-Enhanced Strategies (via Synthetic Token)

Hello! I went back to the lab after efforts toward getting uEASE off the ground fizzled out due to tech/potential community interest issues. I’m back with another synth strategy that, I believe, is even more relevant as a bridge between traditional investors and the DeFi space. Enjoy!

Title of your idea
Mitigate against downturns in a domestic stock market position via COVES, which uses a simple strategy to capitalize on volatility in favorable conditions.

Summary Description
I wrote an entire SSRN paper on my research into COVES, so that really gets into the details of the concept as well as returns, volatility, max drawdowns, and all that fun quant stuff. But if you want a brief synopsis of what it is, here’s the abstract:

The home country bias for investors remains ubiquitous, despite innumerable warnings of over-investment in the investor’s domestic market. While we’ve provided potential mitigations for this phenomenon in the past, this time we focused on providing a intra-market solution that would hedge against the riskier aspects of domestic over-investment. Through the use of simple signal-based switches, we were able to provide a robust strategy that plays off the anti-correlation between the market and its volatility. Initially tested in the US market via SPY and VIX, we tested our strategy with a synthetic volatility index derived from SPY pricing data. The synthetic volatility index performed similarly to VIX, with the same broad results across both variations. These market and synthetic volatility index derivative strategies were applied to ETFs of 45 countries and resulted in improvements over the base market in practically every instance. These Country-Oriented Volatility-Enhanced Strategies (COVES) provide a powerful proof-of-concept on a volatility-based hedge for a standard equity market index. Unfortunately, since the volatility aspect of the COVES isn’t directly investable, these strategies are not currently viable. However, a recent advancement in Decentralized Finance known as synthetic tokens could provide the vehicle to make COVES a tangible investment product. Furthermore, additional advancements in DeFi could supplement a country-focused strategy with an inflation-hedged base currency, providing an even more powerful preservation of wealth while holding a long-term investment asset such as COVES.

Which metric will your synth track?
COVES-XX are country-specific: COVES-US for the United States, COVES-ZA for South Africa, and so on. So while uSTONKS tracks the ten most-discussed stocks on WSB, COVES-XX would track an index representing the country (either one that already exists like the S&P 500 or one created specifically for COVES) as well as a synthetic volatility index for the country. I get into more specifics in later sections, but COVES represents the combination of a long position in the country index supplemented by a “double-switch” that toggles between long market, long volatility, or no position based on a simple trading signal. It’s a little bit more complex than tracking just an index or ETH Gas prices, but it’s nothing too wild.

How will you get data for your metric
Daily pricing data is readily available via Google Finance or Yahoo! Finance for 40+ countries. For others, daily pricing data would need to be obtained elsewhere and/or an approximate index will need to be made from scratch (see my example of a COVES-HT here).

What collateral would you use for this synthetic
USDC, with the hope that in the future an inflation-adjusted stablecoin would be used. Eagerly awaiting the outcome of’s $100k prize for a decentralized inflation dashboard contest.

Describe how you would create this synthetic
The double-switch is fairly simple: if the 5-day^ return of the market index after market close on day t is negative, the double-switch position is in the market index from market open on day t+1 to market open on day t+2. If the 5-day return of the market index is positive but the 5-day return on the synthetic volatility index is negative, then the double-switch position is in the volatility index from market open on day t+1 to market open on day t+2. If both 5-day returns are positive, then no position is held.

For the synth token, they would be 3 months each: the proposed COVES in the SSRN paper rebalances quarterly, so a three-month synth token accomplishes a similar thing. The initial balance would be 70:30 between the market index and the double-switch. For example, COVES-US could start with 70% in the S&P 500 and 30% in the double-switch.

^The “5-day return” signal used is slightly different than typical: I’m using the closing price on day t divided by open price on day t-5 minus 1.

What issues might you encounter in the development of the synthetic
I’m going to lift a bit from my uEASE proposal for this, since a lot of the issues are similar

I’m much more of a quant/MFE type than dev/engineer and am relatively new to the DeFi space, so a lot of my “known unknowns” are in the idea portion versus the structural portion (where there’s a bevy of “unknown unknowns” from my perspective). Based on what I know, I think there’s two issues that might crop up: 1) Transposing an equity investment strategy into the crypto/DeFi space is going to seem…boring? Crypto is to Equities as Equities were to Bonds decades ago: a higher-return vehicle with a higher level of risk and volatility to go along with the “faster” movement of the asset class. Will an equity-based strategy be exciting for anyone, even if it does well? It’ll all depend on the narrative: is corporate governance a fraction as interesting as WSB sentiment? 2) How confident will investors be in a synthetic token derived from essentially a trading signal between one well-established market index and a volatility index created in-house? I want to be 100% transparent in any COVES synth, posting the market index, synthetic volatility index, 5-day returns, and the double-switch position signal on a daily basis. If community doesn’t believe in the foundations of COVES, then it should not succeed. Hell, I’m strongly considering posting daily positions and (paper-trading) cumulative return on the Novatero Twitter account starting in mid-September if only to show proof-of-concept/confidence in the strategy.

How you would make sure that people who would find the synthetic useful could access it
My current thinking is using a two-prong approach. The first prong would be to provide strategy information, commentary, and FAQs on the Novatero website in a dedicated COVES dashboard. This would be the accessible portal to the COVES strategy for those investors outside of the DeFi space who need a gap bridged between their traditional understanding of investing and synth tokens. The second prong would be a synth token platform that’s already up and running for the actual investing portion. Yam Synths is the frontrunner, but I am more than willing to hear about alternatives because I just do not know a lot about options on this front.

Website & Logo Mockup
The Novatero Investments website would host that first prong mentioned above, so I already have a site and a general Novatero logo live. As for COVES-specific logos, I don’t have anything formed in my head or on paper and am more than willing to hear suggestions!

1 Like

Sounds interesting!

Will take a read at the paper

Finally back from vacation and attempting to squeeze into ETHOnline after-the-fact. Any suggestions for future steps to take toward making this a reality (or a proof-of-concept synth at the very least)?

Did you manage to register OK for EthOnline? There is a pool prize for anyone building on UMA using our LSP contract

It seems like the LSP would be a suitable - although you only mention long positions in your post, I assume that there would not be an issue offering an associated short.

I guess the next step would be to write an UMIP to build the price identifier that you would like to use

Haven’t heard back from them when I signed up on-site, but I just sent them a Twitter DM.

I’d have to think on how to structure a short, but it should be doable. I’ll dive back into R&D this week to find it; it’ll probably just be a signal mirror of the long position :slight_smile:

Sounds good re: UMIP. I’ll send you a message via Discord to continue this discussion since Discourse is a little less efficient for that.