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Risk Management & Hedging

Protect your DeFi positions from market volatility and liquidation risk.

The Strategy

Use stablecoins and diversification to hedge against collateral price drops while maintaining DeFi positions.

What you'll learn:

  • Hedge collateral volatility
  • Reduce liquidation risk
  • Maintain upside exposure
  • Balance risk and return

Result: Sleep better while staying in DeFi

Complete Example: Hedge 10 ETHST Position

Your situation:

  • Collateral: 10 ETHST ($30,000)
  • Borrowed: 16,000 USDST
  • Health Factor: 1.5
  • Problem: Worried about ETHST crash

The hedge:

  1. Mint additional USDST via CDP
  2. Swap portion to stablecoins
  3. Hold as safety buffer
  4. If ETHST drops: Use stables to add collateral

Time needed: 10 minutes
Cost: ~$0.50 gas + swap fees

Understanding DeFi Risks

Primary Risks

1. Collateral Volatility - ETHST drops 30% → Health factor plummets - Risk: Liquidation

2. Interest Rate Changes - Borrow rates spike during volatility - Debt grows faster

3. Smart Contract Risk - Platform exploits (rare but possible) - Mitigation: Audited contracts, insurance

4. Liquidation Cascade - Market-wide selloff - Mass liquidations drive prices lower

Hedging Strategy 1: Stable Collateral Mix

Mix volatile and stable collateral

Implementation

Starting:

  • 10 ETHST ($30,000) = 100% volatile

Target:

  • 6 ETHST ($18,000) = 60% volatile
  • 12,000 USDST ($12,000) = 40% stable

Steps:

  1. Mint USDST via CDP:

  2. Mint 6,000 USDST (low CR)

  3. Stability fee: 2.5%

  4. Swap to stablecoins:

  5. Swap 6,000 USDST → USDST

  6. Cost: ~$18 (0.3% fee)

  7. Supply USDST as collateral:

  8. Add 6,000 USDST to collateral

  9. Now have mixed collateral

  10. Optional - Remove some ETH:

  11. Withdraw 2 ETHST - Sell or hold separately

  12. Keep 8 ETHST + 6,000 USDST collateral

Result: 

Before:

- 10 ETHST collateral
- 16,000 USDST debt
- HF: 1.5
- Risk: High (100% ETHST exposure)

After:

- 8 ETHST + 6,000 USDST collateral
- 22,000 USDST debt (16k original + 6k new)
- HF: 1.09
- Risk: Lower (60% ETHST, 40% stable)

Impact Analysis

If ETHST drops 25%:

Without hedge:

  • Collateral: $22,500 (10 ETHST @ $2,250)
  • Debt: 16,000
  • HF: 1.12 (safe)

With hedge:

  • Collateral: $24,000 (8 ETHST @ $2,250 + 6k USDST)
  • Debt: 22,000
  • HF: 0.87 (liquidated!)

Wait, that's worse! Need to adjust...

Hedging Strategy 2: Safety Buffer (Better)

Hold stablecoins OUTSIDE collateral as emergency fund

Implementation

Step 1: Create Safety Buffer

  1. Mint USDST via CDP:

  2. Use 10 ETHST collateral

  3. Mint 7,000 USDST

  4. CR: 286% (safe)

  5. Swap to stablecoins:

  6. Swap to 7,000 USDST - Hold in wallet (NOT as collateral)

  7. Keep borrowing position:

  8. 10 ETHST collateral

  9. 16,000 borrowed + 7,000 minted = 23,000 debt
  10. HF: 1.04 (safe with buffer ready!)

Result: 

Collateral: 10 ETHST ($30,000)
Debt: 23,000 USDST
HF: 1.04
Safety buffer: 7,000 USDST in wallet

Using the Safety Buffer

If ETHST drops 25% ($3,000 → $2,250):

  1. Without buffer:

  2. Collateral: $22,500

  3. Debt: 23,000

  4. HF: 0.78 → LIQUIDATED ❌

  5. With buffer:

  6. Use 7,000 USDST from wallet

  7. Swap → 3.11 ETHST (at $2,250)
  8. Supply as collateral
  9. New collateral: 13.11 ETHST ($29,498)
  10. HF: 1.03 ✅ Saved!

The buffer saved you from liquidation

Hedging Strategy 3: Delta-Neutral Position

Advanced: Maintain DeFi position with zero price exposure

Concept

  • Long ETHST (via collateral)
  • Short ETHST (via perps or options)
  • Net: Zero price exposure
  • Earn: Lending/LP fees minus short costs

Implementation on STRATO:

  1. Supply 10 ETHST collateral
  2. Borrow USDST against it
  3. Short ETHST on another platform (e.g., dYdX, GMX)
  4. Net exposure: Zero ETHST price risk

Pros:

  • Completely hedged
  • Earn DeFi yields without price risk
  • Perfect for ranging markets

Cons:

  • Complex to manage
  • Shorting costs (funding rates)
  • Need account on derivatives platform
  • May not be net profitable

Not commonly recommended for most users

Hedging Strategy 4: Gradual De-Risking

As market becomes uncertain, gradually reduce risk

Phase 1: Normal Market

Collateral: 10 ETHST
Debt: 15,000 USDST
HF: 1.2
Risk: Moderate

Phase 2: Volatility Increases

Actions:

  1. Repay 3,000 USDST
  2. Improve HF to 1.4
  3. Cost: Interest stops on repaid amount
Collateral: 10 ETHST
Debt: 12,000 USDST
HF: 1.4
Risk: Lower

Phase 3: Market Crashing

Actions:

  1. Repay another 5,000 USDST
  2. HF increases to 2.57
  3. Very safe from liquidation
Collateral: 10 ETHST
Debt: 7,000 USDST
HF: 2.57
Risk: Very low

Phase 4: Recovery

Actions:

  1. Borrow again as market stabilizes
  2. Return to normal risk level
  3. Missed some downside, kept position open

This is the simplest and most reliable hedge strategy

Cost-Benefit Analysis

Strategy 1: Mixed Collateral

Metric Value
Setup cost $18 (swap fees)
Ongoing cost Increased debt interest
Benefit Reduced volatility
Best for Conservative users

Strategy 2: Safety Buffer

Metric Value
Setup cost $18 (swap fees)
Ongoing cost Opportunity cost on buffer
Benefit Emergency protection
Best for Moderate risk-takers

Strategy 3: Delta-Neutral

Metric Value
Setup cost Varies (exchange fees)
Ongoing cost Shorting funding rates
Benefit Zero price risk
Best for Advanced traders

Strategy 4: Gradual De-Risk

Metric Value
Setup cost None
Ongoing cost Reduced interest (benefit!)
Benefit Simple, effective
Best for Everyone

Recommendation: Strategy 4 (Gradual De-Risk) for most users

Real Example: 2022 Bear Market

User: Bob

May 2022:

  • Collateral: 10 ETHST @ $3,000 = $30k
  • Debt: 15,000 USDST
  • HF: 1.2

Bob's action: Implemented Safety Buffer - Minted 5,000 USDST via CDP - Swapped to USDST - Held as emergency fund

November 2022:

  • ETHST crashed to $1,200 (-60%)
  • Collateral now: $12,000
  • Debt: 20,000 (15k + 5k minted)
  • HF: Would be 0.36 → LIQUIDATED

Bob's response:

  • Used 5,000 USDST buffer
  • Bought 4.16 ETHST @ $1,200
  • Added to collateral
  • New collateral: 14.16 ETHST @ $1,200 = $17k
  • New HF: 0.51 (still liquidated!)

Bob needed more buffer!

Lesson: In extreme crashes (>50%), even buffers may not be enough

By leverage level:

Leverage Debt/Collateral Buffer Size Can Survive Drop
Low 30-40% 10% 40-50% crash
Medium 50-60% 20% 30-35% crash
High 60-70% 30% 20-25% crash

Formula: 

Buffer = (Target drop% × Collateral value) - Available borrowing room

Example:

  • Want to survive 40% drop
  • Collateral: $30k
  • Current debt: $15k (50%)
  • Max debt: $22.5k (75%)
  • Available room: $7.5k

If 40% drop:

  • New collateral: $18k
  • Debt stays: $15k
  • HF would be: 0.72 (liquidated)

Buffer needed:

  • $15k / 0.6 = $25k collateral needed
  • Have $18k after drop
  • Need: $7k buffer

Buffer needed: ~$7k (~23% of original collateral)

Automation Ideas (Advanced)

Set up automatic hedging:

  1. Price-triggered repayments:

  2. If ETHST < $2,700: Auto-repay 2k USDST

  3. If ETHST < $2,400: Auto-repay another 3k

  4. Requires keeper bots or limit orders

  5. Dynamic collateral ratios:

  6. Monitor volatility index

  7. Auto-rebalance to stable collateral when volatility spikes

  8. Requires custom scripts

  9. Health factor triggers:

  10. If HF < 1.5: Auto-add collateral from buffer

  11. Keeper bot watches on-chain
  12. Executes transactions when needed

Most users: Manual monitoring is sufficient

Red Flags: When to Hedge

Market Signals

  • [ ] VIX > 30 (high volatility)
  • [ ] ETHST drops > 10% in 24 hours
  • [ ] Liquidations spiking across DeFi
  • [ ] Macro uncertainty (Fed meetings, etc.)
  • [ ] Funding rates extremely negative/positive

Position Signals

  • [ ] Your HF drops below 1.5
  • [ ] Borrow rates suddenly spike
  • [ ] Can't sleep worrying about position
  • [ ] Position size is uncomfortable
  • [ ] Haven't checked in 3+ days

If 3+ boxes checked: Consider hedging or de-risking

Summary: Hedge Strategy Selection

Your Situation Recommended Strategy
Beginner, worried Gradual De-Risk (#4)
Medium position Safety Buffer (#2)
Large position Mixed Collateral (#1)
Advanced trader Delta-Neutral (#3)
Market crashing De-Risk immediately
Bull market Light hedge or none

Golden rule: Hedge when you can't afford not to

Next Steps

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