Written by: Samuel McCulloch

Compiled by: TechFlow

The barbell structured investing approach is a strategy in which investors divide their portfolios into two extremes: low-risk, predictable assets, such as government bonds, and high-risk, high-return assets, such as speculative ETH. This approach intentionally avoids medium-risk investments and aims to leverage both the safety of low-risk assets and the potentially significant returns of higher-risk assets.

Asset allocation is not always 50/50; it adjusts based on an individual's risk tolerance and financial goals. The strategy believes that the low-risk end provides stability, while the high-risk end offers growth opportunities that can offset the modest returns of safer assets. As market dynamics change, investors can rebalance their portfolios to shift gains from one end to the other.

Until now, if you wanted to execute this strategy, there was no efficient way to do it completely on-chain. While cryptocurrencies offer a ton of risk assets, there is no place for safe, reliable yields. Just like when investors were attracted by the 20% interest rate on Luna/Anchor, the price of UST collapsed and went to zero almost overnight.

Other avenues for finding yield in DeFi can also be risky, and it only takes one motivated developer to manipulate liquidity internally, or an army of North Korean hackers looking for exploitable code, and your hard-earned cash can be gone in an instant. Hackers have stolen more than $3.8 billion in 2022, proving how risky cryptocurrency investing can be.

But even after all the hacks, there are still a lot of people who want to keep all their assets on-chain and have no contact with centralized third-party services where they have no control over their assets.

This post was inspired by a comment Naly made in the chat.

Naly noted that Frax is creating a “fully vertical, on-chain liquidity stack” for investors, who can seamlessly mix and match the returns and risks of sfrxETH and Fraxbonds (FXB) based on their risk appetite.

“In a high-interest rate environment, investors often gravitate toward low-risk, high-yield investments, such as U.S. Treasuries,” Naly wrote. “FRAX and FRAX BONDS are seeking to provide similar on-chain exposure.”

Fraxbonds will offer FRAX at a discount similar to off-chain short-term treasury yields. By choosing one of 4 annual maturity dates, FRAX holders can park their FRAX and ensure they receive a fixed return during this period.

OK, but why do investors buy bonds? In some cases, bonds are similar to cash, but they also pay an interest rate, or yield.

As interest rates rise, new bonds offer higher periodic interest payments, making them attractive. Additionally, during times of economic uncertainty, often associated with high interest rates, the low-risk nature of bonds, especially those issued by governments, is attractive for capital preservation.

All risk assets are priced against bond yields. If you invest in real estate that yields 7% and short-term bonds yield 5.5%, that's probably not a very good choice.

Fraxbonds will simulate the same type of exposure to real bonds, but entirely on-chain. When markets turn negative, FXB will be a safe haven for investors seeking safety and stable yield. FXB does not pay interest, but it represents the purchase of future FRAX issues at a discounted price.

Conversely, in a low-rate environment, Naly writes, “investors move up the risk curve.” As yields fall, the expected returns on risky assets as a whole decrease, which drives up their asset prices.

Naly went on to say, “People believe Ethereum (ETH) could become the low-interest internet bond of choice.” ETH has both yield and upside. If you know ETH will accrue returns and it could have huge upside volatility, it makes sense to prepare for this event.

There is also the possibility of hedging the sfrxETH price difference, i.e. the rate of change of the value of the position for every 1% increase or decrease, so that when the interest rate rises, the impact of the price fluctuation will be offset.

In this new paradigm, investors can find returns in low-risk FXB and high-risk sfrxETH. A true barbell structure strategy.

Naly also mentioned that through AMM management based on external interest rate data, it is possible to manage the conversion between barbell strategies and act as an on-chain asset manager.

“Balancer technology allows for weighted pools, but it also allows for liquidity pools where the weights change over time. There is also a model where the weights are assigned between two tokens based on an external data source. So for this example, you could have a 80/20 FXB/sfrxETH weighted pool in an environment where the US 10-year Treasury yield is greater than ...%, and then switch to a 20/80 FXB/sfrxETH weighted pool when the Treasury yield is less than ...%.”

The idea Naly proposes here is revolutionary. Imagine a pool that automatically adjusts its strategy based on market conditions, providing both the security of bonds and generous staking returns. If executed well, this could redefine how passive investing in DeFi works, introducing the complexity of traditional finance into the decentralized world.

This AMM can also receive FXS scalers, further increasing the rewards of the barbell strategy. So in addition to the liquidity income from FXB and sfrxETH, rewards from CVX, AURA, BAL scalers can also be added through Balancer integration.

Naly’s exploration of the Frax barbell structure investment approach through an on-chain solution is a compelling proposal. Combining the security of bonds with the volatility of ETH, especially through an automatically adjusting pool, is an ambitious task. It requires new oracles to feed in data, but in theory it can be built.

This also writes a new chapter in Frax’s evolution as a vertical supporting the future of USD+ETH, where yield is the lifeblood of its growth. In the coming months, we will see the release of Frax v3, FXB, and frxETH v2, and how this new system ties all of these pieces together.

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