Quickly getting started with DeFi, combining the real data of DeFi whales, learning to obtain on-chain returns using different strategies and risk control. (Background: Detailed explanation of AAVE V4 upgrade: reshaping lending with modularization, can old coins welcome a new spring?) (Background Supplement: From Polygon, Morpho to WLFI: Aave repeatedly becomes a 'stepping stone', is the DeFi gentleman's agreement merely paper thin?) Summary Recently, with the changes in the regulatory environment, DeFi protocols have obtained interest rates that far exceed traditional financial wealth management scenarios, thanks to the enthusiasm of on-chain traders for crypto assets. This has a positive significance for two groups of users: firstly, for some traders, after the prices of most blue-chip crypto assets have broken historical highs, it is a good choice to appropriately reduce leverage and seek some low alpha risk wealth management scenarios. At the same time, as we enter a macroeconomic easing cycle, for most non-crypto office workers, allocating idle assets in DeFi can also enjoy higher returns. Therefore, the author hopes to launch a new series of articles to help friends quickly get started with DeFi, and combine the real data of DeFi whales to analyze the returns and risks of different strategies, hoping for everyone's support. In the first issue, the author hopes to start with the recently popular interest rate arbitrage strategy, and analyze the opportunity points and risks of this strategy in conjunction with the capital allocation of AAVE whales. What is the typical scenario of interest rate arbitrage in the DeFi world? First, let me introduce the concept of interest rate arbitrage to friends who are not familiar with finance. Interest rate arbitrage, also known as carry trade, is a financial arbitrage strategy that relies on the interest rate differences between different markets, different currencies, or different debt instruments to profit. In simple terms, to carry out this business, one needs to follow a path: borrow at low interest, invest at high interest, and earn the interest differential. In other words, arbitrageurs will borrow funds at a low cost and then invest in assets with a higher yield, thus earning the profit from the interest differential. Taking the strategy favored by hedge funds in the traditional financial market as an example, it is the USD/JPY carry trade. We know that Japan has long had extremely low bond yields under the YCC policy environment, with real interest rates even at negative levels. Meanwhile, the dollar remains in a high-interest environment, leading to an interest rate differential between the two different financing markets. Hedge funds choose to use high-yield US bonds as collateral to borrow Japanese yen from various financing channels, and then either purchase high-dividend assets from Japan's five major trading companies or convert back to dollars to buy other high-return assets (PS: one of Buffett's favorite strategies). The benefit of this strategy lies in its ability to increase the efficiency of capital leverage, and just this arbitrage path can scale to the level that influences global risk asset prices, which is why, after the Bank of Japan abandoned YCC last year, every interest rate hike greatly impacted the prices of risk assets. In the DeFi world, there are two major categories of core innovations. The first category is decentralized exchanges (DEX), and the second category is decentralized lending protocols. The former guides the 'price difference arbitrage strategy', which we will not discuss in this article, while the latter is the main source of the 'interest rate arbitrage strategy'. Decentralized lending protocols enable users to use a certain crypto asset as collateral to borrow another type of crypto asset. The specifics can be further classified based on differences in liquidation mechanisms, collateral ratio requirements, and interest rate determination methods. However, we will focus on the currently most mainstream 'over-collateralized lending protocol' to introduce this strategy. Taking AAVE as an example, you can use any supported crypto asset as collateral to borrow another type of crypto asset. In this process, your collateral still enjoys native yields as well as the lending yields represented by Supply APY. This is because most lending protocols adopt a peer-to-pool model, whereby your collateral automatically enters a unified capital pool, serving as the source of lending capital for the platform. Therefore, borrowers who need your collateral asset will also pay interest to the capital pool, which is the source of lending income. What you need to pay is the borrowing interest corresponding to the assets you lend, which is represented by Borrow APY. These two interest rates are variable and are determined by the interest rate curve in AAVE. In simple terms, the higher the utilization rate of the capital pool, the higher the corresponding interest rate level. The reason for this design is that in peer-to-pool lending protocols, borrowing does not have the concept of an expiration date like in traditional financial markets. The benefit of this is to simplify the complexity of the protocol, while the liquidity of the lender's capital is higher, eliminating the need to wait until the debt matures to reclaim the principal. However, to ensure sufficient constraints on the borrower's repayment, the protocol requires that once the remaining liquidity in the capital pool decreases, the borrowing interest rate increases, forcing borrowers to repay and ensuring that the remaining liquidity in the capital pool remains in a state of dynamic balance, able to reflect the true market demand to the greatest extent. After understanding these basics, let’s introduce how interest rate arbitrage works. First, it’s necessary to find native asset yields + Supply APY higher assets to use as collateral, secondly find suitable low Borrow APY borrowing paths to lend out assets, and finally, in the secondary market, use borrowed funds to repurchase collateral and repeat the above operations to increase capital leverage. Friends with financial knowledge can easily see that this path has two risks: Exchange Rate Risk: If fund A depreciates against fund B, it easily leads to liquidation risk. For example, if your collateral is ETH and you borrow funds in USDT, when the price of ETH drops, your collateral ratio becomes insufficient, leading to potential liquidation. Interest Rate Risk: If the Borrow APY of fund pool B is higher than the total yield rate of fund pool A, then the strategy is in a state of loss. Liquidity Risk: The exchange liquidity of funds A and B determines the establishment and exit costs of the arbitrage strategy; if liquidity decreases significantly, the impact remains substantial. To cope with exchange rate risk, we observe that most DeFi interest rate arbitrage designs two types of funds that need to have a certain correlation in price, avoiding significant deviations. Therefore, the main target selection in this track has two types: LSD path and Yield Bearing Stablecoin path. The difference depends on the underlying asset of the managed funds; if it is risk asset-based, aside from interest rate arbitrage, it can still retain the ability to earn alpha returns on native assets, such as using Lido's stETH as collateral to borrow ETH. This arbitrage path was very popular during the LSDFi Summer period. In addition, choosing correlated assets has another benefit, which is that the maximum leverage multiplier is higher, because AAVE sets a higher Max LTV for correlated assets, known as E-Mode, under a setting of 93%, the theoretical maximum leverage is 14 times. Therefore, based on the current yield rate, taking AAVE as an example, wsthETH's yield...