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ELI-5 Explanation of the Data Science behind Sommelier’s First Aave Cellar

With the release of our technical explanation of the first Aave Cellar, it’s important to consider that most crypto-users are not familiar with language used in technical articles. It is therefore necessary to explain concepts in a more easy to read and digestible form. This article will be doing just that.

We’ll begin with the most asked question: what are Cellars?

Think of Sommelier Cellars as vaults where you can deposit assets and receive yield. What makes it different from other vaults is that it runs on a specific strategy that is predetermined by a cellar contract and depends on data given by the strategy provider. This partnership between the two theoretically results in better yield compared to depositing in your usual vaults.

How does this happen?

Sommelier infrastructure allows the interplay of several actors to make automated strategies possible. Below is a description of each actor and what their current role is in Cellars.

Cellar Providers

  • They are the ones who propose the specific strategy to the community

  • Responsible for the evidence that the strategy works

Strategy Providers

  • A person who send data to the cellar and recommends actions based on information obtained through off-chain computations

  • Basically, someone who suggests to perform transactions given market circumstances

Validators

  • A group of individuals who secures the Sommelier chain.

  • Responsible for fulfilling strategic recommendations by strategy providers

  • Confirms transactions / initiates transaction process.

Liquidity Providers

  • A person who wants to be exposed to the specific strategy a Cellar offers.

  • Deposits the asset applicable to the strategy.

The result?

In the case of Aave Cellars, the result of this process is that capital is moved from one liquidity pool from another depending on which pool will give the highest rewards. This is what we call automated portfolio rebalancing with efficient and cost-effective use of capital.

What is the alpha of the strategy?

The strategy is based on an in-depth data exploration of the different Aave stablecoin deposit APYs via data provided from Flipside Crypto.

We found out several interesting facts on Aave deposit supply rates:

  • Supply rates can also be volatile for stablecoins

  • There are periods of higher volatility and periods of lower volatility

  • A pool with the current high APY is not necessarily the best place to deposit capital.

Taking these three facts together, there’s an opportunity in implementing a strategy that would maximize returns for depositors by dynamically moving capital from one pool to the other.

Why does this strategy need to be run on a cellar?

The Sommelier team decided to use sophisticated time-series forecasting which utilizes historical data and predicts patterns to be able to make informed decisions in rebalancing transactions. This kind of forecasting cannot be done using on-chain smart contracts due to the limitation in processing information, which off-chain computation can provide.

This special attribute of Sommelier Finance is that our infrastructure allows us to connect on-chain and off-chain data to determine the best possible strategy that can be taken by the Cellar.

How did we test for performance?

To test the performance of the Cellar, we created a simulator with the following parameters and definitions in the table below. The simulator was then run on top of historical data, which resulted in strategies being implemented according to past data and on-chain parameters.

Inline image

What we found out was that dynamically switching from lending one stablecoin to another can result in optimal use of capital in a given time frame, but only if certain parameters are met.

Does the strategy make sense for validators to run?

It makes sense for the strategy to be run by validators because of the necessary fees that are needed to perform transactions on Ethereum. Rebalancing calls may not be worth spending on depending gas prices and other circumstances when the transaction is needed.

We need to remember that transaction costs are actually paid for the validators and if we rebalance the portfolio too often, it will not be an efficient use of capital.

Does the Cellar scale with TVL?

As with any strategy, there is a TVL limit where the strategy is no longer effective. A large stablecoin position will decrease interest collected from the pool.

Therefore, in some strategies where the TVL exceeds a certain point, the interest being supplied may not be enough to cover for the gas fees paid to perform transactions. This goes the same way with smaller sized TVL positions where the interest gained may be too small to cover for costs.

To address this problem, we included TVL as an additional parameter to which rebalancing calls were used. The strategy now simulates the size of the cellar’s position in vaults to automatically optimize for the best lending position.

The Verdict: Cellar Performance

Overall, the Aave Stablecoin Cellar achieves optimal performance in identifying the best stablecoin to lend in Aave by accounting for volatility, position and gas costs.

The value proposition for Aave stablecoin cellar is that if you’re going to be using stablecoins to gain yield from cryptocurrencies, you’ll be better off depositing through our Cellars to boost your yield rewards.

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Users of the Sommelier website should familiarize themselves with smart contracts to further consider the risks associated with smart contracts before adding liquidity to any portfolios.

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