Chasing High Yields: A Lesson in Correlated Pairs During Bull Markets

In early 2024, during the last major market extended pump, I made a mistake that cost me dearly. Like many crypto enthusiasts, I was lured by the promise of high yields in liquidity pools, chasing attractive APRs in pairs like ETH/USDC and SOL/USDC. On paper, the numbers seemed unbeatable: consistent yield farming rewards with a perceived safe haven in stablecoins. However, what I didn’t account for was the devastating impact of impermanent loss during an aggressive bull market.

As Ethereum and Solana rallied, the stablecoin portions of these pools acted as an anchor, suppressing the capital appreciation I would have captured if I’d held the assets outright. When I finally pulled out of these pools, the impermanent loss erased much of my yield, leaving me with a hard lesson: non-correlated pairs are a liability in a bull market.

This experience led me to understand the importance of choosing highly correlated pairs during uptrends. By aligning assets that move in tandem, you can mitigate impermanent loss and capture greater capital appreciation. Here, I’ll dive into why correlated pairs matter, how to identify them, and actionable strategies for maximizing gains.

The Problem with Non-Correlated Pairs in Bull Markets

Liquidity providers often underestimate the impact of impermanent loss in pools involving stablecoins or non-correlated assets. Here’s why this is problematic:

1. Missed Capital Appreciation:

   • Stablecoin pairs like ETH/USDC or SOL/USDC limit your exposure to the upside when the volatile asset rallies. While yields may look attractive, they can pale compared to the gains from simply holding the asset.

2. Impermanent Loss Becomes Permanent:

   • In bull markets, the price disparity between assets in non-correlated pairs widens significantly. When one asset appreciates rapidly, the protocol rebalances your holdings, forcing you to sell the outperforming asset for the underperformer. Exiting the pool locks in these losses.

3. Psychological Stress:

   • Watching your portfolio underperform in a market rally can lead to poor decision-making, such as exiting pools prematurely or over-leveraging to compensate.

Why Correlated Pairs Are Superior During Bull Markets

Highly correlated pairs mitigate impermanent loss and allow liquidity providers to participate in the upside of both assets. Here’s how:

1. Aligned Price Movements:

   • In correlated pairs, both assets rise and fall together, reducing the rebalancing required within the pool. This minimizes impermanent loss and preserves your upside.

2. Enhanced Returns:

   • When both assets appreciate in tandem, your liquidity pool position grows proportionally, combining capital appreciation with yield rewards.

3. Lower Volatility Risk:

   • While highly correlated pairs can still experience volatility, the risk is more predictable, enabling better strategic planning.

This video on Krystal Finance shows some examples of Correlated Pools

Identifying Highly Correlated Pairs Using Tools

To find the best pairs for liquidity provision, you can use tools like DefiLlama’s Correlation Matrix. This matrix evaluates the correlation between different crypto assets on a scale of 0 to 1:

• 1.0: Perfectly correlated

• 0.75 – 0.99: Highly correlated

• 0.5 – 0.74: Moderately correlated

• Below 0.5: Weakly correlated or uncorrelated

For example, by analyzing the matrix on DefiLlama’s Correlation Tool, you might discover:

• ETH/BTC: Correlation of 0.85, making it an ideal pair.

• SOL/ETH: Correlation of 0.78, another strong option for pooling.

• SOL/USDC: Correlation of 0.12, a poor choice during a bull market.

By focusing on pairs with a correlation above 0.75, you can minimize impermanent loss and align your portfolio with the market’s momentum.

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Top Correlated Pairs to Watch During Bull Markets

Here are some examples of highly correlated pairs that historically perform well in uptrends:

1. ETH/WBTC:

   • Both assets are market leaders and often move in sync during rallies.

2. SOL/WETH:

   • As leading layer-1 protocols, Solana and Ethereum show strong price correlation, making them a compelling pair.

3. AVAX/BTC.B:

   • These layer-2 and layer-1 solutions often share bullish sentiment, driven by ecosystem growth.

4. INJ/OSMO:

   • Within the Cosmos ecosystem, ATOM and OSMO are tightly linked, benefiting from mutual adoption.

Actionable Strategies for Bull Markets

1. Analyze Correlation Before Pooling:

   • Use tools like DefiLlama's CORERLATION MATRIX to evaluate pair correlations before committing liquidity. Here are some examples below

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3. Monitor Market Trends:

   • During uptrends, shift focus to correlated pairs. In sideways or bearish markets, consider stablecoin pairs for safety.

4. Adjust Pool Ranges for Concentrated Liquidity:

   • In platforms like Uniswap v3 or Aerodrome, set tight ranges around expected price movements for correlated pairs to maximize fee earnings.

5. Reinvest Yields:

   • Compound your gains by reinvesting rewards into additional correlated assets, amplifying your exposure to the bull market.

Conclusion: Capture the Bull with Correlated Pairs

The bull market is a time of opportunity but also risk. By prioritizing correlated pairs, you can maximize your returns while minimizing impermanent loss. Tools like DefiLlama’s Correlation Matrix provide a clear path to identifying the best assets to pool together.

Don’t let the allure of high APRs in non-correlated pairs cost you gains like it did for me. Learn from my experience, and let correlation guide your strategy this bull cycle. With the right approach, you’ll not only protect your portfolio but supercharge its growth.

ABOUT THE WRITER: A teacher by profession and a father by choice, my true passion lies in unlocking the vast potential of cryptocurrencies and DeFi. My aim is to educate and inspire anyone eager to explore or understand the myriad opportunities within this dynamic space., and get closer to financial freedom

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DISCLAIMER: The information contained herein is for entertainment and  informational purposes only and not to be construed as financial, legal or tax advice. The content of this video is solely the opinions of the speaker who is not a licensed financial advisor or registered investment advisor. Trading cryptocurrencies and defi poses considerable risk of capital loss. The speaker does not guarantee any particular outcome. © 2024 DAD DEFI SPACE