What Does Arbitrage Have to do With Rebalancing in DEXTF?
Disclaimer: If you do not fully understand what is arbitrage and how that is done, read the piece dedicated to this topic.
Arbitrage is a powerful concept to understand because all of the rebalancing activities in the DEXTF protocol are simply arbitrage opportunities where traders buy and sell tokens to achieve the funds’ allocations that the portfolio managers have predetermined.
The operational complexity of rebalancing is therefore pushed to traders on a first-come-first-serve basis during a rebalancing window that is always open - as opposed to an auction-based rebalancing. With DEXTF, the fund token holders are not required to do anything. The Portfolio Manager will simply change the weights and initiate the rebalancing. Traders will immediately participate to achieve the target weights and profit from these operations. Win-win.
In contrast, auction-based rebalancing models require all investors to be present and active during the rebalancing period, which is complex and not UX friendly. The model ends up making passive investors active.
Typically a Dutch-auction starts off by bidding from the lowest price to end up around a fair value within a specific and reasonable amount of time. As the auction is time constrained, the timeframe within which the rebalancing is supposed to happen may not reach a conclusion, resulting in a failed rebalancing, which has to be dealt with computationally.
A pure arbitrage model used in DEXTF, where the rebalancing period is open at all times, ensures firstly that traders have incentives to act quickly to close the arb and also that in case of turbulent markets weights can be readjusted accordingly without the restrictive time constraints.
Additionally, this model enjoys a downstream benefit in that the protocol does not need to be plugged in with any DEX in order to perform the rebalancing, since the problem is delegated to traders. In fact they will know best which exchanges to tap into (DEX or CEX the protocol does not really discriminate, as long as assets are provided) based on traders’ experience and market pulse, avoiding an important attack vector, which if exploited, may lead to manipulations.
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