A Solution For On-Chain Optimization
November 29th, 2022

Aera was created as a platform for efficient risk management and hedging with a wide range of applications. Though the initial version of the protocol is most applicable to lending treasury management, there are prospective use cases in many areas involving complex trade-offs. This article explains how to use Aera and why protocols like Aera are an important next step in developing financial applications on blockchains.

Why Aera?

Over the last few years, decentralized solutions have emerged for many common user transactions, such as lending, trading, and liquidity provision. While current mechanics work well for spot transactions, managing future needs and hedging risk is challenging. Further progress of on-chain applications would benefit from the ability to optimize through time and uncertainty.

To illustrate, consider the example of a user with 1M USDC and needs 100 ETH. As a spot transaction, this is simple using existing solutions. Decentralized exchanges allow quick and efficient swaps, or a lending protocol could lend ETH on a collateralized basis. A trickier question is what to do about needs that are not immediate. If the user needs 100 ETH a month from now, they have three main options:

Option #1: Buy ETH now and hold. This option is low risk but relatively inefficient, as the total amount is funded upfront and held idle for a month.

Option #2: Do nothing now and buy ETH later. This option is more capital-efficient but introduces risk since the price could move unfavorably. 

Option #3: Buy a more capital-efficient derivative of ETH. This option could be good if it balances risk and capital efficiency, but a suitable derivative product is not always available.

To extend this further, consider a case with uncertainty and a time lag. For example, if the user needs 100 or 120 ETH at some time, 4 to 6 weeks from now, depending on market variables. This is a very tough problem with no widely applicable solution currently - Aera intends to provide one in the longer term.

Objective Functions

The insight of Aera is to approach these problems with a framework of numerical optimization. First, this involves defining an objective function to score how decisions work toward the eventual goal. The role of the objective function is to reduce the set of complex trade-offs to find the maximum score out of possible options.

For example, a protocol managing an insolvency fund might choose an objective function dependent on the value at risk of their loan book and current fund holdings. Since the key goal would be to maintain a safety buffer during market crashes, a simple version may be based on the correlation between asset values and the market risk level. After deciding on an objective function, finding the optimal course of action becomes a more workable problem to solve numerically.

Optimizing with Aera

As the first protocol designed specifically for this type of optimization, Aera seeks to address the most immediate use cases before expanding to more prospective applications. Tasks like runway and incentive management, where many DAOs have already encountered difficulties planning for the future, are two of the most immediate applications. In the initial version of the protocol, Aera will incentivize parameter submitters to optimize assets to a user-selected objective function. By harnessing the off-chain intelligence of experienced risk analysts, DAOs can improve their holdings' efficiency inside transparent and self-custodial vaults. Looking forward, Aera aims to build a flexible platform for users to manage any needs to their desired balance of risk and efficiency trade-offs. 

To learn more visit aera.finance

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