By Author: Dr Shreekant Prasad & Co-Author: Sumon Chatterjee
One of the most common challenges faced by new traders entering the CoFiX ecosystem is the lack of a clear understanding of safe and efficient hedging strategies. This knowledge gap often results in avoidable losses of varying magnitudes.
This article is designed to address that issue by presenting simple yet effective hedging strategies, primarily aimed at beginners, though they remain equally useful for experienced market participants. The goal is to help traders protect profits, reduce uncertainty, and maintain consistent asset growth while participating in CoFiX.
Overview of CoFiX and Its Background
CoFiX is a computable financial transaction model where market makers act as liquidity providers. These market makers earn profits by facilitating transactions while assuming certain risks associated with price fluctuations.
The key activities within CoFiX include:
Market Making
Redemption
Exchange Transactions
All these activities impact the capital structure of the CoFiX liquidity pool, which is the fundamental source of price fluctuation risk. To manage this risk, market makers must hedge their exposure by offsetting pool-based asset changes with positions in external markets.
Proper hedging allows market makers to:
Neutralize adverse price movements
Lock in profits
Maintain a steadily growing asset position regardless of market volatility
The Hedging Logic: A Simple Model
This article assumes that readers already possess:
A basic understanding of CoFiX mechanics
Familiarity with Ethereum and DeFi fundamentals
To explain hedging intuitively, we begin with a simplified example.
The Reference State
Suppose Alice owns:
200 ETH
2000 USDT
She considers this her ideal asset allocation, known as the reference state.
Alice then participates in a DeFi activity (such as CoFiX market making), causing her asset balance to change. These changes can be categorized into four states.
Asset Change Scenarios
- Absolute Growth
Examples:
200 ETH, 2001 USDT
201 ETH, 2000 USDT
201 ETH, 2001 USDT
These states are always better than the reference state, regardless of ETH price movements.
This is called absolute growth. - Relative Growth
Examples:
201 ETH, 1999 USDT
199 ETH, 3000 USDT
At an ETH price of 1 ETH = 400 USDT, Alice is better off than the reference state.
However, this benefit depends on price movement:
If ETH falls sharply, losses occur
If ETH rises excessively, losses can also occur
Thus, profit or loss is price-dependent, making this relative growth. - Relative Loss
Examples:
201 ETH, 1500 USDT
199 ETH, 2100 USDT
At the current price (1 ETH = 400 USDT), Alice is worse off than the reference state, though future price movements could change this outcome. This condition is known as relative loss. - Absolute Loss
Examples:
200 ETH, 1999 USDT
199 ETH, 2000 USDT
199 ETH, 1999 USDT
These states are worse than the reference state under all price conditions, making them absolute losses.
State Analysis and the Role of Hedging
Absolute Growth
Represents direct profit
No uncertainty
No hedging required
Relative Growth
Profit exists but depends on price
Can be converted into absolute growth through hedging
Example Hedging Actions:
Sell excess ETH for USDT
Use surplus USDT to buy ETH
These offset price risk and lock in gains.
Relative Loss
Loss has already occurred due to:
Inefficient DeFi strategy, or
Failure to hedge in time
Hedging cannot reverse the loss, only prevent further exposure.
Absolute Loss
Loss is permanent and unavoidable through hedging.
Causes include:
Inherently unprofitable DeFi activity
Delayed or absent hedging
Core Objective of a DeFi Market Maker
The primary goal of a DeFi participant like Alice is to:
Maintain absolute growth
Eliminate price uncertainty
Hedge immediately during relative growth
Failure to hedge promptly can cause relative growth to deteriorate into losses.
Market Making and Hedging in CoFiX
Single Market Maker Scenario
Alice owns:
200 ETH, 2000 USDT total
Deposits 100 ETH + 1000 USDT into CoFiX
Keeps the remaining assets off-market for hedging
Assuming Alice owns 100% of the pool:
Bob buys 1 ETH for 410 USDT (including fees)
Pool becomes 99 ETH and 1410 USDT
Alice’s total assets become 199 ETH and 2410 USDT
This is relative growth.
Hedging Action:
Alice buys 1 ETH externally using 400 USDT
Final state: 200 ETH, 2010 USDT
Result: absolute growth
Multiple Market Makers Scenario
Assume Alice and Carol each own 50% of the pool.
Bob buys 1 ETH for 410 USDT
Alice’s share changes by −0.5 ETH and +205 USDT
Alice hedges by:
Buying 0.5 ETH with 200 USDT externally
Final result:
200 ETH, 2005 USDT
Maintains absolute growth
Impact of New Market Makers
Equal-Proportion Entry
Pool size increases
Asset ratios remain unchanged
Existing market makers only need to recalculate shares
Unequal-Proportion Entry
Effects:
Pool proportion changes (equivalent to partial exchange)
New market maker’s asset structure changes
Two choices for market makers:
Accept the new structure as the reference state
Hedge immediately to restore the original reference state
Key Concepts
Reference State
A predefined asset balance used to:
Measure profit or loss
Guide hedging decisions
Serve as the target state
CoFiX Hedging Strategy Summary
CoFiX has three fundamental operations:
Market Making
Redemption
Exchange
From a hedging perspective:
All operations can be reduced to asset balance changes
Market makers only need to:
Calculate their ETH and USDT balance based on pool share
Compare it with the reference state
Hedge any relative growth immediately
Market Making and Redemption Types
Equal-Proportion
Only changes ownership share
No asset imbalance
Unequal-Proportion
Equivalent to equal-proportion + exchange
Requires hedging
Conclusion
Hedging is not optional—it is essential for sustained profitability in CoFiX.
By:
Defining a clear reference state
Monitoring post-transaction asset balances
Hedging promptly during relative growth
Market makers can ensure:
Price neutrality
Capital preservation
Consistent absolute growth
A disciplined hedging strategy transforms CoFiX market making from speculative risk into a controlled, profit-generating activity.
(The views expressed are solely those of the author.)
(AUTHOR: Shreekant Prasad & CO-AUTHOR: Sumon Chatterjee)
