Strategy vault returns depend on the amount of initial capital the user contributes, the amount of debt they take on, the returns of the vault, and the fixed rate they pay on their debt.
If the returns to the vault exceed the rate the user pays on their debt, strategy vaults are highly profitable. Let's use the example of a 5X strategy vault and step through the return calculation assuming that the vault returned 8% over the term while the user paid a fixed 5% interest rate on their debt.
Some vaults, but not all, will incur transaction costs when users enter or exit the vault, or during vault settlement. To properly calculate their expected returns, users need to factor in the impact of any transaction fees. Strategy vaults may incur transaction costs if they need to trade between the primary borrow currency and another asset upon entering, exiting, or settling the vault.
An example of this would be a vault that borrows ETH from Notional and then converts that ETH into stETH. When the user enters this vault they would pay the cost of converting their ETH into stETH, and they would pay the cost of converting stETH back into ETH upon exiting the vault.
To illustrate this impact let's examine the potential returns of a simple vault that allows a user to borrow ETH and convert it to stETH with 5X leverage. Let's assume that the user can borrow ETH on Notional at 2% fixed, that stETH yields 4% over the three month term with no exchange rate fluctuations, and that the fee for trading between ETH and stETH is 0.05%. Assume that the user has put in 100 ETH of initial capital and borrowed 500 ETH on Notional.
Without accounting for transaction costs and using the formula from above, the user's return would be 14% APY. But upon entering and exiting the vault, the user needs to convert 600 ETH to stETH and vice versa. With a 0.05% trading fee, entry and exit each impose a flat fee of 0.3 ETH, or 0.3% of the user's initial capital. Annualizing these transaction costs will depend on how long the user stays in the vault. If the user stays in the vault for three months, these fees would equate to -2.4% APY which would bring the overall figure down from 14% APY to 11.6% APY.
