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🔬 How Zap Pilot Allocates Funds

Zap Pilot uses the Kelly Criterion as the foundation for allocating user funds across multiple DeFi protocols. While the original Kelly formula is mathematical in nature, our implementation includes real-world risk modifiers to make it suitable for on-chain asset management.

This page explains how we calculate vault allocations and adjust raw Kelly outputs to reflect on-chain risks, liquidity, and protocol maturity.

🔍 1. What Is the Kelly Criterion?​

The Kelly Criterion is a position sizing strategy that maximizes long-term capital growth by balancing return and risk. It’s widely used in both gambling and portfolio theory.

📐 Basic Formula:​

allocation_weight = expected_return / variance

In Zap Pilot, we treat each DeFi pool as a "bet" with an expected APY and a risk profile. The higher the return and the lower the volatility, the more capital it deserves.

⚙️ 2. Kelly Criterion in Practice​

We apply a simplified and normalized version of the Kelly formula across all eligible pools in a vault.

Step-by-Step Process:​

🔢 Input Metrics (Per Pool):​

  • Estimated annual return (APY)
  • Risk estimate (variance, based on APY history or modeling)

🧮 Compute Raw Weights:​

raw_weight = apy / variance

📊 Normalize Weights:​

Ensure all final weights sum to 1:

normalized_weight = raw_weight / sum(raw_weights)

🚫 Post-Processing Filters:​

  • Pools with negative weights are excluded
  • Pools with extremely small weights (e.g., < 1%) may be filtered out to reduce gas overhead and dust allocation

👉 Full implementation: kelly_allocation.py on our GitHub

🧱 3. Real-World Adjustments: Risk Modifiers​

While the Kelly formula is mathematically sound, DeFi requires additional layers of caution. Zap Pilot integrates risk modifiers to improve real-world safety and reliability.

📦 TVL (Total Value Locked)​

  • Pools with very low TVL may be excluded or capped
  • Why? Low TVL implies poor liquidity, higher slippage, or low market trust

🕰 Protocol Age​

  • Newly launched protocols (e.g., < 3 months) are treated conservatively
  • Why? High APY doesn’t compensate for lack of audits, security, or user base

💡 How We Apply These:​

  • Filters: Remove pools below minimum TVL or age thresholds
  • Multipliers: Risky pools may receive partial allocation (e.g., 50% weight reduction)
  • Boundaries: Set upper/lower limits for each pool

These adjustments ensure that Kelly-based logic reflects DeFi-specific trust and safety concerns.

📊 4. Sample Output​

A sample Kelly-weighted allocation for a Stablecoin Vault might look like:

Aave USDC (Optimism):        35%
Pendle sDAI (Arbitrum):      42%
Compound USDT (Ethereum):    23%

When a user zaps in, their funds are automatically split and bridged to match this portfolio.

🔁 5. Rebalancing Model​

  • Frequency: Allocations are recalculated quarterly
  • Notification: Users are emailed with updated strategy suggestions
  • Execution: Users can one-click rebalance via the frontend
    (all actions are non-custodial and signed from the user’s AA wallet)

🚀 6. Upcoming Improvements​

We are expanding the allocation engine with more inputs and flexibility:

  • Off-chain oracle feeds (APY, volatility)
  • Risk scoring based on governance, tokenomics, and code audits
  • User-defined Kelly curves (personalized risk profiles)
  • Vault-specific overrides (e.g., capital caps, slippage modeling)

✅ Summary​

Zap Pilot uses the Kelly Criterion not as a rigid formula, but as a dynamic, risk-aware allocation engine for DeFi. By combining return-risk optimization with real-world filters like TVL and protocol maturity, we aim to deliver robust, long-term growth while minimizing unnecessary exposure.