Leveraged yield opportunities
Notional has a framework called the leveraged vault framework which allows users to borrow funds from Notional and deposit them directly into leveraged vaults. A leveraged vault is like a special investment account that follows a pre-determined strategy to generate yields. These strategies are executed by smart contracts that may not be a part of the Notional system but have been approved by Notional to ensure they are safe and follow specific rules to mitigate risks.
Leveraged vaults can employ diverse approaches to generate income. While some approaches are exclusive to Notional, others entail engagement with external protocols like Curve, Balancer, or Uniswap. The aim of the leveraged vault framework is to enable users to increase their returns by managing a greater risk. This is achieved by enabling users to borrow more funds than they would typically be eligible for, and then invest these funds into a leveraged vault that adheres to a predetermined strategy.
Notional's leveraged vault framework works by using the assets in the strategy vault as collateral against the user's debt. This means that if the user's investment loses money, Notional can sell the assets in the vault to pay back the borrowed money. This helps to protect Notional and its users from losing too much money.
To use a leveraged vault, a user will need to bring some amount of initial capital, select a debt maturity and leverage ratio, and then execute the transaction. Notional will then borrow from the corresponding liquidity pool on behalf of the user and deposit the borrowed capital along with the user’s initial capital into the vault.
For example, consider a vault that allows a user to get up to 10X levered exposure to providing liquidity on the Balancer boosted stablecoin pool. A user could bring 100,000 USDC to Notional, borrow 700,000 USDC from Notional, and then deposit the total 800,000 USDC into the leveraged vault. This user would earn the returns of the vault on 800,000 USDC and pay Notional's fixed interest rate on 700,000 USDC, all while only holding 100,000 USDC in initial capital. If the returns to the vault exceed the interest rate the user pays on their Notional debt, this strategy will be quite lucrative.
And from Notional's perspective, the user's debt is still overcollateralized - they hold 800,000 USDC in assets against a 700,000 USDC debt. If the value of the user's assets in the vault fall below a minimum collateralization ratio, they can be liquidated and the strategy will be unwound.
What are leveraged vaults?
Leveraged vaults are whitelisted smart contracts external to the Notional system that execute pre-determined strategies under specific risk constraints. Leveraged vaults may execute Notional-specific strategies or strategies that involve interacting with one or more external protocols like Curve, Balancer, or Uniswap.
The purpose of leveraged vaults is to allow users to get highly levered exposure to the returns of a particular strategy. Notional achieves this by recognizing the assets in a leveraged vault as collateral against the user's debt.
Learn more about leveraged vaults here.
Leveraged vaults return
Leveraged 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.
Users should also take into account transaction fees when entering a vault.
Learn more about leveraged vault returns and vault transaction costs here.
Leveraged vaults risks
Vaults are also subject to economical risks such as price risks and liquidity risks.
If the value of a vault share decreases such that the value of a user's assets falls and their leverage ratio breaches the max ratio, they can be liquidated. Learn more about leveraged vault liquidations here.
Some vaults can also be settled early in the event that on-chain liquidity dries up. Early settlements are used to protect vault users against excessive slippage when redeeming vault shares.
Vault Concepts
Vault Shares: Each maturity (“vault state”) within a strategy vault can be considered a two token “pool”. One token is the strategy token which represents an account’s share of the yield generated by the strategy. The other token is “asset cash” which is held as repayment for debts as the vault reaches maturity. Accounts’ positions in the strategy vaults are measured in vault shares rather than strategy tokens to ensure that they are able to fully withdraw their position at any time. If a vault state has any asset cash, accounts will be prevented from entering. It is assumed that a strategy vault will only ever hold asset cash during an emergency stop out or during settlement, in both cases accounts should not be allowed to enter.
Vault Authentication: Some strategies may require additional business logic prior to allowing accounts to enter vaults, governance can enable methods where the leveraged vault is the only address that can call the Vault Controller.
Secondary Borrow Currency: Some strategies may require borrowing in one or more secondary currencies (the Balancer 2 Token Weighted Pool) is an example of this. The Notional Vault Controller will manage accounting for secondary borrowed currencies for vault. Secondary borrowed currencies are accounted for using the concept of “account debt shares”. During settlement, the strategy vault may pay down the total borrowed secondary currency and therefore individual accounts only need to repay a partial amount of their full secondary borrow amount. Any profits or losses in an individual vault should be forced into the primary borrowed currency to the maximum extent possible.
Zero Interest Rate Lending: There are a few instances where accounts will lend to repay debts at a zero interest rate. This is implemented by having the account deposit money market tokens (i.e. cTokens or aTokens) and then using the current exchange rate of those tokens to net off fCash directly. Since fCash trades at a discount prior to maturity, this is in effect a 0% interest repayment. Since we also do not credit the account with the “asset cash” they also effectively lose any money market interest that would normally accrue to them prior to maturity (this is how repayments work in Notional outside of strategy vaults).
Maximum Borrow Capacity: Each strategy vault will have a maximum borrow capacity across all of its maturities to limit its risk. This borrow capacity is measured in the notional value of fCash (meaning 3 month fCash is added to 6 month fCash). While two maturities of fCash are normally not fungible with each other, this approximation is sufficient for this purpose.
Max Borrow Market Index: Accounts may borrow at any listed market index to enter a vault. Longer duration markets (i.e. 1 year markets) create “idiosyncratic fCash” which implies that fCash that is between 6 month and 9 months to maturity does not have a corresponding Notional fCash liquidity pool to exit. Vaults that cannot handle this condition should not list a max borrow market index greater than 2.
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