Fixed Rate Vaults Proposal With Deco Protocol

Fixed Rate Vaults Proposal With Deco Protocol

This post presents a proposal to bring a new revenue generating and user retention feature to MakerDAO: Fixed Rate Vaults. The Deco Protocol operates to decompose Yield-Bearing Assets into Fixed Rate and Yield Rate instruments providing a hedge against rate volatility for all yield bearing assets. We are putting up this post with the purpose of introducing you to the Deco Protocol and hope to gain your support for the implementation of an integration with Maker Protocol. We desire to take this project forward with the support of the Maker community and are preparing a proposal for a core unit to execute the integration and maintain it on behalf of MakerDAO.

Using the Deco fixed rate protocol, Maker will be able to issue tokens that permit Vault owners to hedge their stability fee for a fixed duration and for a specific collateral type. This proposed Deco and Maker integration uses a market driven solution so that vault owners of all sizes can hedge stability fees for any desired duration. Integration of Deco will enhance rate stability, achieve a predictable and stable revenue flow for Maker, boost DAI supply, and enhance vault owner retention. The Deco protocol is ready for immediate integration.

Summary

This proposed integration brings the following immediate benefits to the MakerDAO ecosystem:

  • Boost supply of DAI.
  • Develop an immediate and reliable revenue stream for MakerDAO.
  • Attract MakerDAO prospective users who may be intolerant of rate volatility.
  • Provide a novel product for the Growth Core Unit.
  • Enhance vault owner capital and operational efficiency.
  • Improve vault owner retention and discourage vault migration.
  • Introduce rate-predictability.
  • Allow stability fees to be discovered by the market through auctions.

Proposal

This proposal is for the creation of a new product for MakerDAO by the integration of the Deco Protocol:

  1. Fixed Rate Vaults via Deco Protocol

Deco Protocol

The Deco protocol is a fixed rate protocol designed to be flexible and safe. Its design anticipated that its first and most effective initial application may be on Maker. The core protocol is outlined in the whitepaper and in the technical documentation. Codebase repo of the base protocol implementation can be found on Github.

The Deco protocol, in collaboration with MakerDAO, can offer fixed-rate vaults to Maker vault users. The Deco user experience is simple: vault owner purchases a pure-yield token which earns a yield that offsets the entire stability fee on the vault. A vault need not migrate to an external protocol, either before or after the fixed rate expires, which makes it possible for the Maker protocol to retain its core business and not lose stability fees. Vault owners are not required to change any of their own vault management processes; users may continue to use the same UI or smart contract to manage the vault. The vault itself remains fully independent, and within the Maker Protocol. Fixed rate token issuance on Deco is controlled and maintained by Maker governance, allowing MakerDAO to control the fixed rates without relying on external governance.

Problem: Rate Volatility and MakerDAO

Stability fee volatility means vault owners are unable to accurately predict the future fees, which limits MakerDAO’s user base and in turn the DAI supply. Rate volatility constrains the market for Maker vaults by eliminating participants who require stable rates. At the same time, stability fee variance means Maker is unable to accurately predict its own cashflow. In a bear market, the inability to predict and depend on revenue and control cash may prove very problematic to the DAO. MakerDAO needs a method of retaining vault owners and expanding Dai supply, while also providing for a stable cash flow to support DAO operations. Deco is already developed and provides these features to Maker.

Solution: Deco Protocol Retains Vaults and Captures Revenue for MakerDAO

Deco protocol decouples a yield bearing asset into a pure-yield and zero-yield component. Through an integration with the Maker protocol, Deco makes it possible for MakerDAO to issue a token that tracks the stability fee for a certain collateral type over a fixed duration, a FEE-CLAIM token. For the user to get a fixed rate on their vault, all they need to do is buy the FEE-CLAIM token and hold it. The token will accrue yield to offset the fees accrued by the stability fee for the fixed duration.

Deco optimizes the Maker protocol and vault owner user experience. Vaults need not migrate to an external protocol before or after the fixed rate expires. Vault owners are not required to change any of their own vault management processes. The UI or smart contract already used to manage a vault may continue to be used. Even after the expiration of the fixed term token, vaults are left “as is.” Since the rate fix is performed outside of the vault infrastructure and contracts, vaults are never touched. This design is secure and means that the Maker protocol retains its core business even after the expiration of the fixed rate term. The vault itself remains fully independent and within the Maker Protocol.

High Level Integration Design

The Deco protocol integration has been thoughtfully designed to work with Maker and allows the DAO complete control over its own fixed rate infrastructure, while mitigating any underlying risks which are inherent in other fixed rate protocols. Figure 1 below demonstrates how the integration functions.

Figure 1. Fixed Rate Vaults: Deco on MakerDAO

The usage steps are as follows:

  1. The vault owner purchases a token. Ex: 100,500 CLAIM-FEE-ETH-A tokens valid for three months to hedge the ETH-A vault with 100,500 DAI in debt for three months.
  2. The purchase price of a token is the total stability fee paid in advance. Ex: Vault owner pays 500 DAI to purchase these 100,500 CLAIM-FEE-ETH-A tokens, uses the 100,000 DAI in debt for their own purposes, which fixes their total vault debt at 100,500 DAI for the entire duration the CLAIM-FEE-ETH-A tokens are valid for irrespective of the changes to the ETH-A stability fee over this duration.
  3. The token earns yield during its validity period which equals the actual stability fee accruing on the vault. Ex: ETH-A stability fee increases to 50% APR at some point which increases the vault debt to 113,000 DAI. 100,500 CLAIM-FEE-ETH-A tokens would earn 12,500 DAI as yield over the same duration (equal to the stability fee accrued) which will pay down debt back to 100,500 DAI.
  4. The Vault owner can collect the yield on a token as many times as desired continuously paying back the accrued stability fee on the vault, and thus eliminating any additional interim exposure to a lower collateral ratio. Ex: Vault owner can collect Dai yield from the 100,500 CLAIM-FEE-ETH-A tokens as many times as one wishes to repay the additional debt being continuously added to the vault with the stability fee.
  5. Token balances are fungible and allow vault owners to hedge a portion of the debt by buying a lower number of tokens than the vault debt. Ex: Vault owner can choose to purchase only 50,000 CLAIM-FEE-ETH-A tokens to hedge a portion of the vault debt.
  6. Vault owners can also sell tokens on the market at any time. Ex: Vault owner can sell the 100,500 CLAIM-FEE-ETH-A tokens at any time at a price that is based on the latest stability fee outlook.
  7. Vault owners can also purchase new tokens to extend the hedge when the current tokens expire.

Please check our technical docs for more details about the components in this integration proposal.

Summary

Fixed-rate protocols face liquidity issues. Liquidity requires that there must be buyers for both zero and claim tokens at the same time at the conclusion of the issuance process. By integrating with a collateral type, the need to find buyers for zero balances immediately has been removed. There is no need for symmetric demand; the DAO may issue claim tokens without needing to find a buyer for the zeros. The processes we have engineered permits the DAO to hold ZERO tokens temporarily or permanently, creating a seamless user experience for MakerDAO, while satisfying the demand for CLAIM-FEE tokens without constraint.

ZERO-FEE tokens can also be unlocked from the adapter whenever required. The debt is automatically repaid on the maturity date; or, if an emergency shutdown is triggered, or if MakerDAO wishes to shut down the Deco instance for whatever reason, all obligations will be repaid. Auctioning Zeros may also help MakerDAO discover the yield curve for Dai and can use this information to set an appropriate DSR.

The benefits of integration to vault owners and the MakerDAO, include:

  1. Fixed Stability Fee: Once purchased, the token issued by Deco and MakerDAO will offset the stability fee with limit to any increase as there is no upper limit.
  2. No Vault Management Changes: Vault owners do not have to make any changes to their vault ownership or management.
  3. New Revenue Stream: This protocol provides a stable and predictable income stream in the form of fixed-rate risk premiums for MakerDAO and gives it the ability to upsell new products to the largest vault owners, and future RWA vaults which also tend to borrow at scale.
  4. Vault Owner Retention: Vault owner stickiness is vastly improved, especially for the largest vaults, since the stability fees have been prepaid and locked into a fixed term.
  5. Integration with Gnosis Auction Protocol V2: Discovery of rates permitting the performance of large sales competitively and transparently.
  6. Compatible with Asymmetric Demand: There is no requirement to find buyers for Zeros or to be able to sell Claims.

Deco is the Safest, Most Flexible Fixed Rate Protocol.

Deco is designed to avoid typical protocol risks by reducing the number of assumptions to a minimal level. For example, Deco’s core operations do not assume that yield protocols will always be solvent, or that redemptions will always succeed even when they are solvent. Deco is built on the premise that fixed-maturity asset lockups should quickly change when going through a phase of instability and may require yield token holders to redeem; Deco has a built-in mechanism to ensure that swift and early redemptions are possible.

Deco works exactly to the specifications of the Maker protocol, and addresses edge cases in its design that may in time be forgotten at the institutional level. The Deco instance has been built and deployed so that it is controlled by MakerDAO governance, and thus removes the governance risk typically present in such external protocols.

Deco is designed to use minimal smart contract infrastructure to issue a token that tracks the stability fee for a fixed term, and for a specific collateral type. It ensures that sensitive FEE tokens issued by MakerDAO are automatically removed from circulation at or by the maturity date, or in an emergency shutdown. Vault owners simply hold a token, enabling an offset of the stability fees.

By keeping regular vaults virtually untouched throughout the process, we ensure liquidation infrastructure, and assure that service providers do not have to update their systems to deal with a special fixed-rate vault type. Deco does not add complication to the liquidation process, and makes the yield from FEE tokens collectable on-demand. Deco ensures that the collateralization ratios are not affected by stability fee accrual. Vault owners do not lose the excess stability fees they have paid upfront. If their vault is liquidated, CLAIM-FEE tokens are held separately and can be sold on the market at any time to collect the residual value.

Deco Supports Existing Users and Attracts New Supply Side Users

Maker is currently missing out on a huge market of vault owners that would immediately sign up if they had a fixed rate. In the first half of 2018, there were stories about users confidently refinancing their home mortgages with Maker or purchasing cars when the rates were low and constant at 0.5% but these stories disappeared the moment stability fees became volatile, and even worse, it left users with a bad taste in their mouth. Maker may bring these users back with the promise of stable rates, the potential for this market segment could be four times the size of what we already have, considering the low percentages of collateral like ETH and BTC currently locked within Maker as collateral.

Maker presently finds sufficient Dai demand but has concerns regarding growing Dai supply backed with debt. To help grow Dai supply, present market segments need to be expanded. Fixed Rates allow for more conservative users, or borrowers who need to better anticipate future rates. Fixed rates would offer a new feature that the growth core unit could use to expand existing Maker business lines. Recently, the protocol engineering team and the growth core unit have aptly highlighted market demand and provided a potential vault-oriented solution to fixed rates.

Fixed Rates Mean Fixed Revenue: Deco Affords Stability

By using fixed rates, Maker stands to smooth out its revenue and achieve some predictability in its cash flow. Maker may now lock in vault owners and be able to reliably cover its fixed operating costs through the upfront sale of Fee tokens. The nature of a fixed rate premium suggests that Maker is receiving more than the current floating rate, which is to Maker’s advantage, in exchange for assuming the minor risk of future rate changes. If the future rate decreases, Maker stands to make even more revenue than it would have in the absence of the fixed rate instrument. However, if the rate goes up, such as in a bull market, Maker will lose the potential upside of the higher floating rate.

However, considering current market conditions, losing a potential upside in a bull market is likely not the biggest concern. The cost benefit of possible loss of future gains is greatly outweighed by gaining a stable and predictable revenue stream, enhancing retention of vault owners, and opening new user markets. Deco on Maker allows Maker to hedge revenue under bear market conditions or a prolonged downturn. This feature should not be underrated as it provides a remedy to a serious potential problem for MakerDAO.

Deco Supports Parallel Smart Contract Development

The SES core unit is focused on scaling internal operations for DAO sustainability. One of the current initiatives is to evaluate and promote systems which manage parallel contract development. Specifically, the Project Sandbox is seeking project candidates to perform smart contract development in parallel with the current Protocol Engineering Team. Our team, with deep knowledge of MakerDAO and our prior work with the foundation, is a perfect fit for this project.

Scalability: Transparency, Intention, and Trust

Deco’s flexibility solves problems inherent in fixed rate protocols, i.e., solvency and market instability. The current goal is to support MakerDAO and solve or ameliorate rate volatility and supply-side issues for the DAO.
For any DAO to scale effectively, it not only needs internal operational scalability, the core tenet of the SES core unit, but also to incentivize external actors to bring novel solutions to the DAO. It requires the capability to create a deal flow for product features and crowdsourced technical solutions. A Deco and Maker integration may be the first of its class and a unique structure, a feature acquisition by a DAO through integration with another protocol. This work is very much in line with the SES core unit mission statement and its long-term vision of building a sustainable and self-organizing ecosystem. We have discussed this project with @wouter, SES Team Lead, and have received very positive feedback.

Team

Deco is led by Vamsi Alluri, principal protocol designer and smart contract programmer. Vamsi is a long time MakerDAO participant, was on the original MKR issuance block, and a previous member of the Maker Foundation Integration Engineering team as a Senior Integrations Engineer. He has assisted a wide group of external partner companies to integrate with the Maker suite of products. Deco is also substantively supported by former senior Maker operations team and unit members, as well as by Rohit Kapoor, designer, and product manager.

Links

Website
Github
Blog
Technical Docs
Twitter

We would like to receive your valuable feedback either here or on #speculation. You can also reach out to us at [email protected] with any questions.

26 Likes

How does your proposal compare with Yield Protocol, MIP 43?

3 Likes

I am so excited to see so many fixed rate tools being developed! I’ll save my detailed questions until I’ve read another couple times.

But one question I do have: Maker issues/sells yield-claim tokens? Or does Deco do the actual issuance?

1 Like

This looks great, congratulations to everyone involved!

One question:

The Vault owner can collect the yield on a token as many times as desired continuously paying back the accrued stability fee on the vault

This does mean that unless actively managed by a reliable operations team, fixed yield vaults can be liquidated despite claimfee tokens being available. This makes sense from the pov of not touching core maker infrastructure but is a small drawback for the user.

This is fixable by going through any good “managed fixed rate vault” service but I’ll note for future reference that there may be a more smart contract based solution achieved by modifying vault behavior: add a callback before liquidation. The called contract uses locked claimfee tokens to repay outstanding debt. Then the liquidation proceeds if there is still bad debt. Callbacks would be authorized by Maker governance only for well-behaved contracts (contracts that don’t suddenly lose debt payback ability). This would be similar to B.Protocol managed vaults.

4 Likes

In the context of the proposed integration, Deco through the FEE token design essentially permits Maker itself to function as a fixed-term lending protocol. On the other hand, Yield is a fixed-rate lending protocol on its own.

Everything I mention below is about the proposed TLM integration, and not a critique of the Yield Protocol. We think the TLM module proposed has risks for Maker, primarily because TLM is being tasked with linking two lending protocols, while Deco only brings deterministic smart contract behavior to Maker and does not deal with collateral or liquidation by itself.

Emergency Shutdown
Dai holders receiving fyDai during the redemption process must work with Yield, wait until borrowers pay back debt, most likely at the fixed-term loans maturation, to finish the redemption. This process is not instantaneous, and there would be exposure to interest rate fluctuation that would affect the price of fyDai which will result in additional loss.

Deco allows Maker to close it and replace all Zeros locked as collateral in Maker with Dai in one transaction before triggering emergency shutdown. Even if emergency shutdown is triggered abruptly, Dai holders will be able to redeem the Zeros they receive during redemption for more Dai immediately. Deco’s close mechanism uses the Dai it holds through FEE tokens to replace all Zeros, irrespective of their maturity date.

Yield not tokenized
Yield protocol does not tokenize the yield component. CLAIM-FEE tokens are tokenized pure-yield and give Maker the option to sell them in a variety of ways.

Revenue potential
TLM allows Maker to get back some of the lost stability fee from migrated vaults by supplying liquidity, but it will be competing with other liquidity providers for a share. Deco allows Maker to collect the entire stability fee directly because the vaults never leave. Also, new vaults will be attracted by the fixed-rate feature.

Zero collateral type within Maker
Yield uses fyDai (zeros) as collateral and backs them with debt from its lending system. fyDai redemption is linked to borrowers purchasing Dai from the market to payback their debt which ties the process to market conditions. Deco backs Zeros directly with Dai that is already under its control and is ready to clear debt 1:1. Dai is not purchased from the market.

User Experience
TLM incentivizes Maker vault owners to migrate to Yield and access the fixed-rate feature. Even after migration, they have to roll-over their vault to a new maturity series periodically after the current one expires or migrate back to Maker when the regular stability fee becomes attractive again. They might not be able to migrate back if debt ceilings are hit in Maker. CLAIM-FEE tokens can be bought or sold in whatever quantities and maturities the vault owner wants without changing anything about their Maker vault and achieve the exact hedge.

Collateral Types
Not all collateral types that are in Maker will be available in Yield, especially RWAs, making it hard for those folks to access the fixed-rate feature, even if they are willing to migrate their vault.

Scaling
TLM must start at a low ceiling due to the external risks it brings. Deco does not deal with collateral, liquidations, oracles et cetera and consequently it would permit Maker to scale faster after its integration.

1 Like

MakerDAO would issue CLAIM-FEE tokens, and maybe even start an auction, with the executive spell. No other actor needs to be involved. The Deco smart contracts deployed for Maker will be fully governed by MakerDAO. We would assist MakerDAO with crafting relevant portions of the spell to achieve whatever issuance goals MakerDAO may have.

2 Likes

We made a conscious trade-off because stability fee accrual is a slow drip. Percentage changes in the collateralization ratio would happen over the course of a year due to no debt rebalancing (1-5% APR) and happens regularly on an hourly basis anyway due to collateral price volatility. We assumed that vault owners would check-in frequently enough, even when they have DefiSaver enabled, that they should be able to manually collect yield from CLAIM-FEE tokens and rebalance easily and without hassle.

Another reason for the trade-off was the one you mentioned, automated vault management systems are pretty good these days, and this is more of a cron job that just must be scheduled at an interval without incurring too much gas cost.

Our end goal is for the user to not even realize that there is a CLAIM-FEE token in their wallet that needs to be managed in addition to the vault. We envision that vault management UIs will wrap vaults and the CLAIM-FEE together making it a very seamless user experience for fixed-rate vault owners who simply pick a duration, lock-in the stability fee, and manage it to avoid liquidation as usual.

Another smart-contract based solution I have in mind is to incorporate a bounty for rebalancing since anyone can payback debt on a vault. We can setup a function within the Deco instance that directs CLAIM-FEE yield collection to a vault user sets up. Any address submitting a transaction to do the rebalancing, when the yield collected by CLAIM-FEE hits a threshold, gets paid a small bounty.

2 Likes

The way the Deco protocol is built seems like a straightforward extension of the Maker protocol. How does your team expect to get paid? Do you plan to submit an application to become a DAO core unit?

What is the next step toward incorporating Deco or activating Deco for Maker? What is the roadmap?

1 Like

The first part of the Deco roadmap is to determine the level of community interest in the proposal and whether the community agrees with us that this is of significant value to MakerDAO. A specific compensation plan has not yet been finalized, but the objective is to make it performance based. Of course, if Deco does not receive an appropriate level of interest and acceptance by the community, presenting a compensation plan becomes pointless.

If the community wishes to incorporate and activate Deco for Maker, we will then submit a finalized integration budget and timeline, a protocol maintenance budget, and a performance revenue sharing proposal. We are taking this process a step at a time and are open to suggestions on how we may become a DAO core unit.

6 Likes

What more encouragement do you need? Do you want Recognised Delegates to weigh in with comments? @PaperImperium @Planet_X @ElProgreso @monet-supply @twblack88

7 Likes

I am generally in favor of what is presented here. My main hang up is with regard to whether this would attract unwanted attention as a security or if it can be structured such that it is clearly not one.

But — with the caveat I prefer to read through things a couple times on different days — I like the functionality if I understand it correctly.

So put me in the “I’d like to hear more” camp.

2 Likes

Have you “testnet” tested this scenario, or you’re assuming all the stars will be aligned if such a scenario plays out?

To be fair—this is probably something @niemerg Yield can add.

Fair enough—but perhaps one day this can be automated.

This is super cool. :+1:

Yup—that came across my mind—but I think this product is unique in the sense that I can’t identify it with any traditional product available today—but maybe I’m not thinking clearly :thinking:

BTW, I wonder if products like this would have an effect on “investment interest expense” for Yankees like us? Meh, hard to tell since IRS can’t provide clear guidance…

@vamsi hey man—looking over the Deco docs, can you please explain the following, and how are timestamp kept accurate, or safe from being manipulated?

“Within insert , governance is allowed to calculate the fraction value externally and directly insert it at a timestamo. It is up to developers to allow governance to overwrite existing frac values, insert values at future timestamps etc. Both are dangerous practives and should typically not be allowed.”

Would it be fair to say that, in your presentation, you basically make MakerDAO issue interest rate swaps? MakerDAO would be the counterparty as it doesn’t have collateral issues (as MakerDAO can print as much DAI as needed, no need to put collateral aside).

While MakerDAO is good at that, no secondary market can (yet). Buyers need to pledge the full amount of future interests upfront. I understand those CLAIM-FEE-ETH-A would be quite complex to manage on a secondary market (as you will have many series, one for each call/minting?).

Therefore it would be similar (but more flexible) to having term vaults on MakerDAO (like ETH-TERM-2022-08). At scale, it poses the interest rate risk that MakerDAO would face (which might or might not be an issue, it’s MakerDAO Governance to decide).

It would prefer to start (or do ni parallel) with an ETH-TERM-2022-08 (maturity August 2022 where SF is raised to 100%), 100M DC, SF 3% (more precisely 3% origination fees and 0% SF) and see what happens. Fixed borrowing demand is currently a hypothesis, let’s find out if it is really there.

4 Likes

I think this is the reason that Deco offers Maker a competitive advantage. Maker is uniquely positioned to take the opposite side of the swap more efficiently than any other potential counterparty. Even if there isn’t much demand for hedging with CLAIM-FEE tokens, I think Maker could gain a lot of information by regularly auctioning CLAIM-FEE tokens at various durations on major vaults like ETH to do price discovery on the yield curve. This could jump-start interest in hedging. Why should we only do custom deals with Institutional and Long Term Vaults Proposal when the origination fee could be a generic feature available to all?

For CLAIM-FEE tokens, what would be a good initial maximum duration? 1 year? 2 years?

Okay, maybe roll the proposal into MIP39c2-SPxx: Adding the StarkNet Engineering Core Unit (SECU) ?

2 Likes

The only thing Deco does is allow you to pay the security fee at a different time (now vs later). How could this make a difference about whether CLAIM-FEE tokens or vaults are a security? It’s just splitting existing vaults into two separate stand-alone products.

1 Like

If we offered it only to the vault user, perhaps? Unsure about what happens if there’s a secondary market.

I like the gist of it. But we live in a treacherous neighborhood and just need to make sure we don’t antagonize anyone needlessly.

I think there’s potential here and want to know more.

So, sorry to be that guy but… I have like no experience in financial instruments beyond what I’ve picked up from crypto. I’d really appreciate it if you could help me understand better how this works.

I think I understand the goal - provide users with fixed-rate vaults over a certain time period.
I think I understand the benefits - open up a new market and mint more DAI (though I do wonder if that market is as large as everyone is hoping. I’d be astounded if we saw 3x the current ETH-A issuance as a result of this for example. Maybe I lack imagination.)

What I don’t understand is the costs and the implementation.

So for costs:

  • How do we ensure that fees are stable? Who pays the difference if fees rise? Who receives the difference if fees decrease?
  • Does DAI remain fully-backed throughout this (given that we’re talking about using DAI minting to compensate for the lack of a counterparty)?
  • What are the initial and on-going governance costs to this? (What does governance now need to worry about and manage with the addition of DECO?)
  • What are the development and deployment costs to this? (What new vaults do we need, what new development needs to happen?)

For implementation:

  • I’m not even sure where to start here. I’m afraid the (very pretty) clarifying diagram was not terribly clarifying for me. I think the main issue I had with it was that I didn’t understand why each of the steps was being made? Like I understand the eventual goal, but not the breakdown of that goal into the steps communicated.
  • How does this differ from us creating an ETH-D vault and pledging that the stability fee will not change for time t? And what is the benefit of this over that?

Maybe you can walk through what implementation looks like from our perspective (fill in the ???)

  1. Governance decides it wants to implement DECO.
  2. ???
  3. Profit (presumably.)
4 Likes

As somebody not affiliated with the Deco term, let me see whether I can answer your questions. Obviously @vamsi can correct me if I come to any wrong conclusions. I’ll update my reply in an hour.

1 Like

A CLAIM-FEE token is composed of a notional value and a duration. For example, suppose I draw 100 DAI from an ETH vault for two weeks and then pay it back. I am obliged to pay the stability fee during those two weeks while the loan is outstanding. If I buy a two week CLAIM-FEE token for the notional amount of 100 DAI then that CLAIM-FEE token will mint exactly the amount of DAI that I will need to repay the stability fee of my vault (regardless of changes to the stability fee by Maker governance).

  • notional value = 100 DAI
  • duration = two weeks

However, the CLAIM-FEE token does not have to match the value and duration of my loan. If I hold my 100 DAI loan for more than two weeks, the CLAIM-FEE token will expire; I will be back to paying the floating stability fee out of my pocket, the stability fee which is a floating rate determined by governance. Or alternately, suppose I take out a 200 DAI loan instead of 100 DAI for two weeks. In this case, the CLAIM-FEE token will only pay for half of the stability fee.

Now to answer your question. CLAIM-FEE tokens are purchased by vault owners and are sold by the Maker protocol. Once purchased, the CLAIM-FEE token mints DAI to pay the stability fee (whatever the current rate is) for the duration of its existence. If the stability fee increases after the CLAIM-FEE token is issued then the vault owner will save some money on the stability fee and Maker will collect less DAI then it would have had the CLAIM-FEE token not been purchased. If the stability fee decreases after the CLAIM-FEE token is issued then the vault owner overpaid and Maker will collect more DAI in fees then it would have otherwise. The other thing to keep in mind is that the fees are collected at a different time: with CLAIM-FEE tokens, the fees are collected by Maker when the CLAIM-FEE token is sold. In contrast, without the CLAIM-FEE token, stability fees are collected continuously by the Maker protocol.

The worse possible situation for the Maker protocol is to sell long duration, high notional CLAIM-FEE tokens cheap while the stability fee is zero and then for governance to aggressively raise the stability fee very high. Suppose the stability fee is raised to 20%. In this case, fortunate vault owners who purchased CLAIM-FEE tokens will not be affected by the new, much higher stability fee until the CLAIM-FEE tokens expire. So DAI remains fully backed, but Maker is not able to change the price of risk on these vaults until the CLAIM-FEE tokens expire. Presumably we moved from a low-risk environment to a high-risk environment. The CLAIM-FEE tokens delay the change in fees.

Although it may seem like it would be hard to manage hundreds of CLAIM-FEE tokens with different durations and notional values, they are all priced the same way. There is some mathematical formula that takes CLAIM-FEE token parameters and the stability fee, and outputs price. Another ingredient to this formula is some measure of expected stability fee volatility.

Governance can look at the total duration and notional value of issued CLAIM-FEE tokens to understand how much inertia exists in anticipation of changing the stability fee. If all outstanding DAI loans are 100% covered by CLAIM-FEE tokens for the next two years then stability fees have been effectively fixed for two years. Governance can change the stability fee, but it will not have any effect on loans covered by CLAIM-FEE tokens.

It is the same, but how do you choose time t? With CLAIM-FEE tokens, any arbitrary duration can be selected by the buyer. As CLAIM-FEE tokens are issued, every one will have a different duration. I don’t really see how to offer this kind of duration flexibility via a regular vault.

6 Likes