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.
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.
This proposal is for the creation of a new product for MakerDAO by the integration of the Deco Protocol:
- Fixed Rate Vaults via 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.
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.
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.
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:
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
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:
- 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.
- No Vault Management Changes: Vault owners do not have to make any changes to their vault ownership or management.
- 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.
- 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.
- Integration with Gnosis Auction Protocol V2: Discovery of rates permitting the performance of large sales competitively and transparently.
- Compatible with Asymmetric Demand: There is no requirement to find buyers for Zeros or to be able to sell Claims.
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.
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.
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.
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.
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.
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.