Institutional Vaults

Why does Maker need to offer an institutional service?

During the last weeks, the community has been discussing different ways to optimize the protocol, starting with evaluating the current collaterals concerning its usage and maintenance costs, confirming that the most efficient collaterals in that sense are ETH and WBTC.

At the same time, we are having conversations with larger vault users that happen to be crypto-native companies, asking for their feedback to improve the Maker Protocol. We are focused on them because of the way they use Maker Vaults:

  • They have a clear use case for the Maker Vaults besides speculation. Maker Vaults are one part of the solution they offer to their clients/users.

  • As Maker Vaults are part of their business, they have dedicated resources preventing the liquidation of their position, making those vaults more predictable for Maker.

  • Usually, these companies are using either ETH or WBTC and their own token as collateral.

With the increase of the percentage of USDC in the protocol, it is necessary to attract more of these crypto-native companies and improve the Maker lending solution in a way our current institutional users want to increase their current positions.

Institutional vaults (or vaults for these crypto-native companies) will allow Maker to be more efficient in distributing loans and will help the protocol to attract these companies looking for working capital efficiency solutions.

What is an Institutional Vault?

Until now, risk parameters are set depending on the collateral characteristics. For Institutional vaults, risk parameters also consider the risk analysis of a potential borrower, and although this generates an operational complexity, it also provides a better understanding between both parties.

As these companies use Maker Vaults for their business, they are looking for solutions that enable them to give better terms to their users/clients by:

  • Optimizing the cost of debt, giving them the tools to predict changes on the stability fee to reduce the impact on their users

  • Increasing capital efficiency by creating more flexible liquidation mechanisms

  • Having a continuous dialogue between both parties to ensure fair terms and advance notice in the case of anything that happens

  • Having a longer-term commitment with predictable terms (12-24 months) to assign and manage their capital

Although, at first sight, the implementation of this kind of solution could look like something against the ethos of the protocol, we should think about institutional vaults as another type of RWA: custom vaults that guarantee a significant Dai supply on a predictable duration.

To implement this type of vault, we could use a MIP for the agreement between both parties. As they will use collaterals that are already accepted by the protocol, the condition to open an institutional vault will require a minimum size (from 50m Dai to 100m Dai).

Competitive landscape

Aave and Compound are working with a large custody platform to create an Institutional Solution for non-crypto native companies. They are planning on launching a regulated solution, with KYC, in a separate liquidity pool. While this may not specifically be what we want for Maker, we would like the protocol to be prepared to offer a similar solution that supports our larger b2b vault users like Nexo who rely on these types of solutions. Further, we want to be ready for the demand from the institutional side that is signaling their interest in DeFi yield opportunities. We have clear feedback from the major digital asset custody platforms who’s institutional clients want a more compliant access point to DeFi with fixed terms they are used to in the traditional markets.

What’s next?

Suppose we as Maker decide Institutional Vaults are a necessity for the protocol. In that case, we could start working with Nexo in the first type of Institutional Vaults and define a roadmap for that type of solution. We know there’s a huge opportunity, but we also understand the risk around regulators looking at us more closely if we implement some sort of a permission solution.

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Perhaps these Institutional Vaults will be separate (like an ETH-INST Vault with blacklisted addresses) from traditional Vaults and also include KYC/AML (not sure how that can be implemented)? This way regulators can’t say the Community is not doing/trying to do all the right things.

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I would like to see this come to fruition. I think many institutional investors would bring in a ton of value. It is just a matter of figuring out the right structure/vehicle for this.

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If I could buy enough MKR to pass this myself, I would. This is part of Maker becoming the heavyweight it should be. We aren’t a quirky DeFi project anymore — Maker can be and should be in the top tier of world financial institutions, and part of that is expanding our product offerings to meet the needs of our customers.

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I love this proposal, the truth maker is making a qualitative and quantitative leap in all aspects, we do not leave aside the small consumer as sidechain networks, and now with the possibility of offering services to large, I love all this that beautiful paints MakerDAO.

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I think this is an important step to take in the multi-pronged approach to get the DAI supply up and secure the peg with high quality collateral. By offering permissioned vaults with predictable fees we can likely attract new types of customers both directly and indirectly. Personally I don’t think this takes away from the core principal of offering loans permissionlessly. ETH-A and the others are still available to any user that needs to borrow. This is our chance to branch out to new markets in an increasingly competitive space.

Longer term we can figure out ways to generalize this approach and open it up in terms of fairness of access, but in the mean time we need to take a pragmatic approach to get things done quickly with the tools we have. Stablecoins in DeFi are popping up and going nowhere by attempting to construct ivory towers. Real products are built by compromise and listening to your customers.

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Without a doubt I think it is brilliant, there is thinking outside the box and this is something that if applied will make Maker grow. We must let Maker take the leadership it deserves by being one of Defi’s builders offering services for its potential users.

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If I understand correctly, the only difference between the institutional vault and a regular vault for collateral that’s already accepted is the effective “dust” parameter. In return, they get better rates and more vault management tools. I assume the Risk CU will still ensure that we’re able to liquidate these vaults when they go under.

So why not tailor them for a specific client’s requirements (to ensure we have at least one user) but leave the vault open to anyone who’s happy to use it and keep the protocol permissionless? Whatever we offer them in terms of vault management tools might be things that can be made public, in which case, it’s a win-win.

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The proposition of lower liquidation risk and lower fees is attractive no matter what you call the Vault type. And the lower risk is good for the Protocol (ignoring the issue of liquidation fees, which I feel are a necessary evil rather than a core part of the model).
What would be great to see is a set of tools that could be used by anyone (like DeFiSaver’s service) more closely integrated, and then fees and other parameters could be set for large (50m+) users.

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Another way to differentiate collateral types is to let actors create their wrapped versions of assets. So Nexo creates NexoETH and Maker has an ilk for those which reflects the risk difference between ETH and NexoETH. This seems more general as a solution and focuses more on risk than on individual relationships.

edit: forgot to state the obvious which is that I am all for this proposal.

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I think community first needs to decide whether such vaults should be permissionless or permissioned. I can see why permissioned institutional vaults would make our life easier, but I can also see benefits of permisionless ethos Maker maintains. RWA implementation is however already permissioned.

The other topic is regarding the benefits of such vaults, risk and business wise. I can see why having communication with these users and understanding their books/reserves and unwinding procedure helps us on risk side, which means lower rates and more long term commitments and usage.

If such vaults were to be permissionless, there are few tricks that could work. We could set dust limit to some high value when vault is being opened by a known institutional user. After debt is taken out and DC fully utilized, both DC and dust are again lowered, so that vault owner can safe himself in a worse case scenario when and if partial repayment is needed. But again, Maker would behave as if such vault is permissioned anyway, because it would aim to let in only those we have communications with so that we know how safe user it is.

Because such vaults would ideally be less risky than average vault at Maker, more relaxed version of liquidation ratio/stability fee/debt ceiling would probably be the end goal from user’s perspective. From Maker’s perspective, the end goal would be more DAI minting, safer portfolio and long term commitments. More DAI minting can be achieved by offering relaxed parameters and safer portfolio by knowing and communicating with such vault owners. If Maker wanted to guarantee long term commitment, origination fee (with much lower ongoing stability fee) is also one possible solution.

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Are you saying that each wrapped asset is different from the rest? Do I always take them as the same, hence WBTC, RenBTC, TBTC, HBTC and bBTC, are completely different assets even though they are anchored to the same asset? How would you assess the risk of each?

You bring-up such a great point Primoz. You know, this movement of decentralization helps businesses get away from the Liability of holding/storing DATA. I think more and more companies are going to want to move away from storing Customer DATA, because it has become a liability–with all the data breaches that we hear about these days. So, do we collect KYC/AML data for these permissioned Vaults? Maybe. I say that because it won’t be Millions of Institutional Vaults, so it shouldn’t be a lot of data. Also because it complies with regulations. But ya–this is something the Community really needs to think about, permissionless vs. permissioned.

I think this is a great idea. But I want some care into thinking about having institutional liquidators because one institutional vault liquidation could basically swamp the entire liquidation system. One thing we have wanted is to keep a careful eye on clumping in CRs as this increases overall portfolio risk.

Something else I have not seen discussed which is the rate at which the system can liquidate vaults generally? Is this a by vault control in liq2.0 or is there a system value. I mean if we can only liquidate 50M/hr and have 5B outstanding we are talking 10hrs just to liquidate 500M.

I mean if we are going to go the route of institutional vaults - we better start thinking about institutional level liquidations/keepers.

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It is better to play it safe, we are not talking about a few million dollars.

I think that in this case the safest thing to do is to increase the liquidation ratio, if we think about it, it is not the same to liquidate 200K as 50M. It would knock down the price of any asset by 10% or more.

@Nadia Would the permissioned vaults be controlled by Nexo or some other player for the benefit of institutional users? Presumably, Nexo or some other provider would take a fee for this service, no?

Permisioned vs. Permisionless debate

As one of the potential borrowers for the pilot, I would like to address and bring the institutional perspective to the attention of the community.

To put it simply, both modes have both pros and cons which one should take into consideration when designing institutional products. One of the main propositions of institutional vaults is their ability to offer additional due diligence into the financials, business model, borrowing use cases & overall risk profile while at the same time being a more reliable and predictable revenue channel. Similar to the collateral evaluation matrix, the protocol risk committee should take careful consideration into both economics and risk profiles of potential borrowers.

When evaluating institutional counterparties , however, no institution is the same when it comes to the complex tradeoff between it’s counterparty risk profilе, loan requirements (duration, size, collateral requirements) and revenue potential. Therefore for Maker to take meaningful market share, the ability to customize it’s offering as much as possible and create tailor-made solutions becomes critical.

Whether such customization comes in the context of an individual vault (e.g ETH-NEXO) or type vault (ETH-INSTU) to optimize protocol revenue, minimize risk and achieve other policy goals, one should make sure to first address the needs of institutions individually thus establishing product-market fit.

One drawback of using group type vaults (e.g ETH-INSTU) in a permissionless fashion only using broad limits, such as dust brings many complications and nullifies the effort of bringing in additional off-chain due diligence as an additional way to evaluate and minimize risk. If one borrower is subject to additional off-chain due diligence, it’s a given that it should be a mandatory requirement for all future borrowers as well, to the same degree of scrutiny.

In my opinion, the most logical progression would be to start with 1 or 2 pilot customers based on a permissioned protocol to establish product market-fit within a short time-frame, while in the long-run establishing a detailed counterparty risk methodology and tiers similar to the asset evaluation matrix.

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