MIP30: Farmable cUSDC Adapter (
MIP#: 30 Title: Farmable cUSDC Adapter (`CropJoin`) Author(s): Lev Livnev (@equivrel), ￼🌧️ McRainface Contributors: n/a Type: Technical Status: Formal Submission Date Proposed: 2020-11-16 Date Ratified: <yyyy-mm-dd> Dependencies: n/a Replaces: n/a License: AGPL3+
- The proposed CropJoin implementation
This is a proposal for the technical implementation of a USDC collateral type which would allow a CDP user to benefit from the COMP “farming” reward, by depositing the collateral into Compound and optimising its COMP yield through “tactical resupply”.
COMP farming offers an attractive yield on USDC with very little risk, and the ability to receive additional leverage from a CDP is likely to present an attractive opportunity for a yield-seeking investor, so this collateral type could be expected to produce very high dai issuance, while generating significantly higher fees for MakerDAO than what is currently collected on MakerDAO’s significant stablecoin exposure. We propose a new USDC based collateral adapter that performs COMP farming on behalf of depositors.
MIP30c1: Proposed code: contains snippet of proposed implementation.
MIP30c2: Test cases: lists existing test cases, including integration tests
MIP30c3: Security considerations: comments on the security implications of using
MIP30c4: Economic / Governance considerations: discusses insolvency and liquidity risks, governance and example parameters
MIP30c5: Formal verification/audit information: comments on the amenability of the proposed code to formal verification, even though formal specification, audit, or code review have yet to be conducted.
MIP30c6: Licensing: states the license under which the proposal and code are distributed.
Since Black Thursday, the MakerDAO governance community has faced issues with managing the supply and demand of dai, with dai trading on the market consistently above the target price of $1.00. In July, the market demand for dai began to increase significantly, due to dai becoming the dominant asset for “COMP farming”. Further to that, other “farming”/“liquidity mining” schemes emerged, similarly boosting dai demand.
With interest rates near the zero lower bound, governance was left with limited options for scaling supply to meet the new demand. Measures that have been considered to address this problem have included:
- the addition of fiat stablecoin collateral types, with
collateralisation ratios close to 100%
- open market operations to buy stablecoins with DAI, aka PSM
- the implementation of negative interest rates using TPAM, aka
- accelerating the timeline for real-world assets using MIP 21 and MIP 22
with the first of these being the current status quo policy (at the time of writing there is around 406MM DAI issued against USDC-A, 57MM against TUSD-A, and 21MM against PAX-A).
The case for farmable collateral
Since July, dai supply has struggled to keep up with the seemingly insatiable demand created by yield farming opportunities in Defi. One way to think of the effect this has on the dai market is to consider the farming yields as an artificial, “exogenous DSR” which is very high, (perceived to be) low risk, and beyond the control of MakerDAO governance, which has the expected effect of exerting a strong positive influence on dai demand. Another way to view the problem is that a large portion of the dai supply is locked away, and taken off the market by contracts offering depositors an attractive yield for depositing their dai. Most prominently:
- 363MM DAI sitting inside Compound
- 197MM DAI in the Uniswap ETH/DAI pool (though the liquidity mining
incentive is expected to end on the 17th of November)
- 34MM DAI deposited in Curve
Currently, collateral tokens (such as USDC) that are deposited in a CDP to generate dai cannot be further deployed to generate yield for the system or for the user. This means that users borrowing dai against USDC collateral are subject to a significant opportunity cost by forgoing yield on USDC, which decreases the incentive to sell the dai on the market (and it is only when dai is sold on the market that increasing supply has the desired effect on the peg). As a result, stablecoin collateral types are now only effective due to their very low collateral requirement, with the 101% collateral ratio acting as an effective ceiling on the DAI/USD premium, by arbitrage.
If instead the CDP user could benefit from a farming yield on their deposited collateral, then dai borrowing could present an attractive way to lever up on that yield and generate an attractive carry. For example, if a yield farm is currently paying 10% APY on USDC deposits, and a CDP can be used to borrow DAI at 5% against those deposits, up to a 110% collateralisation, then a user can earn
(10 - 5) * 11 = 55% APY at maximum leverage. In doing so, they would have borrowed and sold onto the market 10 DAI for every 1 USDC they deposit, and the system would be earning a material interest rate of 5% on this DAI issuance.
We believe that the introduction of farmable collateral types presents the most effective avenue in the short term for scaling up DAI supply in a way which rewards the system adequately for risk taking, by directly leveraging the underlying source of the dai demand.
The case for farmable cUSDC
The technical implementation underlying this proposal aims to support arbitrary collateral rehypothecation, meaning that in the future it could be adapted to deploy farming collateral adapters for yield farms other than Compound.
Compound is currently the largest “yield farm” on the market, and probably also the one perceived to carry the lowest risk for depositors. Indeed, depositors who simply deposit and borrow USDC face no price risk, liquidation risk (provided the position is prudently managed) or “impermanent loss” risk, and the Compound platform has been live with very large amounts of locked capital for a long period of time, having undergone numerous audits. The MIP6 for cUSDC collateral has already been decisively green-lit by governance.
Additional reasons to start with cUSDC farming include:
- Compound is arguably the most well respected, battle-tested, and thoroughly-audited smart contract system that offers yield farming
- MakerDAO already has significant exposure to USDC, and it is the collateral asset with the largest amount of DAI issued
- Compound currently sets the COMP yield on each asset proportionally to the total amount borrowed, meaning there is a 2nd order effect by which an increase in USDC farming would reduce the COMP yield on DAI farming, potentially helping to reduce DAI demand
Farmable cUSDC collateral can be viewed as an alternative to other solutions which involve fiat stablecoin exposure (such as the current stablecoin collateral types, or the PSM), and compared directly from a risk, reward, and effectiveness perspective.
MIP30c1: Proposed code
CropJoin we implement a general purpose farming rewards adapter, that distributes income from a given token proportionally. This adapter can be used for a variety of income generating tokens, e.g. cTokens, UNI-LP, SNXRewards, and will also distribute income from direct token transfers.
To specialise to a given token, a single method must be overridden to implement the claim logic for the given token (e.g.
Existing approaches to this problem were considered (e.g.
UniPool, and Sushi’s
MasterChef), but were unsuitable due to reliance on specified reward rates and Maker contract idiosyncrasies. In particular, designing a reward contract for Maker requires solving the “double reward” problem posed by Maker collateral always being transferable within the system (see the
crop README for more information).
Levered COMP Farming
COMP rewards are determined by the total assets that a user has supplied and borrowed from Compound. Effective COMP farming requires “leverage”: a cToken is supplied, and the underlying is then borrowed and resupplied again. This is repeated to maximise the total amount that a user has supplied / borrowed, up to four times the initial amount in the case of USDC¹. This repeated supply / borrow method is in use by the majority of large Compound Dai deposits today, and is the reason why the total supply of cDai greatly exceeds the real supply of Dai.
¹ The upper limit of supply
s = s0 / (1 - cf), where
cf is the maximum utilisation allowed by Compound (e.g.
cf=0.75 for USDC, i.e.
s = 4 * s0).
In wind.sol we extend the rewards adapter described above, specialising it to receiving COMP rewards for supplying / borrowing cUSDC, via an iterative method with optional user-provided loans. There are two methods:
windsupplies adapter USDC to Compound and maximises leverage up to a given target.
unwindreduces leverage when over the target, and allows for USDC to be redeemed from Compound prior to user
MIP30c2: Test cases
Tests can be found in crop.t.sol. The basic rewards adapter is covered for a mock token reward and this base is extended to test against mock and real Compound behaviour (via RPC). The effect of flash loans on gas costs and collateral reachability is explored, and a number of more complex scenarios are tested against on-chain Compound, e.g. interest accumulation, liquidation, and arbitrary seizure. The mathematical behaviour of Compound is considered in depth in the documentation and tests.
MIP30c3: Security considerations
Security risks of cUSDC-CROP include:
Compound technical risk
Errors or security vulnerabilities in the Compound system could cause the cUSDC-CROP adapter to behave unexpectedly, or could result in the underlying USDC deposits to be lost or stolen.
CropJoin implementation technical risk
In addition to the technical risk inherent to Compound, the adapter implementation itself is non-trivial and could increase the attack/error surface.
Due to the design of multi-collateral DAI, worst-case losses should be limited to the collateral deposited in the adapter, and the debt ceiling should be set with this in mind.
MIP30c4: Economic / Governance considerations
MIP30c4A: Economic risks
It is fair to say that cUSDC-CROP collateral inherits the risks of USDC, and includes the following additional risks, as a minimum:
Compound insolvency contagion risk
If the value of collateral/outstanding borrows in the Compound system drops/rises (respectively) too quickly before collateral can be liquidated to cover debts, it is possible for the system to become insolvent (similarly to how underwater CDPs in MakerDAO can exhaust the surplus buffer and eventually lead to insolvency). In that case, users of this adapter may take a loss, and if the loss is great enough, cUSDC-CROP CDPs may become underwater too, resulting in Compound insolvency spreading to MakerDAO.
Compound liquidity risk
Even if the Compound system is solvent, there is no theoretical guarantee that it is possible at any time to withdraw a supplied asset, since the reserves of the supplied asset may be tied up in outstanding borrows. In that case, it may be impossible to withdraw USDC from the adapter until a USDC reserve is accumulated in the contract, either through repaid borrows or additional supply. In order to prevent illiquidity events, Compound adjusts supply and borrow rates dynamically based on utilisation, incentivising supply and repayment with very high interest rates when reserves run low. Historically, the Compound platform has been successful at managing liquidity with this technique.
MIP30c4B: Governance considerations
In order for the cUSDC-CROP collateral type to stay competitive relative to other Defi yield opportunities, while maximising returns for MakerDAO, it may be necessary to periodically adjust the stability fee to reflect prevailing market rates and the Compound COMP-adjusted yield on USDC.
In the future, the same mechanism can be used to deploy adapters for leveraging other “yield farming” schemes.
MIP30c4C: Example parameters
We consider some example risk parameters to illustrate the economics: with a liquidation ratio of 110%, and stability fee of 10%, a user maintaining a collateral ratio of 111% will have levered up around 10x on their net interest of
14.6% - 10.0%, earning a net carry of around 46% APY.
From the perspective of the user, this is well above the USDC yield on most established “yield farms”. From the perspective of MakerDAO, the stability fee is much higher than that of any existing major collateral type, and the high collateralisation ratio of 110% allows liquidations to be initially disabled (similarly to the status quo with USDC-A) with interest still being effectively collectable for at least one year following the opening of a CDP.
MIP30c5: Formal verification/audit information
The proposed contract is written in a way which is amenable to formal specification and verification, in accordance with the style and practices of the core multi-collateral DAI contracts, though it has not been formally specified. Full formal specification would be a challenge due to the dependence on Compound supply / borrow / reward logic, which is non-trivial compared to a simple token transfer as it would require modelling of much of Compound.
No audit or code review has taken place yet.