MIP39c2-SP23: Adding the Deco Fixed Rate Core Unit

MIP39c2-SP23: Adding the Deco Fixed Rate Core Unit

Preamble

MIP39c2-SP#: 23
Author(s): Vamsi Alluri @Vamsi
Contributors: @juanjuan, @Wouter, @NikKunkel
Tags: core-unit, fixed-rate, cu-deco-001, mandate
Status: RFC
Date proposed: 2021-09-08
Date Ratified: <yyyy-mm-dd>

Sentence Summary

MIP39c2-SP23 establishes a Deco Fixed Rate Core Unit for the integration and maintenance of the Deco protocol facilitating Fixed Rate Vaults. For more information about the history of this MIP, which was originally posted on 5 August 2021, please see here.

Specification

Motivation

This post presents a protocol designed to bring a new revenue generating and user retention feature to MakerDAO: Fixed Rate Vaults; the proposal also provides for a fully staffed core unit to support the protocol. The Deco Protocol operates to decouple Yield-Bearing Assets into Fixed Rate and Pure Yield instruments thus providing a hedge against rate volatility for all yield bearing assets. Using the Deco fixed rate protocol, Maker will be able to issue tokens that permit Vault owners to hedge the stability fee for a fixed duration and for a specific collateral type. The proposed Deco and Maker integration uses a market driven solution to make it possible for vault owners of all sizes to hedge stability fees for any desired duration. The 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. The Deco instance for Maker 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.

Problem: Rate Volatility and MakerDAO

Stability fee volatility means that vault owners are unable to accurately predict their exposure to future fees which in turn limits the MakerDAO’s user base and in turn the DAI supply. Rate volatility constrains the market for Maker vaults by eliminating the 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 revenue and control cash may prove problematic to the DAO. MakerDAO needs a vehicle to retain vault owners, expanding Dai supply, and provide a stable cash flow to support DAO operations. Deco is already developed and provides these features to Maker.

The Deco protocol, in collaboration with MakerDAO, can offer fixed-rate vaults to Maker vault users. By using fixed rates, Maker may smooth out its revenue and achieve some predictability in its cash flow. 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.
  • Maker may now lock in vault owners and be able to reliably cover its fixed operating costs through the upfront sale of Fee tokens.

This proposal is for the creation of the Deco Fixed Core Unit and the addition of a new product for MakerDAO by the integration of the Deco Protocol: Fixed Rate Vaults via Deco Protocol.

Core Unit ID

DECO-001

Core Unit Name

Deco Fixed Rate Core Unit.

Core Unit Mandate

Mission

Integrate, manage, and maintain the Deco fixed rate 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.

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.

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 a 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.

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.

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.

image

Figure 1. Fixed Rate Vaults: Deco on MakerDAO

Technical documents and usage steps are available at technical docs for more details about the components in this integration proposal.

Deco Core Unit Responsibilities

Fixed rates promise to be a significant product offering for MakerDAO. A fixed rate product lends itself to a self-supporting and independent core unit. The core unit will be staffed to support the Maker integration and work with the growth core unit and governance to achieve Maker’s objectives, while providing for minimal burden to the protocol engineering and risk core units. The core unit is designed to be efficient and performance focused, with the principal objective to support MakerDAO and be a profit generating cost center for Maker. The core unit will manage the integration and serve MakerDAO and its various stakeholders in the required functions.

The core unit will perform the following responsibilities:

  1. Deploy new FEE token and Deco instances for collateral types as needed.
  2. Develop Spells necessary to issue and manage CLAIM-FEE token issuances and the ZERO-A collateral type.
  3. Incorporate timely fraction snapshot captures as part of weekly spells.
  4. Perform data analysis to discover optimum fixed-rate premiums for various collateral types, and help the DAO sell the issued CLAIM-FEE tokens.
  5. Assist Growth team in product development and ongoing Deco operations, including providing integration support and working with integration partners who wish to incorporate this feature seamlessly into their smart contracts or user interfaces.
  6. Assist the DAO in ZERO-FEE token sales if the need arises.
  7. Assist the DAO in setting the Dai Savings Rate if the need ever arises.

Future Directions

Deco on Maker is a flexible toolset. Not only can Deco be applied to fixed rate vaults, but there are other avenues for potential exploration. The Deco protocol promises to add feature sets to Maker. With Deco, Maker can support surplus buffer health and help mitigate flop auctions and stop new MKR issuance by sourcing the needed Dai through fixed-rate future stability fee sales in the form of CLAIM-FEE tokens.

Links

Related Docs

7 Likes

Thank you Vamsi for presenting and also proposing this Core Unit. We worked together for many years at Maker so I, like many others, can definitely defend your excellent technical abilities and personality. So don’t take it in wrong way but I am worried that the current proposal seems to be skewed.

$1,712,500 annual budget is not light and the Core Unit taking 15% of the revenue seems to be excessive considering the Core Unit will likely also get MKR compensation in the long term.

Similar to how PSM or Chai didn’t have such revenue split mechanisms, I suggest to the Maker Governance to consider encouraging the Core Unit to remove the 15% revenue share.

7 Likes

Did you notice the buyout option? I’m not disagreeing with your concern. I’m just pointing out that the budget is not as simple as you seem to suggest. Also check out Appendix A.

3 Likes

In the current regulatory environment, I’d like to get some clarity about whether the yield tokens represent securities. If so, I’d like to know if they can be sold to anyone other than the vault owner without causing us problems.

There may be an exemption that makes it commercial paper as long as the maturity is short term. That’s still a security, but relieves the issuer (Maker Protocol?) from registration and reporting requirements.

I’m not sure how to quickly get clarity on that. But I also wouldn’t want us to have to block American users somehow. Too much complexity and bad UX (see the recent dydx situation)

4 Likes

I don’t think this should be a deal breaker. Getting clarity on the regulations could take years. The fixed rate stuff can always be hidden from Americans. I wouldn’t want to see this core unit delayed.

On the other hand, if somebody can provide clarity on regulations, that would be great!

6 Likes

Thank you for sharing. I have read it:

“This option would be available for activation at the three-year mark after initiation of the Deco Core Unit, November 1, 2024. The payment for the buyout would be a lump sum payment, and in the absence of agreement, determined by three mutually agreed upon independent appraisers from internationally recognized accounting and valuation organization. Until the option is exercised, the Deco Dai budget would renew on the same budget terms quarterly.”

This seems like a unnecessary extra burdensome process for the governance to coordinate around to claim. My point is simple. If the Maker governance is paying for the Core Unit to bootstrap and maintain, all the returns should go to the Maker governance.

7 Likes

It could be worse than that. If the Deco CU looks towards fixed rate fees as it’s primary incentive then they may try to push sale volumes of fixed rate fees beyond what is prudent for MKR as a whole. Every other CU has MKR tokens as an incentive. The community should acknowledge the effort than Deco has put in prior to the MIP application. Maybe the best way to do that is to offer a somewhat more lucrative MKR incentive plan (relative to the Protocol Engineering CU).

Maybe I’m overthinking it, but I just worry about CUs pulling in slightly different directions to raise their performance incentive pay.

1 Like

“The community should acknowledge the effort than Deco has put in prior to the MIP application.”

While I appreciate them preparing such, it’s not like the Maker Governance asked Deco team to prepare nor had some obligation. Therefore, I prefer we look at this proposal objectively and try to find the best option for the Maker governance.

That being said, Vamsi himself said “This is not an R&D project, nor is it a proposal for Maker to fund the development of a product. Instead, we are asking Maker to fund the integration and support the operational core unit until such time as it becomes sufficiently profitable to cover its core budget and generate a profit for Maker.”

However, how is paying for 5 people team+ their benefits+ even accounting for their tax not “funding the development of a product”? The Maker governance is literally incubating Deco team while bearing the risk and the cost (for example, what happens if the development or the integration is delayed? the cost still comes out). Therefore, it’s only fair that the Governance requests a better deal.

In terms of question regarding incentive. Maybe it’s a misunderstanding but I saw it they are likely to also request MKR incentive in the future as well. If the Deco team is not thinking of such, then maybe they can explicitly note that they will not ask for such in the future so that can be part of the Governance’s decision reasoning.

In addition, compared to Protocol Engineering CU, where the demand is clear (and it’s continuity), this CU is literally a test and experiment. I disagree that the reward should be higher for CU team when the Maker Governance has to bear more risk for approving this CU.

6 Likes

They ask for MKR compensation => MIP40c3-SP36: Deco Fixed Rate Core Unit MKR Budget

So they get DAI compensation, MKR compensation, 15% of revenues + buyout clause (the last two being a call option).

It is my understanding that without MakerDAO they can’t do anything. By reading the whitepaper, I understand that they are pivoting. All interest rate swaps protocols are capital inefficient and MakerDAO is the main stablecoin that can mint capital for collateral without any cost. This is the secret power of DAI (which I called balance sheet manipulations).

I would suggest that MakerDAO submit an RFP for all interest rate swaps-related protocols and make a decision with all data. @niemerg submitted a MIP long ago where all the code is done. They would probably submit an offer as well. @Akiva proposed one as well (asking nothing from MakerDAO).

I think it would be fair to let those people know we are willing to pay some millions for such a product and let them present what they would offer for that.

15 Likes

@SebVentures all of your suggestions above plus before deciding on anything we should also do some research and try to detect the size of the market for fixed rates. Aavewatch.com have something, but they say the numbers are V1 while stable borrowing on Aave is V2.

I do not want to through all the onboarding, paying through our noses, and then find there is no demand.

2 Likes

@Planet_X we are tracking AAVE and we are using debank for it right now.
So based on debank data, here are borrow amounts with stable rates, which AAVE2 is using (for how stable rates are working you can read here Borrow Interest Rate - Risk, tldr; its base on utilisation and they will change it in some conditions)

LINK: $148,660
BAT: $15,320
MANA: $30,174
ZRX: $224,624
WETH: $2,433,689
TUSD: $1,635,173
WBTC: $445,207
USDT: $12,647,416
ENJ: $436,052
USDC: $45,871,882
MKR: $15,043
REN: $1,585,982
DAI: $8,949,015
KNC: $82,639

4 Likes

Thank you for those numbers @miha.
All in all a grand total of USD 74.5 million of fixed-rate loans, or 0.8% of total outstanding of USD9,250 million at Aave.

2 Likes

I did a little more digging and here you can see variable vs. stable for each asset

Asset Variable rate Stable rate Total share of stable rate %
LINK 5624189 148660 5772849 3.0%
BAT 350861 15321 366182 4.0%
MANA 1566814 30174 1596988 2.0%
ZRX 76607 224624 301231 75.0%
WETH 408591195 2433690 411024885 1.0%
TUSD 80821755 1635174 82456929 2.0%
WBTC 97385890 445207 97831097 0.0%
USDT 913359487 12647416 926006903 1.0%
ENJ 166104 436052 602156 72.0%
USDC 5207512335 45871882 5253384217 1.0%
MKR 1476935 15043 1491978 1.0%
REN 913983 1585982 2499965 63.0%
DAI 1709497607 8949015 1718446622 1.0%
KNC 418741 82639 501380 16.0%
Total 8427762503 74520879 8502283382 16.0%
3 Likes

This is not an apples-to-apples comparison! Aave “fixed rate” is still subject to utilization curves, Borrow Interest Rate - Risk ; As I’ve said before, I think a better indication of the level of interest is the Nexo institutional vault. In Appendix A, Deco projects that 30% of borrowing will be fixed rate. I think this is plausible if we steer people toward a fixed rate in the UX, by making it the default. Fixed rate should be the default. It’s easier to understand and better for novice borrowers.

3 Likes

Sure, but I think a requirement should be that MakerDAO is the counterparty. That is, MakerDAO itself should be the main seller of floating-to-fixed swaps. That’s what makes the market liquid. As far as I know, that’s the architectural advantage that Deco has over @Akiva’s Pairwyse and @niemerg’s Term Lending Module. Maybe @Akiva and @niemerg can comment on how much development it would take to make MakerDAO the main selling counterparty.

Where does the Deco team see themselves in three years? It seems to me like they could grow into a second protocol engineering CU. Maybe Deco can comment on their future plans. Even if Maker decides that it doesn’t want the Deco Protocol, what about the Deco team? These people seem like talented people that are intimately familiar with the details of Maker.

1 Like

In our codebase MakerDAO already is the counter-party.

We are going to post our production codebase very shortly.

In your terminology, the agreement is between a borrower and lender. I find this a bit confusing because borrower and lender are approximate synonyms. If I understand you correctly, the borrower is the vault owner and MakerDAO itself is the default lender? If this is correct then why is there a matching process between borrowers and lenders?

What does this mean?

1 Like

To the extends that Nexo gets a better rate than the variable one (at least this is my understanding). So we are giving them better SF and interest rate security. Yet they don’t have to commit much as they can exit anytime (and the origination fee is not that much). To get fixed rates you usually pay more and have to commit. Make Nexo pay a bit more for the privilege of getting fixed rates and I’m not sure they will be so happy to jump in.

The problem of fixed rates is that most of the borrowers are targeting a spread. People borrow at MakerDAO to yield farm (Compound, Aave, Curve, …) or to lend at higher rates (Nexo charging more). They all borrow short term and lend short term. It doesn’t make sense to borrow long term and lend short term.

The other problem is that the collateral is volatile (ETH). DeFi lacks a stable collateral (like t-bonds or any high quality bond in the real world). Betting long term is risky.

It is my point that they all need MakerDAO (or any other stablecoin issuer) to scale due to the need of liquidity. I can be wrong, but that’s not an unreasonable assessment. IRS (Interest Rate Swap) market notional value is bigger than the actual bond market. You need an insane amount of collateral to make it work trustless.

Making a fixed rate term market in DeFi is a very tough problem.

1 Like

These contracts are based on ideas from CeFi. Regardless there is no comparison which is 100% perfect.

In general we think of it as a 3-sided market.

  1. Fixed Rate Borrower - any RWA issuer
  2. Fixed Rate Lender - Corporate Treasury
  3. Credit Support Provider - Maker

This is one way to conceptualize the deal. Note that under this model it requires no code changes or MIPs to Maker.

If you dont understand - consider that we will post our codebase very shortly.