Provide vaults on existing collateral but different terms. Instead of a variable-rate vault that can have collateral added or DAI paid until the vault is closed or liquidated, provide a vault with a fixed payment schedule for a fixed lump sum of DAI. Whether the stability fee rate should be fixed or variable is still an open question.
Those who follow the chat will know there’s been some talk about some differently structured vaults (like ones that are acceptable for those with religious proscriptions on interest). After soliciting some loose opinions from several folks about the technical complexity, a good first step may be to offer vaults similar to the current ones, but with a fixed payment schedule and a single lump sum of DAI, as it seems easier to implement without utilizing as many of the scarce resources of the smart contracts team.
For a user, payment that is on a fixed schedule eliminates the risk of sudden liquidation during an unforeseen extreme market event. Our products offer leverage to those who don’t wish to sell their underlying collateral, so the risk of liquidation likely keeps our most conservative – and likely most credit-worthy – users far away from the liquidation threshold for their vaults. This is generally a good thing, but with knowledge they won’t get liquidated until after missed payments, these users may be interested in levering a bit more, which would result in more fees for us.
In short, this should be a better customer experience for users who avoid or underutilize traditional vaults for fear of liquidation when not very actively managing their vaults during turbulent markets. Happier customers are repeat customers.
From our side, this would introduce more market risk, as the value of collateral can continue to fall before a payment is missed but after a traditional vault would have been liquidated. This is a concern that would need to be weighed. If we chose to offer fixed rates along with a fixed payment schedule, that would also introduce interest rate risk.
The benefits, however, would be a reduction in timing risk with regard to liquidation. In the event of a sudden market downturn, this would create rolling liquidations, as vaults would not be eligible for liquidation until scheduled payments had been missed. In some cases, this will allow the collateral’s market value to rise, and liquidation avoided. In some cases, this will allow the collateral’s market value to continue to deteriorate.
An added benefit would be greater predictability of DAI cash flow into the Stability Buffer. We currently have excellent knowledge of receivable growth, but due to the flexible repayment schedules offered, that does not necessarily translate into DAI received on a certain schedule and receivables are still vulnerable to loss in bad-case scenarios.
Risk Profile of User
It is hard to extrapolate well-established characteristics of developed debt markets to the crypto debt market, as the users are by their nature self-selecting into the system. That being said, it seems very likely that someone inclined to choose a fixed-schedule vault would be more risk averse than someone taking a standard vault. At the least, it seems improbable that the two vaults would be used in the same way by the same user, and over time it may become apparent how they differ, and allow for more/less allowed leverage or higher/lower stability fees in one type of vault vs another. It also provides us a tool to manage risk of disorderly liquidations due to high volume in a short time.
Fixed Rate/Fixed Debt
Fixed payment schedule does not necessarily equate to a fixed rate of fees. A credit card is an example of a line of credit with a variable rate but a fixed payment schedule. It also allows the user to draw further upon their credit line.
At the other end of the spectrum are car or home loans, which typically use fixed rates and a declining balance of debt owed.
And one can imagine a vault with any combination of these features of fixed/variable rates, one-time draw or revolving credit. Under the right circumstances, any would be appropriate.
Personally, since the idea is to diversify both the timing risk associated with mass liquidations and to attract a more risk-averse user, I would propose a fixed-schedule, one-time draw vault, either with or without a fixed rate.
Why One-Time Draw/Lump Sum
With a set loan issued upon receipt of collateral, each scheduled payment reduces risk to Maker, as the collateral remains unchanged in quantity, but the exposure to the individual loan declines over time, shifting the risk of slow, ongoing price declines in the underlying collateral to the user. Our risk is defined and reduced over the life of the vault. In a traditional vault, Maker becomes more and more exposed to the risks associated with liquidation in the event of slow, steady declines.
Offering a new set of terms for loans on the same collateral gives us diversification of user risk profiles, reduces timing pressure on the liquidation ecosystem in the event of a mass downturn, provides users with a way to know with certainty when liquidation can occur, reduces the exposure of Maker to losses on each individual vault as older vintage vaults would have repaid a greater portion of their principal and fees while still holding collateral steady, and increases the predictability of when stability fees owed will actually be deposited into the Stability Buffer.
This can provide us with a greater offering to customers with existing collateral types, which hopefully should be fairly easy to do risk analysis upon.
I would like to hear reactions to the financial structure, how difficult this would be to implement technically, and how much user education would need to occur from Content and other related teams. Please also include thoughts on fixed/variable stability fees for this product.