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. Using the Deco fixed rate protocol, Maker will be able to issue tokens that permit Vault owner 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.
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.
The Deco protocol is a fixed rate protocol designed to be flexible and safe and the core protocol is outlined in the whitepaper.
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.
Problem: Rate Volatility and MakerDAO
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.
Solution: Deco Protocol Retains Vaults and Captures Revenue for MakerDAO
Deco protocol is an elegant protocol that 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.
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.
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 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 documentation for more details about the various components present 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 or a selective DSR.
The benefits of integration to vault owners and 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.