Proposal to add USDT Yield Tranches LP tokens

Biaf · October 20, 2023, 3:48pm

Proposal to add the LP tokens of the Senior USDT Yield Tranches as a capped collateral to Interest Protocol on Optimism.

Overview

Current on-chain credit markets offer an uneven diversification for liquidity providers, resulting in a suboptimal service. That’s why Idle released in 2021 Yield Tranches: a new DeFi primitive that allows to segment yields and risks on any DeFi yield source, catering to a diverse range of users by offering two risk-return profiles, Senior and Junior:

Senior YTs withhold part of the yield generated in exchange for funds coverage, given by the Junior class’ liquidity. The retained yield is then distributed to the Junior YT. Senior holders benefit from a full spectrum coverage on smart contracts and financial risks related to YTs themselves, underlying yield sources, and all their dependencies.
Junior YTs, on the other hand, provide greater returns, as they are compensated by the Senior counterparty with a higher share of yield for the coverage provided.

Yield Tranches offer built-in, DeFi-oriented features such as the on-chain default settlement and the adaptive yield split across Senior and Junior Tranches based on the liquidity deposited on each side. YTs contracts are present on Ethereum, Polygon zkEVM and soon Optimism with the intention to deploy the codebase on other L2s.

Parameters

Parameters	Specs
Token Address 1	0x50BA0c3f940f0e851f8e30f95d2A839216EC5eC9
Token Address 2	0x8552801C75C4f2b1Cac088aF352193858B201D4E
Capped Token address 1	`TBD`
Capped Token address 2	`TBD`
LTV	50%
Liquidation incentive	10%
Maximum Cap	$1m for each LP token
Oracle Address	NA
Primary oracle	NA
Secondary oracle	NA
Price deviation	`TBD`

Liquidity

This section does not apply to the YTs LP tokens, being they always liquidable by withdrawing the deposits in Idle.

Technical risks

Type of contract: The YTs LP tokens are interest-bearing ERC-20 tokens always increasing in price.
Underlying asset: the underlying yield sources are two borrowing pools on Clearpool, one of Portofino Technologies and one of Fasanara Digital
Time: The pool will be launched on Optimism in early November 2023. They have a proven track record on mainnet since April 2023.
Value: The pool will have a base lending rate of ~10% (with 85% utilization rate). Additional OP tokens granted by the Optimism Foundation will be used to bootstrap the markets.
Privileges:
Upgradability: The implementation for each Tranche can be upgraded through a shared Proxy Admin, which is 0x9438904ABC7d8944A6E2A89671fEf51C629af351. The owner of the Proxy Admin and of Yield Tranches’ contracts is the Treasury League multisig, which is 0xFb3bD022D5DAcF95eE28a6B07825D4Ff9C5b3814. The multisig is made part of 6 owners composed of 5 core contributors and 1 advisor. Any transaction requires the confirmation of 3 out of 6 signers.
Proposals to improve and update Idle’s protocols follow these steps: off-chain temperature check on Snapshot, on-chain voting phase on Tally (for the strategies controlled by the DAO, as for example Senior Best Yield). A complete overview of the Idle DAO governance processes can be found here.

Other risks connected to the Yield Tranches that should be considered are:

Oracle risk: Yield Tranches do not rely on external oracles. Yield Tranches’ LP token prices are fully on-chain. YTs prices can be found by calling the function virtualPrice, i.e. function #43 from every CDO contract address, using as parameters the AA LP token address for the Senior Tranches or the BB LP token address for the Junior Tranches specific to each Tranche.
Smart contract risk of YTs: Yield Tranches have been audited multiple times both by auditing firms, such as Consensys Diligence and Certik and by independent auditors from Code4rena and Hats Finance. A full overview of Idle’s audits is available here.
Additionally, Idle has two active bug bounty programs with Immunefy and Hats Finance.
New Tranches are first tested in beta and then released in the main Idle’s dApp. An overview of the security management policy of Yield Tranches can be found here.
Smart contract risk of the yield strategies: Idle selects platforms for yield generation that have a proven track record, have been audited, have solid TVL and maintain a bug bounty program. Additionally, Idle DAO has established a Risk Framework to standardize analyses of new underlying markets to be integrated into Yield Tranches by quantifying and assessing the risks related to new underlying strategies. This framework comprises four sections that lead to a final rating: 3rd party review, internal security review, strategy review and coverage.

Supplemental Information

Integrating the YTs LP tokens as collateral would create a two-sided effect for Yield Tranches:

Extending liquidity through USDi with Senior Tranche tokens would incentivize users to deposit on that side creating a solid and stable liquidity base
The funds flowing to the Senior side will draw new Junior liquidity deployments thanks to the boosted APYs generated

Idle has already started discussing this possibility with the partner institutions and the majority showed interest in further using the YTs LP tokens. We can then expect an increase in the USDi borrowing activity linked to the YTs tokens, backed by stable yields higher than 10%.

Relevant References

Project	Idle
Website	idle.finance
Docs	docs.idle.finance
GitHub	github.com/Idle-Finance
Discord	Idle server
Twitter	twitter.com/idlefinance

IPTMan · October 22, 2023, 1:06pm

I have a couple problems with these.

Too new, hence no real time tested history.
Completely unclear how legal terms like senior and junior are applied here
multisig that basically manages contract upgrades/changes.
I see no liquidity reports or markets where these things trade hence it is completely unclear how reliable any oracle could be.

While no single one of these might be a show stopper, all of them together put me off. Also you are talking about LPs (LP with what exactly, and where?)

All of this to me signals a proposal on products that are too new, and the proposal itself lacking in specific details mostly because it is proposing something on a product that doesn’t exist yet (see 3 above) for the chain of interest (optimism).

Also each single LP token is demanding a $1M borrow cap. Not a lot but I have no clue how such a beast would even be liquidated.

I have had discussions regarding USDT in general in Maker and given the reluctance of USDT to be transparent about where their cash is, how the generate return, etc. even in the face of USDT being the top stablecoin by cap in the space Maker absolutely refused to allow USDT into the protocol for many of these reasons and more.

Biaf · October 23, 2023, 3:16pm

Hey @IPTMan,

thanks for your feedbacks. Let me reply to your doubts one by one

As mentioned in the proposal, the codebase of the Yield Tranches was deployed in mainnet in late 2021 and since then managed up to $70m in liquidity. The codebase has been audited 4 times. The same smart contracts were deployed on Optimism without changes.

We follow the legal terms of the underlying yield protocol. In this specific case, Clearpool Finance ones. An overview can be found in our documentation. In a nutshell, Senior token holders can always share their preferences in case of borrower default, Junior token holders only when they are a majority in the pool.

Senior weight	Junior weight	Senior vote	Junior vote
> 60%	< 40%
< 40%	> 60%

True, the Treasury League multisig has the role of upgrading smart contracts when needed. To increase your trust in the Idle team, I’ll share some background on us.

All core contributors have extensive experience in Web2 and Web3 sectors, with 30+ years in crypto, software development and traditional finance combined. Smart contracts developed by Idle DAO contributors secured up to $300m TVL at peak, with no security issues found.

The plan is also to move ownership of the Yield Tranches to the DAO, as was already done with the Senior Best Yield vaults.

As mentioned in the proposal, there is no need to have an oracle. The Yield Tranches’ smart contracts have embedded the LP token price (see method #33 here for example). If any liquidation will be needed, it can always be done through our UI by redeeming the liquidity deposited.

I’m referring to the LP tokens received by the users depositing in the Yield Tranches pools. We have two different ones for each Tranche, i.e. Senior LP tokens (AA) and Junior LP tokens (BB).
These LP tokens are ERC-20 tokens that always increase in value. If there is any reduction in the LP tokens prices our security system immediately pauses the tranche to investigate the issue.

The product is not new. Its deployment on Optimism is new. The idea to have an integration early would be to leverage all the communication surrounding our launch on Optimism and indirectly give more coverage to Interest Protocol.

We can discuss to downsize the borrowing cap if needed. Having funds and institutions alike depositing into Yield Tranches the goal in setting a borrow cap of $1m each was to present a reliable use case to these players. In addition, this is only a cap, that can adjusted if needed, it does not imply a USDI loan of exactly the same size.

Again, liquidation would happen through Idle.

I see your point and this is a DAO decision. Having said that, we are speaking about a stablecoin with $84,626,112,008 market capitalization. In our specific case, this is only the underlying token. Yields are generated thanks to lending and borrowing pools.

nekosan · October 24, 2023, 6:52am

Hi Biaf,

Thank you for the detailed post and interest in IP!

Just adding a bit of colour to the proposal:

From what I can gather, the USDT deposited into IDLE Senior YTs will be used to underwrite two off-chain and undercollateralized loans for two prop-trading firms, Portofino and Fasanara. Additionally, Clearpool, not IDLE finance, is the entity that is responsible for the credit assessment of the two firms.

Please correct me if that’s incorrect!

I think before we even talk about the feasibility and detail of this specific proposal, we as a community probably want to discuss whether we want to & at the stage to onboard off-chain assets as collateral, let alone undercollateralized ones.

The only RWAs I am comfortable with right now are USDC-type-stablecoin tokens. I have my qualms regarding USDT as well but imo USDT is generally safe-ish, and I would definitely consider adding USDT into our multi-reserve way before even thinking about other exotic RWAs as collateral.

Just my 2 cents. Curious what others think

Biaf · October 24, 2023, 10:44am

Thanks @nekosan!

You got a proper understanding of the underlying activities behind the Senior Tranches.

Let me add that the borrowing pools are permissionless, hence Idle won’t be the only lender but one of many. The credit rating on the borrowers is done from Credora and the score is then used by Clearpool to set the rates and capacity of the pools.

The two institutions are well established. Fasanara was born as a TradFi hedge fund that also opened an on-chain arm. Portofino is an on-chain-only market maker.

In the end, it will always be a DAO choice, but I think that starting to explore new use cases could be beneficial for the protocol. If there are concerns regarding the uncollateralized nature of the loans, we can review the parameters shared.