Unlocking Interest Protocol's USDC

IP Unlock is a proposed system based on Fei Turbo to allow Interest Protocol to safely lend its USDC reserves while maintaining the same level of liquidity.

The solution is a borrow relationship. “Unlocking” our USDC requires a few changes to the current vault system.

Borrowing
The “Unlock” vault allows overcollateralized borrowing of protocol-owned USDC. However, the borrowed assets are not moved to the borrowers wallet like a USDi vault. Instead, the borrowed assets are deposited into a protocol-chosen yield venue (Compound, Aave, etc.). Instead of charging an interest rate to borrow, Interest Protocol can collect a share of the profits from the external loan.

Liquidation
Just like a normal vault, it is possible for an “unlock” vault to become undercollateralized. In order to prevent this, we can utilize the standard IP liquidation mechanism (considering a debt of 1 USDC as $1). Due to the borrow relationship, losses in a yield venue must be repaid if a vault owner wants to reclaim their collateral.

Liquidity Constraints
To ensure USDi maintains a similar level of redeemability with USDC as before, a “forced repay” function must exist to draw USDC out of the yield venue back into the PSM. This mechanism can be similar to LUSD’s redemption mechanism, where vaults with the lowest collateralization are targeted for forced repayment first. Forced repay can be called when there is insufficient PSM USDC to fulfill a redemption. For the sake of informing the USDC reserve ratio, yield venue assets should be considered 1:1 to USDC as they can be liquidated immediately if redemptions require.

IPUnlock.drawio

Important questions for IP Unlock are:
How should development of this mechanism be funded?
What share should the IP DAO take?
What yield venues are appropriate to onboard?

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Maybe I’m misunderstanding, but wouldn’t it be simpler to just onboard the LP token for an approved venue (e.g. aUSDC or yUSDC)?

Using those tokens as collateral is completely different in risk, as “unlock” vaults do not take on the risk of the yield venue (being overcollateralized by other assets). As an example, allowing cUSDC to be used as collateral exposes us to Compound getting hacked, while allowing a borrower to deposit into Compound through an unlock vault only takes on the risk of their collateral.

OK so let me get this straight:
User “borrows” USDC at no cost by posting collateral - which kind? Any approved collateral?

USDC is then automatically invested in aave, earns aave’s supply yield. Some of this yield is captured by IP, some stays with the borrower who borrowed for free?

Whose aave vault does the USDC go to? Presumably the borrower’s, so why might a borrower do this? Do they want to borrow some other token or leverage up on aave? Because as specified, it seems like there is essentially no downside for USDC borrowers - interest free USDC loan than earns a supply rate. In this proposal, is IP just using “unlock” borrowers to deposit its USDC into AAVE, why doesn’t the IP just do this by itself, and pass thee earnings on to USDi holders?

So what exactly is the cost to the borrower? Just their opportunity cost of capital? Seems like a really good deal for USDC borrowers and a rotten deal for USDi borrowers. Cuz the more USDC that leaves IP, the higher their borrow rates go. So basically you are penalizing current USDi borrowers to split aave supply revenue with some rando who has contributed nothing. Yeah maybe USDC supply rates go up on IP, but still, the assumption is that aave/compounds USDC supply rate is higher than IPs. Perhaps this proposal would bring the USDC supply rate of IP and Aave more in line - but still it would be easier to just have IP vote to take some % of protocol owned USDC and put it in aave.

The whole proposal seems rather convoluted to me. The entire point of IP is to get people to use USDi - focusing on freeing up protocol owned USDC seems to create conflicts for users of USDi imo.

User “borrows” USDC at no cost by posting collateral - which kind? Any approved collateral?

Any approved collateral would be sufficient. The borrow is not a traditional borrow where the USDC goes into the borrowers wallet, it has to go into an approved yield venue directly from the vault.

Whose aave vault does the USDC go to?

Aave doesn’t use vaults, it uses pools. The USDC is deposited in the general Aave, Compound, or Euler pool.

In this proposal, is IP just using “unlock” borrowers to deposit its USDC into AAVE, why doesn’t the IP just do this by itself, and pass thee earnings on to USDi holders?

It’s true that we are using “unlock” borrowers to deposit into lending markets, however these borrowers collateralize our deposits in exchange for a share of the profit. This lets us lend with a greatly reduced risk of losing funds in case the lending market accrues bad debt.

Cuz the more USDC that leaves IP, the higher their borrow rates go. So basically you are penalizing current USDi borrowers to split aave supply revenue with some rando who has contributed nothing.

To address the point that this raises the borrow rates, I suggested that lent USDC be considered 1:1 with reserve USDC for interest rate purposes. This is because the liquidity management system allows full redemption of all “unlock” positions at any time by using forced repayment.

The contribution of the borrower is that they are collateralizing the deposit. If the lending market we deposit into goes bust, the borrower has to repay their debt to reclaim their collateral (or be liquidated).

The short of it is that we are paying to fully insure our USDC deposits into a lending market. I suspect this will be a better deal than paying for insurance via nexus mutual (or another traditional insurance product) as

  • the insurance is fully overcollateralized
  • the borrower is depositing an asset like stETH, ENS, DYDX, or LDO which has limited yield opportunities (causing this to be one of the best options for use of the asset).

If all USDC reserves are redeemed, this protocol first drains PSM USDC, then drains unlocked USDC.

Unlocked USDC is riskier than PSM USDC, so:

  1. The protocol should first drain unlocked USDC, then drain PSM USDC.
  2. To limit exposure to unlocked USDC, the protocol should target a maximum ratio of unlocked USDC to PSM USDC like Balancer’s boosted pools.

The reason why I prefer that “unlocked” USDC be redeemed after PSM USDC is because this prevents the gas costs of having to open a vault, deploy into a yield venue etc. An appropriate middle ground may be to start redeeming unlocked USDC after we reach a ratio like you talked about (for example once >60% of protocol USDC is unlocked, start redeeming unlocked rather than PSM USDC). I also agree that a hard cap (70-80%) is necessary to prevent all of the PSM from being deposited into yield venues.

A minimum borrow size should be necessary when unlocking to ensure that we’re not wasting gas force-repaying a 100 USDC deployment. I think around 10k USDC might be an appropriate minimum.

Thanks for your thoughts!