Balancer/Aura wstETH/WETH Strategy

This document goes over the specific risk and return drivers of the Balancer/Aura wstETH/WETH pool strategy.

Motivation

The Balancer/Aura wstETH/WETH vault allows users to borrow ETH from Notional, deposit that ETH into the Balancer wstETH/ETH pool, stake the LP tokens on Aura and then harvest the incentive rewards. Learn more about Balancer metastable pools here.

The Balancer wstETH/WETH pool holds wstETH and WETH. The pool allows Balancer users to trade between these two tokens, thereby generating trading fees for LPs. The pool also generates some ETH staking yield as part of the pool sits in wstETH. The pool is also incentivized with BAL tokens. To generate additional yield this strategy puts the Balancer Pool Tokens (LP tokens) on Aura finance to get an increased amount of BAL incentives while also earning additional AURA tokens.

For example, consider a vault that borrows ETH in the 6 month maturity and enters the Balancer wstETH/WETH with the proceeds. The vault allows users to profit from the spread between the returns of the pool and the fETH borrow rate.

Return drivers

The return of the Balancer wstETH/WETH pool strategy has two main drivers:

• The value of the pool's incentives (ex: Lido, Bal, and Aura incentives)

• The Balancer Pool Token (BPT) to ETH exchange rate. Let's note that BPTs accrue value from:

  • The pool's swap fees

  • The pool's wstETH staking APR

For example, consider a vault where a user deposits $100,000 of ETH, borrows $400,000 of ETH on Notional at a net 3% interest rate (incl. slippage and vault fees) for 6 months, LPs the $500,000 in the Balancer wstETH/WETH pool, and then deposits the BPTs in Aura. If the balancer pool generates 1.5% in staking APY, 0.5% in swap fees, 5.0% in Bal incentives, 0.5% in Lido incentives, and 12.5% in Aura incentives, the strategy would generate $50K in pool rewards. When accounting for the borrowing interest cost of $6K, the strategy would net $44K over 6 months or 88% annualized.

Let's note that the strategy will harvest incentives and reinvest them automatically for additional BPTs over time.

The profitability of this strategy can be summarized with the following formula:

$$profit = \frac{incentivesDenominatedInETH + (endingBPTvalueInEth - startingBTPvalueInEth) * BPT balance - ethInterest}{eth Deposit}$$

Risk factors

Price risk

Exchange rate risk

This strategy is subject to some exchange rate risk as the stETH to ETH exchange rate is variable. For example, consider a user that borrows ETH, LPs in the pool, and receives BPTs in exchange. If the price of stETH depreciates in value against ETH, the value of the BPTs will decrease, increasing the vault's leverage ratio. This is because as traders sell stETH for ETH, the Balancer pool accrues more stETH at a lower price.

If a user's leverage ratio is ever higher than the vault's maximum leverage ratio, the account would become eligible for liquidation. An account leverage ratio can be calculated at all times using the following formula:

$$collateralRatio = \frac{vaultShareBalance * vaultShareValue - debt} { debt}$$

For example, consider the following account:

• BPT balance: 1,000

• Value of one BPT: 1.00 ETH

• stETH/WETH exchange rate: 1.0

• fETH debt: -900

• Maximum leverage ratio: 0.08 (12.5 X leverage)

• Vault shares balance: 1,000

The value of a vault share at any point in time can be calculated using the following formula:

$$vaultShareValue = \frac {BPTbalance * BPTvalueInEth + incentivesValueInEth} {vaultSharesBalance}$$

$$vaultShareValue =\frac{1,000 * 1.00+2} {1,000}$$

$$accountVaultShareValue = 1,002 Eth$$

$$collateralRatio = \frac{1,002 - 900}{900}$$

$$leverageRatio = 0.113(8.82 Xleverage)$$

Let's now recalculate the account's leverage ratio assuming the stETH / ETH exchange rate decreased to 0.95. The change in the value of a BPT is non-linear when compared to the stETH/ETH exchange rate since it is a function of the pool's metastable curve and of the magnitude of the exchange rate change. A decrease from 1.00 to 0.95 in the stETH / ETH exchange rate would imply a new BTP price of 0.965 ETH.

$$accountVaultShareValue = 965 Eth$$

$$leverageRatio = 0.072(13.85 Xleverage)$$

The ending leverage ratio has now breached the maximum leverage ratio. The account is therefore eligible for liquidation.

Liquidity risk

On-chain liquidity

The strategy is also subject to on-chain illiquidity risk. If the stETH/WETH on-chain liquidity was to decrease substantially, it could lead users to incur a large amount of slippage when redeeming their BPTs for ETH. For example, if large stETH holders swapped their stETH for ETH the balancer pool would hold a greater amount of stETH and a diminishing amount of ETH making ETH redemptions more costly due to slippage.

Once stETH withdrawals are enabled a few months after the Merge, the liquidity risks of holding stETH will become practically null as stETH will be redeemable for ETH.

Smart contract risks

The strategy interacts or is subject to the following smart contract risks:

• Notional for borrowing

• Balancer for trading and entering the pool

• Lido as part of the pool sits in wstETH

• Aura finance to boost the BPTs and generate additional yield

Transaction costs

Entering the strategy

Upon entering the strategy, a user will have to cover for:

• Notional trading fees, vault fees, and slippage on the borrowed ETH

• Balancer swap fees and slippage to enter the Balancer pool single-sided.

Exiting the strategy early

Upon an early exit, a user will have to pay for:

• Balancer trading fees and slippage to redeem the strategy tokens BPTs back into ETH

• Notional trading fees and slippage to close his borrowing position.

Settlement

Upon settlement, when the vault reaches maturity, the strategy will incur the following transaction cost:

• Balancer trading fees and slippage to redeem the strategy tokens BPTs back into ETH

Settlements at maturity involve no trading on Notional as the debt will automatically close out against the proceeds of the strategy when it matures.

Vault governance parameters

Parameter	Value
Maximum leverage ratio	0.09 (12.1 X leverage)
Target leverage ratio	0.15 (7.6 X leverage)
Maximum vault capacity	750 ETH
Minimum debt size	100 ETH
Vault fee	0.00%
Reserve fee share	80%
Liquidation bonus	1.02 (2%)
Settlement period	2 days

Strategy governance parameters

Parameter	Value
Max Underlying Surplus	20 ETH
Oracle Window In Seconds	1200 (20 minutes)
Settlement Slippage Limit Percent	0.15%
Post Maturity Settlement Slippage Limit Percent	0.40%
Emergency Settlement Slippage Limit Percent	0.30%
Max Reward Trade Slippage Limit Percent	2.00%
Max Balancer Pool Share	15%
Balancer Oracle Weight	0%
Settlement Cool Down In Minutes	20
Fee Percentage	0%
Oracle Price Deviation Limit Percent	2.0%
Balancer Pool Slippage Limit Percent	0.25%

Historical return data

The historical unlevered return data for this strategy is displayed on this Dune Dashboard.

Emergency settlement

In case of an emergency, the protocol reserves the right to settle up to 100% of the vault if funds are compromised due to an active hack or a smart contract vulnerability.

An emergency settlement can also be triggered if the expected slippage to redeem the entire vault via a DEX aggregator such as 0x or 1Inch is larger than the vault liquidation discount. Under such a situation, it would be unprofitable for a liquidator to liquidate the vault. The emergency settlement acts as a way to ensure that the vault is always profitably liquidatable. This is key to making sure that the protocol is not subject to an excessive amount of risk.