Notional's leveraged vault framework allows users to borrow funds from Notional to deposit directly into leveraged vaults. Leveraged vaults are whitelisted smart contracts external to the Notional system that execute pre-determined strategies under specific constraints that mitigate risk to the Notional protocol and its users. Leveraged vaults may execute Notional-specific strategies or strategies that involve interacting with one or more external protocols like Curve, Balancer, or Uniswap.
The purpose of the leveraged vault framework is to allow users to get highly levered exposure to the returns of a particular strategy. Notional achieves this by recognizing the assets in a strategy vault as collateral against the user's debt.
For example, consider a vault that allows a user to get up to 10X levered exposure to providing liquidity on the Balancer boosted stablecoin pool. A user could bring 100,000 USDC to Notional, borrow 700,000 USDC from Notional, and then deposit the total 800,000 USDC into the leveraged vault. This user would earn the returns of the vault on 800,000 USDC and pay Notional's fixed interest rate on 700,000 USDC, all while only holding 100,000 USDC in initial capital. If the returns to the vault exceed the interest rate the user pays on their Notional debt, this strategy will be quite lucrative.
And from Notional's perspective, the user's debt is still overcollateralized - they hold 800,000 USDC in assets against a 700,000 USDC debt. If the value of the user's assets in the vault fall below a minimum collateralization ratio, they can be liquidated and the strategy will be unwound.
- Primary currency: Every vault will involve borrowing one currency type from Notional. The vault itself might interact with multiple currencies and assets, but the debt that the user takes out and the value of a vaultShare will be denominated in the primary currency.
- Secondary currency: Some, but not all, vaults will involve borrowing a second currency type from Notional in addition to the primary currency. An example of a two-currency vault would be a vault that borrows ETH and USDC from Notional to deposit as liquidity into the ETH/USDC pool on Uniswap V2.
- Max leverage ratio: Every vault will specify the maximum amount of leverage that a user can obtain. If the value of the user's assets falls and they breach this ratio, they can be liquidated.
- Minimum borrow size: Users must maintain a minimum debt size to use Notional's levered vaults. Minimum debt sizes ensure that liquidators have sufficient financial incentive to liquidate levered vault positions in adverse market conditions.
- Max capacity: Levered vaults maintain a capped borrowing capacity that is a function of the risk of the strategy and the strategy's overall capacity.
- Vault fee: Users pay a fee to use a leveraged vault that varies by the vault depending on the riskiness and potential profitability of the strategy. The fee is assessed on the interest rate that the user pays on their debt when they enter the vault and it is split between nToken holders and the protocol's reserve.