Price Risk: Consider a strategy that borrows one stablecoin (USDC) for another (DAI) to take advantage of rate differentials. The strategy is subject to exchange rate risk as the DAI/USDC peg could potentially break. If DAI depreciates in value against USDC, the vault's assets (DAI-denominated) would deteriorate in value relative to its debt (USDC-denominated). If the DAI/USDC exchange rate falls too far, users could become over-leveraged and eligible for liquidation.
Smart Contract Risk: Any DeFi protocol has some amount of smart contract risk - leveraged vaults are no exception, and can involve multiple protocols, eg. a DEX for swapping tokens, Maker for DAI strategies, etc. A smart contract hack could place vault assets at risk.
Liquidity Risks: If the DAI/USDC on-chain liquidity was to decrease substantially, it could lead users to incur a large amount of slippage when exiting the vault and redeeming their DAI for USDC.
Leveraged vaults expose Notional's funds to two risks: smart contract risk and economic risk.
Smart contract risk: Leveraged vaults hold user funds and generally deploy them onto one or more external protocols. Smart contract hacks of external, integrated protocols or of leveraged vault code itself can potentially result in lost funds.
Economic risk: Vaults borrow funds from Notional in one currency and invest them into a whitelisted strategy, but the assets in the leveraged vault could decline in value. If the value of the assets in the vault falls too low, the vault is at risk of becoming insolvent, and in need of liquidation. Thus, assets used in leveraged vaults strategies must have deep liquidity and be readily liquidatable, while the vault must be able to respond in real-time to on-chain liquidity levels. Accounts will also have a minimum borrow amount to ensure liquidations are profitable.
Leveraged yield farming protocols like Alpha Homora allow you to provide liquidity on Uniswap V2 forks in highly volatile pairs (ETH/SUSHI for example) and then borrow against those LP tokens to provide more liquidity. This strategy is extremely risky due both to the significant impermanent loss that these LP tokens can sustain and the volatile borrowing rates that users pay on these platforms. The volatility of the strategies offered by leveraged yield farming protocols makes them generally unsuitable for users who want more stable and consistent returns on their capital.
In contrast, Notional’s initial leveraged vault strategies are much less volatile and give users highly leveraged exposure to stable, and consistently high-returning strategies. Notional may introduce more volatile leveraged vault strategies in the future, but at the moment the protocol’s vault offering is focused on more stable and consistent strategies.
1) Balancer/Aura wstETH/ETH LP strategy Users will borrow ETH from Notional to deposit into a strategy that puts the ETH into the Balancer ETH/wstETH pool, stakes the LP tokens on Aura, and periodically harvests the incentives. Max leverage: 10X
2) Balancer/Aura boosted stablecoin LP strategy Users will borrow DAI/USDC from Notional to deposit into a strategy that puts the DAI/USDC into the Balancer Boosted stablecoin pool, stakes the LP tokens on Aura, and periodically harvests the incentives. Max leverage: 10X
3) fCash spread strategies Users will borrow DAI (USDC) to deposit into a strategy that swaps it to USDC (DAI) and lend the USDC (DAI) on Notional at the same maturity to take advantage of rate differentials in the same maturity between two different stablecoins. Max leverage: 20X
If you have a strategy you’d like to see listed, or would like to propose an integration strategy with your protocol, please reach out to @kyleplong on TG or join the Discord community. Please keep in mind that to adequately protect users, new strategies will be rigorously vetted with a potentially lengthy process with the following qualifications:
- External protocols must receive multiple audits from qualified auditors.
- External protocols must be live, hold significant TVL, use strong security practices, and maintain open lines of communication with the Notional community.
- Strategy code must be audited by a qualified auditor.
- Strategy code must be reviewed and audited by the Notional core team.
Leveraged vaults allow users to take out up to 20x leverage for certain strategies. This means that users are effectively able to earn the returns of a strategy on multiples of their initial capital. If the strategy returns stay above the fixed borrowing costs, and no liquidation thresholds are breached, users will greatly boost their returns.
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:
While the strategies are designed to maximize stability, the debt ratio could fall due to any of the aforementioned risks associated with the particular leveraged vault strategies.
No - While leveraged vaults allow for users to gain up to 20x leverage on their initial capital, all of the assets are locked into the vault and eligible for liquidation if the leverage ratio threshold is crossed. Notional’s rigorous and competitive liquidation infrastructure will be applied to leveraged vault users as well, and all accounts will remain overcollateralized.
The minimum borrow size ensures that in the event an account falls below the required leverage ratio threshold, liquidators are properly incentivized to unwind the position. Because the vault strategies are complex and may involve several other protocols/dex, etc. the gas costs for liquidating accounts may be relatively high. Minimum borrow sizes will be reassessed on a regular basis to ensure the safety of the protocol.
If you wait until after maturity, your position will be settled automatically. Vault shares will be redeemed and used to pay off the debt. Any capital that remains will stay invested in the vault strategy on an un-levered basis - you can re-lever or withdraw that capital.
If you wish to keep your position post-maturity, you can: a) wait until settlement and then re-enter the vault (involves transaction costs) or b) roll your debt prior to maturity (no transaction costs associated with redeeming and then re-minting their vault shares)
To roll, you simply select the maturity to extend to, and Notional will borrow from that maturity and then use the borrowed cash to pay off the debt at the initial maturity. The only difference a user experiences when rolling a levered vault debt compared to a normal debt is that you must roll their entire debt in one transaction.
Yes! Users can exit a vault at any time, either before or after their debt matures. If the user exits prior to the maturity of their debt, Notional will redeem the user's vault shares, pay off their debt by lending to the specified liquidity pool at the current market rate, and return the excess capital to the user.
Monitoring the leverage ratio of your portfolio and being aware of maturity dates are the main things to be concerned with. Because the entire strategy’s assets are liquidatable collateral, it is in the user’s best interest to ensure that the asset’s value does not fall too far and put the account in danger of liquidation. For more information on liquidations, click here.
Yes! Although leveraged vaults will launch in beta with capped investment allocations, you may allocate resources into as many vaults as you wish as long as there is available capacity.
Certain strategies will have specific requirements for the initial collateral brought by the user. Please see the individual leveraged vault strategy page for exact requirements.
Users pay a fee to use a leveraged vault that varies by the vault. 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.
Some vaults, but not all, will incur transaction costs when users enter or exit the vault, or during vault settlement. To properly calculate their expected returns, users need to factor in the impact of any transaction fees. Strategy vaults may incur transaction costs if they need to trade between the primary borrow currency and another asset upon entering, exiting, or settling the vault.
In the event an account becomes over-leveraged, a liquidator can purchase a portion of the user's vaultShares at a discount to their value for cash, which is then used to pay down the user's debt. The liquidation discount will vary by the strategy.
Liquidators cannot liquidate an account past the target leverage ratio for the given strategy, however, they may liquidate the user’s entire debt if liquidation drops the user below the minimum debt threshold.