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.
Leveraged vault example
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.