Customized Yield Vaults

VeradiVerdict - #159

A team of Goldman Sachs and Facebook technologists launched a new protocol to help diversify risk and simplify entry into decentralized finance yield.

  • The comparatively high volatility of DeFi is one of its biggest barriers to mass adoption, discouraging the vast majority of investors who seek strong, stable returns with controlled risk. Without fixed yields that parallel those in more traditional, stable financial markets like fixed income investments, DeFi remains unable to demonstrate its capacity as a universal tool for wealth creation. 

  • Ondo Finance is a new permissionless fixed income  protocol that enables users to enter into both fixed-yield (FY) and variable-yield (VY) positions, catering to investors all across the risk appetite scale. 

    • Liquidity providers (LPs) deposit assets into Ondo Vaults, which are asset pools that are later invested in a single AMM trading pair. 

    • Once created, vaults have a “subscription period” where LPs can purchase FY positions, which are available in one of the assets of the pair, and/or VY positions, which are available in the other asset of the pair. Vaults initially require an equivalent amount of FY and VY positions, meaning that the vault’s asset value is split evenly between its two assets. LPs can purchase FY and VY positions in any ratio, allowing them to fine tune the risk and return profiles of their investment. 

    • After the subscription period, vaults are invested for a fixed duration into a single AMM liquidity pool. After the investment duration is over, Ondo redeems the underlying LP tokens and first pays out the fixed return to FY depositors and then distributes the remaining assets to VY depositors. 

  • To date, the protocol has already launched 5 vaults, deployed to Uniswap and Sushiswap, offering 7-10% fixed APY on USDC, DAI, and USDT and 40-50% fixed APY on ETH. 

  • The team is composed of DeFi and traditional banking veterans, with alumni of Goldman Sachs Digital Assets, Microsoft, Facebook, various private equity firms, and more. 

  • In offering both stable and highly-leveraged returns, Ondo Finance takes a massive step towards creating a DeFi ecosystem that serves users of any risk tolerance, accelerating mainstream adoption by demonstrating DeFi’s capacity as a means for stable wealth creation. 

The Impasse of Volatility

One of DeFi’s largest barriers to entry is the substantial volatility of the market. Most DeFi protocols offer financial products which are algorithmically composed from highly-volatile, quickly-appreciating digital assets. In turn, users of these protocols often see incomparable returns (3-digit APYs), but must also stomach considerable risk. In 2019, interest rates for ETH lenders on Compound Finance fell from 1.3% to 0.01%, effectively decimating returns. 

This heightened volatility turns away the vast majority of investors who seek reasonable, stable yields with measured, well-defined risk. In traditional finance, the fixed income market (valued at ~$100 trillion) greatly outsizes the public equities market (valued at ~$64 trillion). To capture mainstream and institutional users, DeFi must cater to more risk-averse investors and demonstrate its potential as a means for sustainable and reliable wealth creation.

What is Ondo Finance?

Ondo Finance is a new, permissionless DeFi protocol on Ethereum geared towards both risk-averse investors that seek stable returns with controlled risk and more experienced crypto investors that seek leveraged, higher-risk exposure to earn enormous returns. 

The protocol offers both fixed-yield (FY) and variable-yield (VY) positions, catering to users all across the risk appetite scale. Liquidity providers (LPs) can enter into FY and VY positions in any ratio, allowing them to customize their risk and return profiles.

How does it work?

LPs deposit assets into pools called Ondo Vaults, which use smart contracts to enforce investment provisions (e.g. the split of returns between FY and VY positions). Vaults are unique and distinct from one another, meaning that investors can clearly choose across risk parameters like minimum collateralization, LTV thresholds, and more. 

Vaults are currently composed of two different assets, which are then invested into a single AMM trading pair. Ondo offers FY positions in one asset and VY positions in the other; for instance, for a vault to be invested in an ETH/USDC trading pair on Uniswap, Ondo may offer FY positions in USDC and VY positions in ETH. 

Each vault goes through a short subscription period, during which LPs can purchase FY and/or VY positions in the vault. Vaults only accept an equivalent amount of FY and VY positions, meaning each type of position ultimately comprises 50% of the vault’s asset value. Once the subscription period is closed, the vault’s assets are deployed to a single AMM liquidity pool. After a short investment period, Ondo redeems the LP tokens for the vault’s assets, and then pays out the fixed return to FY investors and distributes the remaining assets to VY investors. With this scheme, FY positions have their investment secured by the assets from VY positions (50% LTV at the vault’s launch), while VY positions receive 2x leverage in AMM pools for effectively paying a “funding cost” of the fixed return. 

To date, Ondo has launched seven vaults (all with a 1 month investment duration), deployed to both Uniswap and Sushiswap, offering 40-50% fixed APY on ETH and 7-10% fixed APY on USDC, USDT, and DAI. In its initial phase, the protocol is enforcing limited caps on invested assets to safeguard LPs’ deposits, but will soon offer more vaults with greater diversity of assets. The project has already undergone successful audits by Peckshield and Certik. Below you can see some vaults that open today:

Who’s behind the project?

Ondo’s team is composed of both experienced DeFi traders and banking veterans who deeply understand both institutional and retail markets, including alumni of Goldman Sachs Digital Assets, Facebook, Microsoft, Symbiont, and various private equity funds. The project is backed by Pantera Capital, Genesis, the Digital Currency Group, the LAO, Stani Kulechov (the founder of Aave), and more. 

Final Thoughts

The pronounced risk profile of DeFi remains one of the space’s largest (and most valid) criticisms, prohibiting mass adoption by discouraging users who may be unfamiliar with crypto and thereby less likely to enter into volatile, insane-yield positions. Controlling risk will be a silver bullet for DeFi, offering a parallel financial experience to more popular markets with stable returns, like fixed income investments, with significantly lower friction and higher capital efficiency. 

Ondo Finance marks a massive step towards creating a DeFi ecosystem that serves users of any risk tolerance. Vaults are an ingenious construction that offer both strong, stable returns and higher-yield, leveraged exposure, and the ability to simultaneously purchase both fixed- and variable-yield positions enables investors to fine tune their risk and return profiles to their liking. As crypto piques the interest of more mainstream users, Ondo will be an incredible demonstration of DeFi’s capacity for both stable and rapid wealth creation.

- Paul V

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ABOUT ME

Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing in blockchain companies and cryptocurrencies. I’ve been in the industry since 2014, and the firm invests in equity, early stage token projects, and liquid cryptocurrencies on exchanges. I focus on early-stage investments and share my thoughts on what’s going on in the industry in this weekly newsletter.