Opus, Collateral Assets, Real Yield & Slaying Liquidity Crunch
Welcome to this week’s article on Aura.
Last week’s article covered the protocol’s mechanisms against insolvency. This week we tackle collateral assets, defeating liquidity crunch, and how you will be able to use Aura to turbocharge real, sustainable yield generation.
Supported Collateral
All money markets must decide what types of collateral to support from their inception. This decision will inform most future design choices, from risk parameters and liquidations, to the protocol’s target audience.
The type of collateral that Aura is going to support falls within very specific constraints:
Decentralized
If there are any lessons to be learned from this cycle it’s that there is no line regulators won’t cross. Circle was strong-armed by the OFAC into blacklisting USDC in the Tornado contracts. If it were to do the same to Maker, it would cease to exist due to its reliance on USDC.
Thus, to avoid existential threats, all collateral must be fully decentralized and immutable. If it can be censored, it is not decentralized.
Short-tail
Aura is an hyperstructure. In order to be as resilient as possible, it must minimize risk, and while Aura will eventually be able to automagically derive optimal per-asset risk parameters, short-tail assets decrease the likelihood of the protocol accruing bad debt (see Mango exploit), increasing confidence in its synthetic assets. For this reason, all assets must be deeply liquid. This property is also correlated with maturity.
Within these two characteristics, supported collateral can be:
ERC-20 Tokens
A normal token. This is the current status quo. A normal ERC-20 token. This can be WBTC, ETH, LINK, LUSD, and so on.
Yield-bearing Tokens
Traditionally, short-tail asset money markets have turned their noses at yield-bearing tokens—smart contract risk compounds with each smart contract layer added to the stack. Smart contracts like Uniswap V3 have undergone extensive testing and withstood the test of time—not only have they been formally verified, audited by top auditing firms, they have also survived in the wild with an effective blackhat bounty in the low billions, their TVL. These industry standard contracts were so battle-tested, Maker’s Risk Team was able to justify their inclusion as collateral.
Aura is going to support yield-bearing projects that have survived in the wild and have extremely high quality codebases. As such, its users will be able to access leverage to turbocharge their yield generating strategies!
Initially, we are looking at Sandclock vault tokens, Uniswap LP tokens, and potentially specific Compound and Aave receipt tokens.
Real Yield: A Wildly Simplified Example
Imagine you’re a Sandclock user. You deposit to a strategy with 15% APY. You receive a receipt token which is then used to mint synthetic USD. This token is then swapped for the underlying of the vault and redeposited to it. You can repeat this process a number of times to get up to, say, 3x leverage—or use flash minting to save gas. Your APY is now considerably higher, minus the interest, so as long as the vault’s APY is reliably higher than the interest, you won’t get liquidated.
Defeating Liquidity Crunch
As the market contracts, borrowing activity decreases. In parallel, existing borrowers start paying off their debt, increasing demand for the synthetic the debt is denominated in. The infamous liquidity crunch occurs when demand for the synthetic outpaces its supply, causing it to depeg to the upside.
How Can It Be Mitigated?
Cross Margin, and Uncorrelated Collateral.
For example, Sandclock’s vault shares are inversely correlated with ETH. When the value of ETH goes down, the number of liquidations increases, causing the vault to generate yield via discounted collateral acquisition. Aura lets you hedge your exposure to certain assets for a better borrowing experience. By allowing our users to mix-and-match collateral, we can reduce the frequency of liquidations and scale faster and safely.
Direct Swaps Module
Direct Swaps are our version of Maker’s PSM. However, instead of USDC and co. Aura will only whitelist stablecoins that fit the aforementioned criteria, such as LUSD and sUSD. This module will help Aura scale.
Is liquidity crunch still possible? Yes. Is it sufficiently mitigated? Probably. Mitigation is the best that can be done without charging negative rates through manipulation of the redemption price.
Anyway, stay tuned for next week for more exciting articles about our architecture!
