Struct Finance

Bringing structured assets to DeFi

Structured products in Traditional finance

US Securities and Exchange Commission defines structured securities as “securities whose cash flow characteristics depend upon one or more indices or that have embedded forwards or options or securities where an investor’s investment return and the issuer’s payment obligations are contingent on, or highly sensitive to, changes in the value of underlying assets, indices, interest rates or cash flows”. That is a bit of mouthful. I’ll do my best to explain the concept of structured assets at least better than SEC.

Structured assets, a relatively recent phenomenon in the finance industry, offer retail investors a convenient way to access derivatives. These securities are usually linked to interest and other products which can vary from FX to debt securities. Think of it this way. Structured products are similar to bonds in that an investor will get coupon payments and the principal value at maturity. However, in the case of structured securities payments are non-traditional which means that the performance of these assets is linked to the underlying assets. Bond investors depend on the issuer’s cash flow; investors of structured products depend on the performance of the underlying securities which is typically an index or a basket of other securities.

Let’s take collateralized mortgage obligation (CMO), a notorious security believed to be one of the reasons behind the financial crisis of 2007–2008. CMO is issued by a legal entity called “special purpose entity” formed for that narrow scope — to originate and distribute CMOs to investors. So, investors buying CMOs from the special purpose entity (SPE) receive payment from the SPE on predefined criteria. However, the cash flow doesn’t come from the issuer himself but from the mortgages in the CMO pool. The mortgages in this case are collateral which comprise of tranches, specified fractions of mortgages with the same risk and reward profile.

To understand structured products better we have to understand the idea of tranching. Tranches are simply slices of the product which are the deal’s capital structure. Tranches with a first lien on the underlying assets are senior tranches. These are relatively safer investments. More risk-averse financial institutions, such as pension funds and insurance companies invest in senior tranches. Tranches with a second lien or no lien are referred to as junior tranches. These are the riskier slices of investments. Investors seeking higher yields, such as hedge funds tend to invest in junior tranches.

But as they say, there is no free lunch in finance. Tranches bear risks according to their return profile. Typically, the more senior tranches are paid first, and if there are any funds left, they’ll be distributed to the most subordinated tranches. If there is any loss in the underlying assets, it is first absorbed by junior tranches.

Struct Finance

Now that we have a basic understanding of structured assets / products / securities, let’s look at Struct Finance, the protocol aiming to bring structured assets to DeFi. What problem does the protocol solve? And how it works?

Though various protocols worked hard and succeeded at building financial primitives in DeFi, one element of traditional finance lacks; it is fixed yield. That yields of many protocols and projects are mostly variable deters large financial institutions and risk-averse investors from entering DeFi. Offering fixed-yield returns in crypto by building structured assets is the main reason behind Struct Finance. That’s why the first suite of structured financial products the protocol provides are Interest Rate Products.

Interest Rate Products

Interest Rate Products, which are also referred to as Struct Genesis Vaults, will make it possible for risk-averse investors looking for fixed yield to provide liquidity for risk-seeking investors who pursue higher variable yields. The interesting part of Struct Finance is that it not only allows investors to use, but also to build their own Interest Rate Products upon yield-bearing positions. At the moment of writing, there are two kinds of yield-bearing assets on top of which users can build their Products. These are:

• yield-bearing tokens, e.g., GLP.
• liquidity pools on TraderJoe, the largest decentralized exchange on Avalanche. By the way, Struct Finance is also built on the Avalanche blockchain.

Though users can choose on top of which assets they can offer Interest Rate Products, there are some criteria to screen the best underlying assets:

• Sustainable yield. Yield of assets should come from protocol revenue rather than token emissions.
• Security and ease of integration. In order to be included in Struct Finance, the assets should be easily integrated into the protocol and be fully audited.
• Multi-chain. The protocol will be more convenient to use if it is already present on multiple chains.

How does tranching work in Struct Finance?

Each Interest Rate Product on the protocol consists of two tranches designed for investors with different levels of risk appetite. Users looking for the stable yield with low risk can choose a fixed tranche. A variable tranche is for investors seeking higher yields.

As the image from the whitepaper makes it clear, returns from the underlying asset are distributed to the fixed tranches first. Fixed tranches are like senior tranches in structured assets in traditional finance. Recall from the discussion above that the cash flow from the underlying asset goes to senior tranches first to ensure consistent returns. If there is residual return left, it will be distributed to the variable tranche where the leverage will be applied to enhance returns. As its name suggests, the yield of the variable tranche is not stable — it may of more, less or no yield in contrast to the fixed tranche.

When a user provides liquidity into a vault, he gets Deposit tokens which are called SPf and SPv tokens for fixed and variable tranches respectively. A user depositing to the fixed tranche of an Interest Rate Product is rewarded with SPf tokens. The tokens are burnt then the investment is redeemed from the vault. For example, if you choose to invest into a fixed tranche of a Struct vault accruing yield from USDC swap fees in a TraderJoe V2 Liquidity Pool, spfUSDC will be minted and distributed to your account. Tokens received for depositing into a variable tranche are referred to as SPv tokens. For example, if you deposit into a variable tranche of a Struct vault accruing yield from the GLP token, you’ll be rewarded with spvGLP tokens which represent your share in that tranche.

Note that the tokens that can be accepted as collateral can differ from vault to vault. It is required that the deposit collateral be related to the underlying asset. Users can only deposit one token as collateral per tranche.