Monetising your Vaults: the inner workings of fees on Enzyme
Enzyme Vaults can charge different kinds of fees, with different purposes. For example, there are fees that compensate the vault manager’s daily work in managing the deposited assets (the Management Fee) or there are fees that incentivise the manager to strive for a positive long-term performance for depositors (the Performance Fee).
Fees in Enzyme Vaults are not new, they have existed in Melon v1 as well. However, Melon v1 suffered from various shortcomings, which we have been able to fix in Enzyme v2. Apart from removing the shortcomings, we have also improved the overall protocol architecture by making fees more modular (they are no longer interwoven with the core functionality).
In what follows, we are going to give a high-level overview of all available fees for Enzyme Vaults. In particular, we are looking at the purpose of each fee and its mechanics. For those who want to dig deeper, we are also linking to the detailed fee specifications and fee formulas.
Good to know
Fees are mostly paid automatically, i.e. without manager intervention
Fees are always paid in shares of the vault. This is a) technologically simpler, b) safer, and c) aligns the manager with the vault (by default, fees do not leave the vault in this way and therefore participate in the future performance of the vault)
Entrance Fee
Purpose
The Entrance Fee is a fee that covers up-front costs that the Enzyme Vault or the manager may have in accepting a new deposit. Examples of up-front costs are rebalancing costs, or KYC costs. Entrance fees also mitigate a potential arbitrage of the share value by investors.
Parameters
Fee rate (%): a one-time percentage rate of the deposit amount.
Mechanics
Whenever a depositor deposits a certain amount of the denomination asset into the vault, the depositor receives shares from the vault, which are newly minted. Entrance Fee is charged by transferring a certain percentage of those newly minted shares either to the vault manager or to the vault (depending on the configuration of the fee). If the vault is to receive the fee shares, they are instantly burned, from which the whole vault (i.e. all current depositors) profits.
Management Fee
Purpose
The Management Fee compensates the manager for the day to day management of the vault. This generally includes research, defining and adapting investment strategies, as well as monitoring.
Parameters
Fee rate (%): an annual percentage rate of the number of shares in existence.
Mechanics
Management Fee accrues continuously, and it is automatically paid whenever there is a new deposit or a withdrawal. The calculation of the fees due is based on the number of shares in existence (before the new deposit or withdrawal) and the time passed since the previous payout. In addition to the automatic payout, vault managers can also claim accrued fees at any time they desire. This can come in handy if the depositor base is unchanged for a prolonged time.
The detailed specifications and formulas can be found here.
Example
The vault has a management fee rate of 1%. Initial investor A buys 100 shares. Thirty days later, investor B buys 200 additional shares. After 365 days, both investors redeem all their shares.
Management Fee payout happens automatically on two occasions:
- When investor B buys their shares, management fee is due for 100 shares for thirty days. We use x = 1%, t = 30 / 365, and S = 100 shares, which gives the manager 0.0826 shares as management fee, according to the following formula:
- When both investors redeem, the management fee is due for 300 shares for 335 days. The formula is the same as above, with t = 335 / 365 and S = 300 shares, and the manager receives an additional 2.78 shares.
Improvements to previous versions of the protocol
We have changed to a continuous compounding formula, which is more precise if the fee is paid in shares and the shares stay in the vault. The previous implementation led to a very small underpayment of vault managers.
Performance Fee
Purpose
Performance Fee is an incentive for a vault manager to generate positive performance. A crystallisation period is used to disincentivize excessive risk taking and to prefer consistent positive long-term performance.
Parameters
Fee rate (%): a percentage rate of the positive performance of the vault.
Crystallisation period (time): a minimum time after which accrued fees can be paid out.
Mechanics
Performance fee is accrued whenever the share price of the vault is higher than a reference share price (the “high watermark”). When the first shares are minted for the vault, the share price is equal to the high watermark. Performance fee is automatically accrued (but not paid out) with every deposit or withdrawal. The fee amount is based on the number of shares in existence (before the new deposit or withdrawal) and the performance of the gross share price since the previous deposit/withdrawal (but only positive performance above the high watermark counts). If the share price drops the accrued performance fee can also decrease again.
Fees are accrued as shares, and as long as they are not paid out, the vault contract owns those accrued fee shares. Payout is possible after the end of each crystallisation period, during the whole next crystallisation period.
Performance fee is only payable after the effect of the management fee has been taken into account, i.e. a vault manager needs to generate a positive performance after management fee.
The detailed specifications and formulas can be found here.
Example
The vault has a performance fee rate of 10% (and no management fee, for simplicity). The crystallisation period is 90 days. Initial investor A buys 100 shares for a share price of 1 USDC / share. Thirty days later, the share price has increased to 1.45 USDC / share (with a corresponding gross share price of 1.50 USDC / share). Investor B buys 200 additional shares for the share price of 1.45 USDC / share. After 365 days, the share price has increased to 1.81 USDC / share (with a corresponding gross share price of 1.9 USDC / share), and both investors redeem all their shares.
Performance Fee accrual (not to be confused with payout) happens automatically at two occasions:
- When investor B buys their shares, performance fee is allocated to the manager for a performance increase of 0.5 USDC / per share for 100 shares. The manager has created wealth of 50 USDC for the depositors (0.5 USDC per share * 100 shares), and with a performance fee of 10%, the manager receives a number of shares with the value of 5 USDC, which is 3.45 shares (at a share price of 1.45 USDC). These shares are not immediately paid out to the manager, but the manager can claim the shares when the crystallisation period ends, i.e. after an additional 60 days.
- At the end of the year, both investors redeem. Since the last deposit, the manager has created wealth of 120 USDC for the depositors (0.4 USDC per share * 300 shares), and the manager receives shares equivalent to a value of 12 USDC, which is 6.63 shares (at a share price of 1.81 USDC).
Improvements to previous versions of the protocol
Performance Fee calculations now take into account changes in the share base during a crystallisation period, and it no longer punishes depositors who deposit their assets in the middle of the crystallisation period.
Further reading
Summary
Enzyme Vaults use fees to compensate the vault manager and to align interests between the manager and the depositors.
Fees have been completely redone from scratch for Enzyme v2, using a modular and extensible architecture. In that process, all fee formulas and fee mechanics have been reviewed and improved.
