Introducing risk tranching to DeFi: cDAI fixed vs. turbo return
First CDO in decentralized finance are here
What is risk tranching?
It is a straightforward way to redistribute the risk effectively among different participants. Tranches are segments created from a pool of assets. Risk tranching (also known as CDOs) is widely used in traditional finance and may be utilised in the current DeFi, efficiently splitting the risk.
cDAI tranches
The initial pool is based on interest baring tokens, in this case, cDAI. Two tranches are being created and tokenised for participants:
- Senior tranche (lowest risk). Participants of this tranche can expect a fixed 7% return on their cDAI at maturity; If cDAI earnings are above 5%, they will be allocated to the junior tranche. If cDAI earning are below 5%, this pool will get compensation from the junior tranche.
- Junior tranche (highest risk). Participants of this tranche will receive all interest left after having paid 5% to the senior tranche. This pool is smaller and will have boosted returns: turbo profit or turbo loss, compared to a 5% fixed rate.
Participants choose the pool based on their risk appetite and market views. Investors that participate in the senior tranche would receive a 5% total return on their cDAI, however, they could have easily earned 20% or higher by participating in the junior tranche IF the floating rate would be that high over the period. In the opposite scenario, participants of the junior tranche would earn small to negative returns in case the effective rate happens to be low over the period. We call the junior tranches “turbo” instruments because of this potential volatility.
How it works
When cash flows are received from cDAI, they are allocated to the senior tranche until its promised return is fulfilled. The junior tranche will receive anything that is left after those payouts. On the settlement date (end of epochs) you can withdraw your funds back including your interest.
In case the total yield on cDAI is larger than the promised fixed-rate, the junior tranche will receive all extra interest, effectively boosting the total return for its participants significantly. At the same time, any negative surprises on the cDAI floating rate will impact the junior tranche first. In case the epoch’s effective rate is lower than the promised fixed-rate, the senior pool will still be filled as promised, but less interest will be left to the junior pool.
Another way to understand the mechanics of the distribution is to imagine a ‘waterfall’ with the participants holding the tranches like buckets. The senior tranches get filled first; anything left falls into the junior pool at the bottom.
How to participate in the tranches
Have you noticed we have taken your feedback and deployed a different interface at Opium.Finance? It is super simple to buy or sell decentralised analogs of derivatives. They are packaged into simple and logical products for anyone to use, such as Protection instruments and Turbo instruments.
It is straightforward to participate in the senior tranche. Like buying insurance for the fixed-rate, you need to specify the nominal amount and accept the quoted fixed rate. The fixed-rate is annualized and calculated until the end of the period.
Participation in the junior tranche is riskier, and the total return also depends on leverage (utilization of the pool), which gradually increasing. If the effective cDAI rate is larger than the quoted fixed rate, you will have leveraged profit and leveraged loss otherwise. However, the interface is also super simple here.
New Liquidity pre-Mining Program
The new cDAI Leveraged deposit. Junior Tranche receives leveraged yield from cDAI (5% breakeven rate), but also it is eligible for liquidity mining campaign of Opium. You can participate by staking cDAI during the staking phase that lasts for two days. Details of the campaign will be confirmed when the actual liquidity mining starts.
It is crucial to understand the staking terms; for instance, you will be able to un-stake your cDAI (including yield on the tranche) during the next staking phase. Please also understand your exposure as you may receive leveraged profits or losses.
There is no 100% guarantee that there would be no exploits in the smart contracts, besides several audits were provided. Opium Staking is in beta, and you are using it at your own risk, never stake money you can not afford to lose.
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