Behind the Tranched Curtain
This article sets out to answer the most important question in DeFi.
Where exactly does the yield in Struct come from?
As the saying goes…
If you don’t understand the source of the yield, you are the source of the yield.
To answer this question, we’ll grant our users insights into the inner workings of Struct Finance.
This article provides a technical overview of:
- The Fundamentals of the Struct Finance Vaults
- The journey of user funds after they deposit in one of our vaults
- Which factors affect the rate of the underlying asset ($GLP)
- How the $USDC and $BTC.B Variable tranches differ in rate mechanics
All of the above will paint a picture of how the yield in Struct Finance products is sourced.
To begin, we must go through a primer on tranching and the underlying mechanisms of our vaults.
Tranching and Investment Options
Struct Finance Vaults are Interest Rate Products and are not to be considered structured products.
They offer users the ability to reconfigure the risk of yield-bearing assets in DeFi, according to specific risk profiles, thanks to the magic of “tranching.”
What exactly is tranching?
Tranching allows us to divide the risk of an underlying asset into a fixed and a variable component, each bearing different risk exposure.
This enables us to change the risk profile of investments, and prioritize the order in which cash flows are returned to investors.
Unlike traditional structured products, Struct Finance Vaults provide greater flexibility and control over investment strategies.
How Tranching works in Struct Finance
At Struct Finance, we use a waterfall mechanism to distribute cash flows to our investors, as exemplified in the picture below.
At the end of the term period, Struct Vaults are converted back into their original assets (e.g. Fixed side to BTC.B and Variable side to USDC), and the returns are systematically distributed to investors.
Using our Waterfall mechanic, the principal and fixed rate returns are first returned to those who opted for the fixed-income tranche. Any remaining funds are then passed on to investors in the variable tranche.
Where does the Fixed Tranche Yield come from?
The mechanics of our Fixed Tranche are straightforward. The deposited funds are converted into $GLP, and the yield comes from the yield-bearing positions, in this case, $GLP.
This is our pre-set design to allow our users to leverage their idle assets and benefit from real yield.
The underlying assets and yield-bearing positions are carefully chosen by Struct, according to protocols that are easy to integrate, secure and generate real cash flow.
This is why we have decided to build our initial Vaults on top of $GLP.
The Fixed Tranche of individual vaults will therefore (approximately) reflect $GLP APR at the time of vault launch.
To oversimplify, the Fixed Tranche of Struct Vaults (or the Senior Tranche on the app) acts as a “reserved” yield and is always lower than the current APR value of the underlying asset.
Where does the Variable Tranche Yield come from?
Variable Rate = (2*underlying Rate) - Fixed Rate
The available yield that is left after the Fixed Side takes its share is then leveraged by 2x. However, the equation above is oversimplified, because many factors affect the return of the underlying asset.
The leverage is determined by the proportions between the Variable and the Fixed segment. By default our vaults are set at a 50:50 ratio, therefore the Variable Tranche always trades at 2x leverage.
Variable Yield from Stablecoins (USDC-USDC)
You might have noticed that some of our vaults display varying APRs, some have a 200% APR USDC-USDC while others have a ~40–60% APR.
There are a multitude of causes and circumstantial factors influencing this disparity — but one stood out above all else for the early Struct Vaults:
BTC’s unprecedented leg up in price in the latter half of July.
In the case of the 200% APR vaults, they happened to be opened when Bitcoin was rising in price — therefore, the yields of the underlying assets of our vaults reflected this price action.
For instance, at the time of our vault launch, the GLP APR was up to 50%.
Among other factors, during this sustained price move by BTC, short GMX traders were getting liquidated, further increasing GLP APR.
In addition to this, the Variable Side of our Vaults is incentivized with wAVAX rewards according to the length of the Vault: longer-term Vaults are incentivized to a greater degree, due to the fact that users are locking their funds for a longer period of time.
To sum up the causes for the high APR of early Struct Vaults:
- $BTC jumped from $25,000 — $30,000
- $GLP Value increased as a result of this
- GMX Short positions got liquidated due to $BTC mooning, causing influx fees
- $GLP APR benefited from all of the above (was 50% at the time of vault launch)
- The AVAX-rush incentives gave the vaults a final boost.
As you can see, there are a lot of factors contributing to the difference in APR between our vaults, and they are very time sensitive: the timing of a vault can significantly impact its performance!
The Variable Tranche is called “variable” for a reason.
Variable Yield from Volatile Crypto (BTC.B)
You’ll notice the difference in assets that can be deposited on the variable side of our vaults.
For now, users can either deposit volatile crypto ($BTC.B), or stablecoins ($USDC). A Struct Vault “buys” $GLP using either of these two assets.
Here’s the difference:
$BTC.B is a volatile asset compared to $USDC, its price can experience significant fluctuations and decouple from the $GLP price and therefore carries an extra layer of risk.
In such cases, there is a possibility of a loss in the APR as the $BTC.B deposited in the vault is used to purchase $GLP.
The repayment of $BTC price, which may have increased in $ terms, can pose additional challenges if $GLP lags behind or remains stagnant.
Let’s have a practical example, assuming that:
- 1 $BTC price is $30,000
- $GLP price is $30
- The total value of our vault is $60,000 ($30k in BTC and $30k in USDC).
- A user deposits 1 BTC in our vault, and the funds are used to purchase 1000 GLP.
If BTC Price Rises:
If the $BTC price goes up 50% but the $GLP price goes up only 10%, the users will suffer a depreciation of the funds deposited.
The $GLP in the vault will now be worth $33,000, while 1 $BTC is now worth $45,000.
Accordingly, the user will only receive 0.73 $BTC.
The reverse is also true.
IF BTC Price Drops:
If the price of $BTC drops 50% and $GLP only drops 10%, users would still be profitable.
• If $BTC drops by 50% the value returned to the Fixed tranche would be ~$15,000 (50% of $30k);
• If $GLP drops by 10%, its total value would now be $54,000 (since the Vault has used the $60k deposited to purchase 2000 GLP).
As a result, the total amount left for the Variable side would be $39000, which means a $9000 gain.
These scenarios highlight different strategies that users could leverage using our vaults.
With all being said, the best outcome for depositors of $BTC.B on the Variable side would be a gradual increase in the value of $BTC, keeping pace with $GLP, or ideally, witnessing a simultaneous rise in both assets.
Conclusion
In conclusion, Struct Vaults provide investors with a variety of investment options tailored to their risk profiles. By understanding the tranching process and inherent risks, investors can make well-informed decisions.
Despite the higher returns promised by the Variable side, prudent risk assessment is crucial.
While Struct Vaults offer a range of investment options catering to diverse risk profiles, it’s vital to be aware of the associated risks before investing.
Even though the fixed side is less risky than the variable side, it should not be deemed risk-free.
Furthermore, unanticipated events like another Terra or a de-peg of $USDC could lead to unexpected drawdowns in the vaults.
For example, in our $USDC-$USDC product, funds are locked up for a specific duration, such as 2 months, preventing users from making early withdrawals.
It’s essential to understand and consider these potential risks associated with the performance of underlying assets and market conditions. Our goal is to build a platform that allows users to accrue value and yield while offering transparency and community engagement.
We are committed to serving our community and welcome any questions or feedback you may have.
Together, let’s navigate the world of DeFi and unlock new possibilities.
