Apr 2, 2022
Vyper Protocol Analysis — Bringing Tranching to DeFi
Welcome to another one of our deep dives, let’s talk about DeFi this week. If you’re a DeFi degen, you’ve probably invested with a DeFi protocol at some point. While these protocols offer lucrative returns that TradFi can’t even compete with, it also comes with many risks.
Most risk management systems on the market faces the problem of capital inefficiency. Hacks still happen all the time and it seems like every other day a project gets scammed or rug-pulled. This week we’ll be diving into a protocol that aims to solve this problem uniquely. We’ve partnered up with Vyper Protocol — a risk management tool on Solana that brings tranching into DeFi. Don’t worry if you don’t know what risk management is or what tranching is, I’ll be breaking everything down in this article. As usual, this is not financial advice but only educational content. Please don’t be dumb and always DYOR on any crypto projects.
Table of Contents
1. Summary
2. Overview of Vyper Protocol
3. Tranching explained
4. Technical Features
5. Roadmap
6. Q&A
7. Concluding Thoughts
Part 1. Summary
The TL;DR for all of you who’s too lazy to read through the whole thing.
- Vyper Protocol is the first tranching protocol for effective risk management on Solana, enabling permissionless tranching of any yield-generating asset.
- Vyper was the 4th place winner in the recent Convergence hackathon hosted by Serum and Wormhole.
- Vyper Vaults is the first Vyper Application Layer built on Vyper Protocol. It allows for safe and yield-enhanced lending across Solana.
- There are two risk profiles, Risk Hater and Yield Lover, for users to choose from.
- Through integration with Serum CLOB, users are able to mint their tokenized position in the vault and sell it on the open market during the middle of an epoch.
- Vyper supports lending and borrowing first, more exotic financial instruments like Yield Farming later.
- Bridging TradFi and DeFi will unlock the liquidity the space needs, with Vyper bringing in the correct risk management framework for this.
Part 2. Overview of Vyper Protocol
Even with the volatility that crypto markets experience, DeFi market continues to grow at a large scale. DeFi market cap was at $67B in March 2021, it now sits at almost $115B at the time of writing. It’s evident that the demand for DeFi continues to grow.
First, let’s address the current problems in DeFi.
1. Users can’t choose the level of risks and reward they want to take on.
2. Current risk management systems in DeFi are either capital inefficient or ineffective.
3. No reliable way to hedge against losses coming from hacks or impermanent losses, preventing potential capital from flowing in and mainstream adoption of DeFi.
Vyper Protocol solves this by enabling permissionless tranching of any yield-generating asset, whether it is a yield-farming LP or a more vanilla lending deposit. Vyper is the first tranching protocol for effective risk management and yield sharing on Solana.
The core vision is to become THE risk management primitive for DeFi through three initiatives:
Reshape — bringing an original approach to risk management in DeFi and opening new frontiers.
Disrupt — allowing entire new ecosystems to be built on Vyper, including innovative application layers and use cases.
Unlock — enabling access to untapped sources of capital by bridging TradFi and DeFi.
The team behind Vyper Protocol has over 27 years of experience in crypto combined. They each hail from different backgrounds and have different areas of expertise.
Vyper was the 4th place winner in the recent Convergence hackathon hosted by Serum and Wormhole.
Part 3. Tranching explained
So how does Vyper bring tranching to DeFi? The protocol pools assets together and tranche them, efficiently distributing risk and returns. Let me give you an example using a lending protocol.
Alice and Bob both deposit $50 on a lending protocol. Alice takes the SENIOR tranche, she earns a smaller share of the interest generated (less risk, less yield). Bob takes the JUNIOR tranche, he earns more but he will be impacted first if any loss happens (more risk, more yield). Vyper wants to bring this simple concept to all interest-generating assets.
Part 3.1 Tranching in TradFi
This is about to become a mini finance class, but unlike my university professors, I’ll try to explain things in a way that’s easier to understand.
Tranches represent segmented debt instruments, including collateralized debt obligations (CDOs) and collateralized mortgage obligations (CMOs).
CMOs are mortgage-backed securities (think a bunch of mortgage loans that get bundled together and sold as investments) that get divided into tranches.
CDOs on the other hand, are similar but not limited to mortgage-backed securities and can include a variety of debts (credit card debt, corporate debt, auto loan, etc.)
Okay, now back to tranches. The word means portion or slice in French. When you apply that in finance, the tranches refer to the sliced form of these CMOs or CDOs that guarantees each investor a return on their investment. So, tranching means segmenting these pools of securities with different degrees of risks, rewards, and maturities to attract investors. By doing so, investors can customize their investment strategies based on their cash flow needs and risk appetites.
There are three different types of tranches, based on different risk tolerances.
1. Equity/Junior — promises better returns but at a higher risk, seasoned investors usually prefer these.
2. Mezzanine — carries a moderate level of risk and expected returns.
3. Senior — includes securities with lower risk but also lower returns, more suitable for investors with little exposure.
If the market economy is good and borrowers repay on time, returns would be as expected for all three tranches. However, if market conditions are horrible, nothing will change for mezzanine and senior tranches. They will both get their expected returns with no significant risks. Equity tranches in this case, will receive lower returns and suffer a bigger loss.
Part 4. Technical Features
Vyper Protocol is deployed as a set of smart contracts on Solana. These smart contracts enable the permissionless creation, management and redemption of tranches, as well as the deployment of locked funds to integrate protocols.
Vyper Protocol is a middle layer on top of existing financial primitives, and thanks to it’s open source and composable approach it can open up to a new class of risk-based financial products like insured yield farming, algorithmic stablecoins, NFT-collateralized lending or structured product protocols.
Vyper Vaults is the first Vyper Application Layer built on Vyper Protocol. It allows for safe and yield-enhanced lending across Solana. In V1, each Vault represents a pair where funds are deployed (eg. SOLEND, USDC)
Users deposit funds in a vault and select their risk profile: Risk Hater (RH) or Yield Lover (YL), The two risk profiles determine the APY and what happens to the funds in case of any hacks/defaults.
Vaults run in epochs of 7 days, they automatically deploy and auto-compound funds. The lifecycle of each Vault is divided into 3 main phases.
- Set Up
In this phase, funds are collected and the interest split is decided. While an epoch is in progress, there’s a concurrent setup phase for the following epoch. Capital and interest split are updated every epoch and apply to all outstanding tokenized positions. - Deployment
This phase lasts an entire epoch. It is when all the funds deposited on the lending protocol start earning interest. During this phase, users can deposit funds for the next epoch, mark funds for withdrawal for the end of the epoch, or mint/redeem their tranches. - Distribution
This phase concludes the cycle. Funds marked for withdrawal are available for users. The rest is automatically compounded and a new epoch starts.
Liquidity
Through integration with Serum CLOB (central limit order book), users are able to mint their tokenized position in the vault and sell it on the open market during the middle of an epoch.
This function greatly diminishes liquidity risk as users can trade in and out of their position without having to wait for the next epoch. This also creates interesting dynamics where traders can speculate on future interest rates, default risks, and recovery rates.
Part 5. Roadmap
Part 6. Q&A
Shoutout to solbricklayer and the rest of the Vyper team for agreeing to do this and for answering some of our questions.
Q: What lending protocols have you partnered with?
A: Right now we integrated Solend, Jet and Port. The beauty of DeFi is that we do not need permission to work on top of an existing application so no formal partnerships exist yet, although we are in touch with the teams and they are providing us the support needed. For that, thank you!
Q: How many assets will Vyper support?
A: All the assets supported by the underlying platforms are also supported by us. So lending and borrowing first, more exotic financial instruments like Yield Farming later.
Q: Any plans on adding more risk profiles in addition to RH and YL?
A: Yes, definitely. As we go to mainnet and we gather more real data inputs about risk preferences of users and use cases of the tranching protocol, we plan to extend also the number of tranches with it. In tradFi for example the classic setup is 3 tranches (in order of yield they are junior, mezzanine and senior).
Q: How did you begin this journey of creating Vyper?
A: The team has been involved in DeFi since the first DeFi Summer, on top of that we also have finance backgrounds, thus we have an understanding of what makes sense for financial markets. In our view what is missing now to scale up DeFi is a set of infrastructure protocols to manage risks that make the ecosystem stronger and more resilient. For example tranching.
Q: What was the process of entering the Convergence hackathon like?
A: It was quite a rush, building the protocol from scratch and putting up a user interface for sharing a visual UI in just a month was for sure challenging. But it is also what made us accelerate and grow faster.
Q: What does winning the Convergence hackathon mean to moving Vyper Protocol forward?
A: The hackathon has helped us a lot to get visibility and entering into the Serum Accelerator, a 10-week long period of coaching and mentoring from the Serum team. It is helping us massively to develop our product faster and move quickly from the idea stage of the hackathon to the go-to-market phase.
Q: What are some challenges you faced while building on Solana?
A: The chain is pretty new, and the tech stack as well which means finding support and resources is still challenging, and same for scaling the team.
Q: What are some things you’re excited for Vyper Protocol?
A: For sure composability! Lots of projects from very different domains can integrate with us and use our protocol to create new products on top of their existing ones. We are looking forward to that.
Part 7. Concluding Thoughts
Vyper Protocol is building a product that aims to bring tranching to DeFi, to elevate risk management starting with Solana. Bridging TradFi and DeFi will unlock the liquidity the space needs, with Vyper bringing in the correct risk management framework for this.
The team has strong backgrounds and expertise in finance and has been involved in DeFi since the very first Defi summer. They are very spear-headed in building out Vyper to the fullest while utilizing its composability to integrate with a vast of other projects.
There has been a huge wave of new projects building on Solana, many of which are exploring innovative ideas that haven’t been seen before on other chains. Obviously, I’m super bullish on Solana but also the protocols building on top of it. While chatting with all these projects, it’s evident that one thing they all have in common is that they’re super friendly and supportive of everyone in the space. I’m excited to see what Vyper Protocol will continue to build, and how they will revolutionize DeFi risk management.
Make sure to follow Vyper Protocol’s social media so you don’t miss any of their updates.
https://twitter.com/VyperProtocol
https://discord.com/invite/khmEm8Ugd5
That’s all for this week, hope y’all enjoyed this project collab piece. Disclaimer: this deep dive is done in collaboration with Vyper Protocol, however I’m not affiliated with Vyper Protocol in any way. This article is written with the sole purpose of providing a more in-depth understanding of this project to more users.
As always, this is not financial advice but merely my own honest opinion. I’m not a financial expert so always DYOR on any crypto projects.
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Toodles!
-SixOhFour
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