Borrowing and Lending the “Yield Dollar” on UMA
The first yield dollar token, yUSD-SEP20, is live now! It will also be the first token to receive $UMA rewards in the Liquidity Mining pilot.
This article describes a “yield dollar” token design built on UMA’s infrastructure. Minting resources are listed at the bottom.
This model was inspired by Dan Robinson and Allan Niemerg in their paper Yield Protocol: On-Chain Lending With Interest Rate Discovery.
The token that just launched is only one particular flavor of yield dollar token. A yield dollar looks similar to a stablecoin but has some important differences:
- It expires (a perpetual is under works)
- As the date of expiry approaches, its price will approach $1
- When it expires, it will be redeemable for $1 of the collateral asset at the exact time of expiry
- Put together, the yield dollar represents a fixed-rate, fixed-term loan
Example: Borrowing against ETH
Alicia wants to maintain her exposure to ETH, but also wants to borrow funds against it in order to use them elsewhere (possibly to increase her exposure to ETH or to buy a car.)
She locks her ETH as collateral in UMA’s contracts and mints yUSD-SEP20, which expires on Sep 1st 2020. For the sake of this example, let us imagine that is 90 days from now. She goes to an AMM like Uniswap or Balancer and sees that this yUSD-SEP20 token is trading for 95 cents.
In 90 days, she can rebuy yUSD to repay her loan and unlock her ETH. At that point, yUSD-SEP20 should trade for $1. Or, she can allow yUSD-SEP20 to expire and $1 of ETH collateral will be automatically deducted from her position balance after expiration.
This means she is paying $.05 to borrow $.95. The interest rate calculation for that is:
Where n is the time in years until expiry, or 90/365. For this example, we have (1 / 0.95)^(1/0.2465) -1 = 23%.
Note: although the example showed yUSD trading at a discount to its expiration value of $1, it is also possible for yUSD to trade at a premium and thereby give the minter the equivalent of a negative interest rate loan if there is lots of demand from users to buy yUSD!
Example: Holding yUSD for yield
Robert is on the other side of this equation. He goes to an AMM and sees that yUSD-SEP20 expires in 90 days and is trading for 95 cents. He sees that this is equivalent to a 23% APY and decides that he would like to earn that return on his capital.
His process is simple: He buys yUSD-SEP20 and holds onto it. As the 90 days pass, the yUSD-SEP20 expires, and he is able to redeem it for $1 of collateral, capturing his yield along with it.
Flavors of Yield Dollar
Yield Dollars (yUSD tokens) have different flavors, and vary in these ways:
The token “expires” on this date which is contained in the token name, such as yUSD-SEP20 which expires on September 1st, 2020.
What happens at expiry? It means that instead of acting as a “yielding stable value token” it will instead be redeemable for exactly $1 of the underlying collateral at the exact time of expiry. They will forever be redeemable for their underlying collateral, and are therefore never valueless; merely they “turn into” a certain amount of that underlying collateral.
Underlying collateral type
Any approved collateral type in UMA’s contracts may become the basis for a yUSD token. For yield dollar minters, this means that they can use the system to generate leverage on all approved collateral types once that particular combination has been launched.
Tokens that differ by the expiry date or underlying collateral are not fungible.
Interest Rates: Maker vs. Compound vs. yUSD
The mechanisms by which the interest rates are determined for yUSD are structurally different from MakerDAO and Compound’s mechanisms.
Compound uses an algorithm to determine interest rates based on utilization. Nothing stops utilization from reaching 100%, although it rarely stays there for long. In these occasions, pools become fully utilized and lenders are unable to withdraw capital. The rates are optimized to encourage the market to keep the lending pools solvent.
MakerDAO adjusts interest rates with the goal of keeping the peg of 1 Dai = $1. These rates are the cost of borrowing (stability fee) and the returns to holding (Dai Savings Rate.) They are adjusted by governance vote. There are extraneous forces that can pull the price of Dai off-peg, and governance is tasked with adjusting interest rates accordingly.
Rates on both protocols are variable.
In the case of yUSD, the interest rates associated with yUSD move freely on the market AND rates are fixed at the time of trade.
An Extraneous Market Force: Liquidity Mining
There is one extraneous market force that will affect the prices and interest rates of the yUSD-SEP20 ETH token: liquidity mining.
Risk Labs has decided to bootstrap liquidity for this synth by offering liquidity mining rewards in $UMA tokens for users who contribute yUSD liquidity to a specified AMM. The reason this is an extraneous market force is because it will affect the funding rate.
The details of this will be released shortly and linked here.
As always, please join the Discord community for questions and discussion.