A new leveraged instrument will make it extra easy for Defrosters to leverage their non-stables positions
It has been almost three months since the birth of Defrost Finance. We have witnessed great growth in both TVL and the use-cases of H2O, none of which could have been possible if it was not for the continuous support and contribution of the amazing community backing Defrost. In other words, you.
The development work has never stopped, and now we are excited to present you with the next big protocol update. (Which was not on the previous roadmap, by the way.)
This new update is a separate group of smart contracts, inspired by the current Defrost model and our core advisory team. It will work independently from the existing stablecoin protocol.
It is not named yet and hopefully, our communities can think of a name. (More info here.)
One of Defrost Finance’s previous innovations is the Super Vault, which allows users to harvest all of the rewards from their yield-bearing collaterals, including transaction fees, mining incentives, rebasing incentives, and more. Basically any rewards you may think of.
These vaults also bring one of the most successful use-cases of H2O, a leveraging tool. Users can deposit yield-bearing assets, like the av3crv LP from Curve, to mint H2O, then convert back to stablecoins, and loop it once again. Aggressive users may leverage by more than 10x with this stablecoin farming strategy, while risks of getting liquidated stay very small when using stablecoins.
Given the popularity of these instruments, the Defrost team began wondering whether it would be possible to duplicate the mechanism above to non-stable assets — facilitating the leveraged mining positions, but still with minimum risks of liquidation.
The good news is, we think we have found a solution.
The coming update of the defrost protocol is a new group of contracts independent of the current stablecoin protocol, creating a group of synthetic assets fully backed by yield-bearing underlying tokens in super vaults.
These synthetic assets will be a series of instruments providing leveraged mining yields for users.
Just like for other rewards, liquidity providers of the synthetic assets will also be rewarded in MELT.
How does it work?
(Please note that the brief introduction here is based upon the current prototype and the final deployment may be subjected to changes.)
To make it easier to understand, we will take AVAX as the underlying asset in this introduction and name our protocol the “L-Protocol”.
The new L-Protocol will accept the yield-bearing AVAX as collateral, like qiAVAX on Benqi, aAVAX from AAVE, or assets from liquidity staking protocols. Users can deposit yield-bearing AVAX into the L-Protocol’s supervault to continue accumulating their yields, while at the same time minting L-AVAX, a synthetic asset fully collateralized.
L-AVAX is 100% backed by the yield-bearing AVAX in the supervault, and soft-pegged to 1 AVAX.
The protocol will only record the amount of minted L-AVAX as the users’ debt. Because the collaterals are all yield-bearing AVAX, and continuously increasing in amount, L-AVAX minters are very unlikely to get liquidated.
An L-AVAX/AVAX liquidity pool will be created on Curve, and liquidity providers will be rewarded in MELT with a boosting mechanism similar to the one currently deployed.
The benefit of the L-Protocol
- This protocol is targeting a different group of investors compared to those who are using the current stablecoin protocol. AVAX hodlers and believers will have a leveraging tool to harvest enhanced returns in AVAX, potentially bringing a whole new community to our platform.
- Liquidation risks are limited, as the collateral is naturally yield-bearing in AVAX and higher than stability fees accrued. Chances that the users may get liquidated are so small that the L-Protocol may even end up not having a liquidation function when we deploy the contracts.
- As L-AVAX is fully collateralized and soft-pegged to 1 AVAX, the L-AVAX/AVAX liquidity providers also face limited risks, while harvesting transaction fees and MELT incentives.
- Users may loop the AVAX yield strategy with high leverage and limited costs. The main cost is the stability fees for minting L-AVAX, entry tickets in MELT and possible slippages when trading L-AVAX for AVAX.
- The protocol can accumulate fees from stability fees of minting L-AVAX, and compounding incentives in the supervault, which will all ultimately benefit MELT stakers.
- The mechanism can also be easily extended to ETH or WBTC as underlying assets, to tap into ETH or WBTC hodlers.
Examples of the yielding strategy in L-Protocol
- Alice is bullish on AVAX and has a position on Benqi worth 1000 AVAX, currently earning 7.5% in APR. She contributes her qiAVAX in the L-Protocol’s super vault and mints 950 L-AVAX. She then pairs those with another 950 AVAX, contributes them into the L-AVAX/AVAX Curve pool and stakes the LP token to mine additional MELT rewards.
- Bob is bullish on AVAX and has a 1000 AVAX position on Benqi, currently earning 7.5% APR. He contributes his qiAVAX in the L-Protocol’s super vault and mints 950 L-AVAX. Then he sells 950 L-AVAX for 949 AVAX, and deposits them on Benqi to get qiAVAX again. He loops this process 14 times to get an almost 10x exposure on his Benqi position.
- Sam is bullish on both AVAX and MELT. He discovers there is an imbalance in the L-AVAX/AVAX Curve pool — for example, L-AVAX is being traded at 0.99 AVAX. He contributes AVAX into the pool, to get a favorable bonus on the LP tokens, and contributes them to the MELT mining contract for MELT rewards.
One may easily copy one of the three strategies above with different underlying assets like WBTC or ETH, of course.
The Defrost team believes this update of the Defrost protocol will provide additional flexibility and use-cases for yield-hunters with different risk-return profiles. Non-stablecoin holders can have a low-risk leveraged yielding position in the underlying assets, attracting additional TVL and accumulating fees, which will ultimately benefit MELT stakers.