The $warp magazine edition #06
Star Warps; Rogue One
Welcome to the sixth instalment of the Warp Magazine, and the last of 2022. As always, the idea behind the Warp Magazine is to unravel the unique components of the Warp technology stack, and spill some ‘alpha’.
Usually, the Magazine is also accompanied by a ‘Devlog’, however, as noted in our last edition we are actively looking to engage more solidity developers resources. There have been lots of discussions, but we were not able to solidify any outcomes in time for this edition. Before posting about development progress, we’d like to have clarity over our new team structure and its organization, and thus this magazine edition will omit the devlog section until there is more clarity on the above. We will provide a more formal update as soon as possible, but won’t be answering individual questions on the topic until this is finalized.
While waiting on an update to resources, please note that we have made progress on other elements since the previous update; for example, liquidation testing of the new pair types (testnet and mainnet) which is required before pair deployment, and implemented many front end improvements (most pushed to production already). More details and the outcome of such tasks will be provided in the upcoming devlog update.
As always with the magazine, here are a list of some important links;
- Warp finance website
- v2 dApp platform
- Deconstructing the Warp vision (the three pillars)
- $warp magazine edition #01 (WARP, the ultimate incentive mechanism)
- $warp magazine edition #02 (Looping, the ultimate gains multiplier)
- $warp magazine edition #03 (Chisel, the ultimate DeFi yield aggregator)
- $warp magazine edition #04 (Lending versus minting)
- $warp magazine edition #05 (Chisel; LP-as-a-Service)
- Old v1 platform
Since the last update, we had some excitement with Warp trending for multiple days, including a brief stint at the #1 spot on Dextools. There were rumors that this could be attributed to a new Warp community member, @elonmusk.
While we don’t actually believe @elonmusk intended to tweet about Warp Finance to his 122M followers, we did recently learn that a large well known verified account with 8.5M followers is following us… Who could it be?
On to the questions:
Q.1: Can I stake my warp? (@VictorTelegramVic , Telegram)
Answer: At the moment, there is no active staking mechanism in the WARP v2 app, however once veWARP is live you will be able to stake your WARP in exchange for a share of the platform fees, and to participate in governance.
Q.2: Guys, what’s veWARP? (Gaston, Telegram)
Answer: $veWARP is the vote escrow representation of the $WARP token. It reduces the circulating supply (locks $WARP) in exchange for governance and fee sharing for the protocol.
The governance aspect provides direct control over what pairs are listed, and also how much TVL to assign to each. In previous editions of the magazine (for example, here) we break down why this governance is uniquely valuable. If parties chose to participate in locking but are ambivalent to voting, it may be possible that they will receive bribes for delegating (à la Votium) in addition to the income from fee sharing.
Q.3: Are there collabs with other projects coming soon? If yes what kind of collab will it be? (@CryptoPortal2, Twitter)
Answer: There are a number of projects with whom we have been discussing plans for integration of collateral assets or capital. Ideally any new collateral explored presents a unique opportunity for leverage farming yield that does not exist elsewhere in DeFi. One such example could be a principal protected yield USDC vault, which would allow massive leverage without risk of liquidation.
However, once veWARP is launched, ideally we would not integrate new assets for ‘free’ without reciprocal commitments from the other platform. Instead we should strive to market our value/USP (i.e. B2B applications) to entice the 3rd party protocol to accumulate veWARP and participate in governance to vote to list their asset and assign capital to it. Having many active B2B participants in this regard will make for a robust and competitive market, and also ensure the third party is actively engaged in the partnership and success of the WARP ecosystem long-term.
As always, BatBird section is back with some thoughts on the potential of Warp’s unique technology stack.
Our previous edition, Warp Magazine #05, discussed the first of our five target B2B applications; LP-as-a-Service, for offering 3rd party protocols the opportunity to use Warp to deepen liquidity of their native token. As part of this, we described the use case for protocols to use veWARP governance to firstly vote to implement their LP receipt tokens as collateral, and then direct Chisel TVL towards this LP to increase the depth of this liquidity. We provided some math as to how this could become a more economical way for protocols to attract liquidity for their token compared to the current methods of offering liquidity mining through native emissions, or via external incentivised platforms such as CRV/CVX. If you missed this article, it may be worth giving it a read before this installment for background, as this second B2B application follows a similar direction.
This edition will focus on the 2nd identified B2B application, which focuses on one of crypto’s biggest addressable markets; stablecoins;
“Stables are the killer app.
Find protocols that make stables permissionless and defensible.
Find infrastructure that makes stables do their thing better”
Stablecoins — “Crypto’s killer app”
Although it may not be immediately obvious, stablecoins offer one of the biggest drivers and opportunities for crypto mass-market adoption. As much as we love ETH or BTC as a native currency of the internet, it is stablecoins which tie web3 to the GDP of the real-world, and thus will likely dominate the near-term future of ‘normie’ adoption. It is no surprise therefore that 3 of the top#10 coins are stablecoins, with a combined market cap that almost rivals the dominant base layer; ETH.
But how do stablecoins work? How can one tether the value of a digital token to the non-digital value of a fiat currency, especially when the newly created stablecoin is primarily traded against “volatile” assets like ETH/BTC? One method is for a centralized issuer to underwrite the digitally represented stablecoin to be redeemable 1:1 with the external fiat dollars, effectively creating a bridge such that its price can be arbitraged by the issuer and other approved entities. An example of this would be Circle’s issuance of USDC, or Tether’s USDT. Another method is to create an algorithmic pegging mechanism known as an algo-stablecoin, deriving its value from other digital assets which it can be arbitraged against. Within algorithmic stablecoins, the currency can be undercollateralized (such as Frax finance, or the late Terra UST), or overcollateralized (such as Maker DAI, SPELL MIM, Liquity LUSD, etc).
Without the ability to arbitrage with the external fiat asset directly, how do algorithmic stablecoins maintain their stability when trading against volatile assets? To maintain peg during volatility, any upwards or downwards trading pressure on the stablecoin needs to get released somewhere. However, during times of large volatility may be when this is hardest to achieve. For example, in times when faith in cryptocurrency is at its lowest, arbitraging a failing digital stablecoin against crashing digital collateral can lead to a death spiral (remember UST?). Furthermore, in volatile times of fear or greed, networks like Ethereum L1 can get congested and too expensive for complex transactions like liquidations, which can result in bad debt.
Although most over-collateralized and under-collateralised stables have redeeming functions to incentivise arbitrage by users, this is mainly only useful for large directional swings where users have time to respond en masse. However, sustained directional moves are also where protocols are liable to be caught out in a liquidity crisis (e.g. during a market dump of forced liquidations) if there are not enough liquid trading options to dampen the volatility.
Indeed, for many systems (fiat currencies included), it is the perception of stability which ends up being one of the most important factors to success. Even for over-collateralized systems where reserves are healthy, a loss of peg can send destabilizing shockwaves throughout the system. Therefore, maintaining peg by absorbing or venting the directional trading pressure to maintain the perception of stability is of utmost importance to any stablecoin project.
As it turns out the only proven way for a USD stablecoin to maintain peg with USD is to vent directional pressure into the most liquid market there is; the US fiat system itself. As Sam Kazemian from Frax Finance puts it;
“You start realizing its extremely difficult to issue pieces of paper that have an exchange rate for something [dollars] without holding a substantial amount of that thing [dollars]”
E.g. “It’s really hard to keep an exchange rate to $1, even if you have $2 of other stuff, or $2 worth of loans, and you can’t actually still keep you’re exchange rate without having some of that thing [dollars]”
In crypto “the closest thing to “dollars” is $USDC, [which is why] Maker has exposure to it, as do we….”
“If you don’t have the actual asset in your central bank / inside your build, you have to at least pay someone that does to go out to the market and make sure the unit is trading at that amount”
FRAX & the 4pool Curve Takeover | Sam Kazemian, Bankless Shows, YouTube (Link)
Effectively, the best way to maintain peg of a USD stablecoin, is to outsource the market making to the stablecoins which are directly redeemable for USD, e.g. USDC. That way, any directional pressure up or down can be vented into USD themselves, which is such a massive market comparatively it can be viewed as being static.
Although now dated, Sam’s interview on Bankless from which the quotes were taken, provides a really great introduction to the history and challenges of market-making stablecoins. Further, it is very interesting to rewatch knowing the outcome of the UST death spiral debacle.
Ultimately, the success of a decentralized algo-stablecoin is directly tied to its ability to maintain peg, and its ability to maintain peg relies not only on its collateralization ratio and algorithm, but it’s ability to be exchanged for hard cash on the markets. This requires deep market making reserves, which represents a cost to the protocol. In a previous magazine edition #04, we discussed the cost implications for Abracadabra SPELL MIM, an overcollateralized algo-stable, spending 4x their run rate just to maintain peg.
Note that maintaining a stable peg to an external exchange rate is different to simply providing liquidity for a token, as the objective is to guarantee a price, rather than simply provide liquidity at the natural market rate. This is why the market making a stablecoin is much more challenging and costly than simply providing blanket liquidity for a market price led token.
In a Magazine edition #04, we discussed the reason for deciding to lend out exogenous stablecoins like USDC, instead of minting our own overcollateralized stable like MIM. We also hinted that one of the reasons was so that we could collateralise the collateral posted on Warp. What did we mean by that? Well, by controlling USDC which is backed directly 1:1 by real USD’s, veWARP governance can assign these USD to provide a pseudo backing to algo-stablecoins and support their peg.
Welcome to B2B application number 2, stablecoin backing-as-a-service.
By having our first Chisel vault as USDC, veWARP holders will be able to control a large pot of digital representations of US dollars. One of the most attractive and biggest addressable business cases of the dollars may be to be directed to support the peg of decentralized algo-stablecoins. By making the algo-stable tradeable 1:1 with USDC, we are effectively transferring the redeemability of USDC for US dollars onto the algo-stablecoin, and therefore backing the peg of the algo-stable.
For example, we can use the looping capability to force USDC into the trading pair of the algo-stable to bolster its reserves, and thus tradeable collateral backing. For example, currently the FRAX base pool (FRAXBP) is ~63% FRAX, and ~37% USDC.
By taking in the FRAXBP receipt as collateral on Warp, the user can then borrow USDC, which can be pushed into the FRAXBP reserves, and added as collateral again. In this way, the Warp platform can direct more USDC reserves in to the pool and increase the peg backing of FRAX.
A visualization of how the process would look;
Furthermore, by adding more USDC into the FRAXBP and effectively allowing FRAX to be swappable 1:1 with USDC, we are effectively collateralising FRAX, and increasing its CR. Therefore, deepening the exogenous market making liquidity allows endogenous protocol owned reserves to be reduced (i.e. reducing their internal collateralization ratio). In this example, Frax Finance could mint more FRAX or FXS, and use this to pay veWARP for the B2B service in bribes, or to accumulate WARP to vote themselves. This is similar to what Frax currently does with Votium, for example, where it pays for bribes in FXS.
In the previous magazine edition #05, we discussed the concept of cost per TVL of liquidity depth. Using similar logic, it would be more economical for FRAX to bribe veWARP to assign capital as B2B backing-as-a-service to increase USDC reserves, rather than further saturating their CRV/CVX bribes with diminishing returns of cost per TVL. However, in contrast to CRV/CVX, directing capital towards a pool on Warp is truly rented, as only Chisel suppliers of USDC will earn WARP rewards, and thus FRAX has no way to compound/flywheel their governance power (unless they too provide some of their USDC collateral to Chisel under ‘Collateral investor AMO’ 👀).
At the same time, we can leverage the cvx derivative cvxCrvFrax, such that the Warp ecosystem will absorb the ~6% APR yield. In line with the ‘Lion’s share’ concept described in Magazine edition #03, we expect that the majority of this yield will be passed on to Chisel and its suppliers. As the FRAXBP LP collateral is ideally 50% USDC and 50% FRAX, where each FRAX has a high collateral ratio itself consisting of a large proportion of USDC, we can consider the pair to have stable collateral and stable debt allowing high LTV. Therefore, if we allowed a degen maximum 98% LTV (FRAX would need to drop below 98c for liquidation), the borrower could pay Chisel suppliers 5.5% and still achieve 30%+ effective APY on their position with fairly low risk of liquidation. This risk of liquidation further reduces as more people enter the pool to firm up the peg more.
We believe therefore that a FRAXBP pair, for example, could provide one of the relatively low-risk yet decent APY bases for Chisel suppliers. Simultaneously other higher yield higher risk (for example yCrv 60%+ APY) could bolster the average USDC supplier yield well in excess of 10% with a fairly broad and managed R:R, thereby attracting more USDC and making the Warp platform more valuable by increasing the assets under management of governance.
Lending Market Competition?
But what about other lending platforms? Why would Frax pay Warp for our services?
In his recent [epic] thread, BillyBobBagHolder named Frax Lend as a permissionless isolated lending platform competitor to Warp. So why can’t Frax Lend offer the same service to itself and others?
As previously described in the section above, in its original form, Frax Finance represents an undercollateralized fractional reserve system, where each $FRAX is only partly backed by ‘hard’ currency, and the rest by its governance token $FXS. Therefore, if Frax was to attempt to provide the backing-as-service to other stables, each loop would only contribute the reserve factor (currently ~93%) towards the LP pool. Thus looping this function has the opposite effect to that desired, and would actively work to decollaterise any other paired stablecoin. This is because whenever FRAX is paired with another stable (e.g. USDC, USDT, BUSD, USDP, GUSD, etc) with higher CR (including 1:1 redeemable with USD), it is effectively leeching collateralization from that other stablecoin. Therefore, when FRAX is paired with an overcollateralized algo-stable such as LUSD, MIM, DAI, etc, it theoretically weakens the reserves of the over-collateralized stable by making it 1:1 tradeable with an under-collateralized (fractional reserve) stablecoin.
It is clearest in the following thought experiment; it would be a clear ponzi if Frexlend used a FRAX LP receipt as collateral as the basis to mint more FRAX, because the new FRAX would be collateralized by itself, whose value in turn was diluted by the newly minted FRAX. For example, if there was 1000 FRAX in existence and paired with 1000 USDC with perfectly concentrated liquidity such that each FRAX is tradable for $1, an oracle would price FRAX at $1 and therefore the entire LP position would be said to be worth $2k. If that $2k LP was used as collateral to mint 1000 new FRAX at 50% LTV, there is now 2000 FRAX in existence, supported by 1000 USDC, and even though the first ~1000 FRAX would be tradeable for $1, the average backed value of each FRAX is 50c, and the effective market collateral ratio has halved.
Therefore, even though FRAX minted through Frax Lend is ‘over-collateralised’, it cannot be used for backing-as-a-service as the minted FRAX effectively leeches its collateralization from the posted collateral, and thus cannot return any value back the other way. This is also true for other over-collateralized minting protocols such as DAI, MIM, LUSD, sUSD, DOLA, alUSD, etc. By nature of these platforms, the debt minted is issued as a liability against the collateral, and therefore the collateral posted must be sounder than the debt, else it creates systemic risk within the platform for under collateralization. With this in mind, it is clear that Fraxlend and other such lending platforms cannot be used for backing-as-service.
This is nuanced from the first B2B application of generic market making “LP-as-a-service”, as only hard assets can be used to provide backing-as-a-service, whereas any other asset (e.g FRAX, MIM, etc) can be used to achieve LPaaS, albeit at potentially weakening their own peg, and thus increasing their demand for Warp’s Backing-as-a-Service in turn 👀. Therefore, any would-be LPaaS competitors may soon become clients.
By lending USDC and accepting long-tail assets as collateral with isolated risk, Warp is therefore in a unique position to bolster the collateralization of algo-stablecoins, even those minted through ‘competing’ lending platforms. This is the second application of five which we have identified as B2B targets. The idea is that Warp can create value through providing a niche service of solutions to pain points for other DeFi platforms using our unique bribable TVL model. As always veWarp governance would need to make a risk assessment of which algo-stablecoins are worthy of such a service to firstly add a lending pair, and then dynamically revise capital assigned and thus the risk (TVL) versus reward (interest) each epoch to either increase or decrease exposure.
Algo-Stable Addressable Market
In the previous section we mainly gave examples with reference to Frax Finance, however, there are many other projects which would be interested in such a valuable service. We will likely continue to see innovation in the algorithmic stablecoin space, with new novel projects joining the mix. Redeemable stablecoins like USDC and USDT are permissioned and centrally issued, and therefore liable to be blacklisted by government entities. Further, the redemption and peg itself are dependent on the trustworthy behavior of the central entity, which goes against the trustless nature of crypto. At some point, we are likely to see a decentralized and permissionless alternative to USDC, USDT, and BUSD join the top#10 coins. For an algo-stable to get this big, would require a LOT of market making, and I’m sure Warp governance would be only too happy to help….
This was just a random selection of some of the more known algo-stable projects. Keen DeFi users will notice that the majority of the stablecoins listed above are effectively minted via lending platforms. But as described above, we do not view these as competitors to Warp.
If all of the above represented a single decentralized stablecoin with $10B MC, it would be in the top#10.
Yet this is far from an exhaustive list. For example, Curve (a protocol initially for stablecoin swaps) is full of stablecoins vying for a pegging. Even Curve itself is expected to release a stablecoin, which could use much of its TVL as collateral 👀… Perhaps it will become the decentralized stable savior that UST could not.
Considering the massive total addressable market (TAM) of stablecoins being the backbone of crypto, along with the narrative towards increasing decentralization, it is likely we will continue to see innovation in the algo-stable space. However, this only increases the need for solutions to support the peg of these stablecoins at the lowest cost, and the value proposition of Warp.
Remember, Warp won’t have competitors, only DeFi allies 🤝
The first B2B application for Warp we presented was liquidity-as-a-service, and now stablecoin backing-as-service. Can you guess the next three?
This will be our last edition before the holiday season, so a very merry Christmas to those who celebrate, and a Happy Warp’d New Year! 🎄
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