Warp Finance’s Upcoming Use Cases

Warp Finance
7 min readOct 19, 2021

One of Warp’s active community members, Stiive, recently posted a twitter thread about Warp that can be found here, which explains the history of Warp as well as its upcoming use cases and prospects. Our team appreciates initiative and commentary, and wanted to summarize his thread here for our Medium followers, while also adding some of our own reflections on the covered topics.

The Future of Warp

Warp Finance is about to release its V2, the Blacksmith update, which will enable user-creation of isolated lending pairs, which Warp will optimize to support the lending and borrowing between niche assets and more traditional assets. This will provide the holders of niche assets with previously unavailable opportunities to leverage these tokens.

Warp is deploying the first few of these isolated lending pools for users, and allowing users to vote on further additions. These initial pools will incorporate Element Finance’s fixed asset tokens to further innovate on lending for yield bearing assets.

The History of Warp

Warp was a pioneer in the “DeFi summer” of 2020 by being the first of its kind, upon launch, to enable borrowing against Liquidity Provisioning (LP) tokens. Thereby, Warp unlocked $4.74 billion total available market (TAM) in the space, while the borrower continued to earn fees on their LP positions. Similar ideas were quickly recreated by other dApps seeking to benefit from this advancement in DeFi, further providing market validation and demand for Warp’s innovation.

The Current State of Warp

Warp Finance is an open finance platform that aims to extend the capabilities of DeFi lending (particularly for receipt tokens), enabling new streams of yield. The Warp Protocol’s initial objective was to create a novel use case for unused Liquidity Provider (LP) tokens by allowing them to be used as collateral for lending.

Warp V1 is live today and still offers this function, with $19.55 million in total value locked (TVL). As described by Stiive, the following is a simple example of how Warp V1 is creating value for its users:

User A is bullish on $WBTC / $ETH in Q4 and wants to keep exposure, but User A also wants money to trade alt coins. Thus, User A could perform the following actions:

* Add 50% of each token as Uniswap v2 LPing and earn ~2.5% annual percentage rate (APR)

* Borrow 75% loan-to-value (LTV) $USDC at 2.19% APR (-0.31% net)

* Buy alt coins

* Profit

Introducing Warp V2: Blacksmith

The Warp development team has continued to innovate with the goal of freeing the potential of other illiquid yield generating assets. Most recently, we accomplished this by introducing Warp V2, the Blacksmith update: an isolated lending pair solution for assets not currently serviced by other lending protocols.

To kick off the Blacksmith update, Warp has enabled support for utilizing tokens from Element Finance, which hold significant yield-bearing potential, yet are underserved by other lending protocols.

More About Element Finance

Element Finance is an open-source protocol for fixed and variable yield markets in DeFi. The Element Protocol maximizes capital efficiency, creates market liquidity, and reduces user costs. Users can purchase BTC, ETH, and USDC at a discount on automated market makers (AMMs) without being locked into a fixed term.

The Element Protocol enables users to split the base digital asset (ETH, BTC, USDC, or DAI) of yield-generating positions such as a Yearn vault or an Ethereum 2 (ETH2) validator into two separate fungible tokens: the Principal Token (PT) and the Yield Token (YT). By using their new tokens to provide liquidity into an AMM, users may also earn trading fees or an annual percentage yield (APY) on their yield positions.

As expressed in an example as presented by Stiive,

Element Finance leverages yield-generating pools like Curve Finance and Yearn Finance and splits positions in these pools it into:

  • Principal Token (PT) = the locked upfront capital.
  • Yield Token (YT) = future yield expectation (accruing value over time)

The innovation here is that the primary market maker can now sell this PT and just keep the YT. As a simple example, let’s consider User A being the primary user with PT = 100 ETH and YT = 12 ETH.

If User A sells the PT for 90 ETH to User B (a secondary buyer):

* User A has spent 10 ETH for a YT worth 12 ETH (20% APR)

* User B has spent 90 ETH for a 100 ETH PT (11% APR)

Thus, Element Finance allows the primary user to sell a PT at a fixed discount, which becomes the secondary user’s fixed interest rate. While this is an incredible innovation, from the example above, one can see that the secondary has much higher capital requirements (900%), and earns lower APR (by 9 percentage points). Meaning, the market will force the discount to be as high as possible, often resulting in the PT’s fixed APR exceeding the YT’s APY. This may not be favorable for the primary who would be at a loss to sell, thereby limiting TVL which has the potential to grow much bigger.

For example, when looking at the TVL of the 3 CRV assets supported at launch, we can see a potential of $5.7 billion that could find its way through Element Finance:

  • $triCrypto2 — $725 million
  • $LUSD — $112 million
  • $stETH — $4.8 billion

How Element Finance Token Holders and Warp V2 Benefit from each other

Warp Finance V2, the Blacksmith update, will provide a platform for users to create isolated lending pairs for more niche assets. As an initial use, Warp is deploying pools where users can borrow stablecoins using Element Finance’s assets as collateral. Meaning, instead of forcing the primary user to sell the PT at an unfavorable discount, they could instead borrow against it. This provides a competing market force against selling the PT and forces the market to reach a nash equilibrium in order to benefit both the primary and secondary users equally. For example, when the annualized discount is less than the borrowing interest rate, the primary user will sell at a fixed rate. Otherwise, the primary user will borrow against it.

We can see from the Element Finance app that the fixed APR tends towards being greater than the YT APY for many assets. In Stiive’s example, the primary APR drops to 0%. Adding the option for the primary to instead borrow against this asset through Warp V2 forces the secondary to reduce their fixed rate to remain competitive. Thus, equilibrium should normalize about the threshold where 50% will sell at fixed discount, and 50% borrow against their asset. This is great for Element Finance as a more balanced system will undoubtedly lead to more assets locked ($13B potential in Curve / Yearn Finance) for greater TVL.

Further, both the primary and secondary participants can use $WARP to borrow against their PT, to buy more PT at discount, creating leverage in the ecosystem. Thus, this also generates demand in the system for PT, thereby increasing leveraged APY incentives of the primary to mint more PTs.

How does leveraged APY work and why is it important?

From Stiive’s example, let’s assume a fixed/YT APY of 24%. If the WARP lending rate is half of that at 12%, the borrower now gets a 10 times return on original APY, equalling 240% APY. As the WARP lending rate decreases (12% is a high APY for stables), leverage tends towards 20 times. So, if both the primary and secondary are using WARP V2, we could see up to 100% of the Element Finance TVL come through WARP V2, while simultaneously making Element Finance’s PT/YT more attractive to significantly increase the size of that platform’s TVL. That is why, assuming just $163M TVL in WARP V2 is likely an underestimation of its total potential.

This is all important because users can lock their WARP into veWARP to earn a share in the platform fees. The fees generated can be used to market buy Warp. Further, veWARP can be used as collateral for borrowing against LP and PT positions.

Risk Isolation Benefits of Warp V2

Additionally, the risk of each lending pair on Warp V2 is isolated to that pair, meaning each will have its own risk/reward ratio. Warp V2 will also release Chisel, which essentially enables users to add lending to multiple pools in one click, to create a weighted fund of varying APR and risk. This makes managing multiple positions in warp lending pools much simpler.

Future Milestones

The Warp team has several plans and is working to develop a number of additional utilities and expansions. The ultimate aim of Warp V2 is to pioneer the unlocking of capital efficiency.

For example, some of the milestones that are planned on the roadmap include:

  • The ability of users to create their own lending pairs
  • The creation of pool-based lending pairs
  • The ability for users to use L2 assets as collateral on L1

Key Takeaways

Warp V2 will instantly join the Element Finance ecosystem with $163M TVL. The market balancing and leverage capabilities of Warp V2 could quickly bolster that TVL to absorb more of the $13 billion-plus TAM. Collected fees will be distributed to veWARP stakers and should have a positive impact on Warp token holders. This is not to even mention the additional value that can flow through our protocol thanks to the creation of further user-generated lending pairs on Warp. Overall, we believe the Blacksmith update will drive significant value into the Warp protocol while also providing enhanced utility and new lending opportunities for niche asset holders.

To follow the Warp Protocol as we carry out these new endeavors, check out our socials:
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Warp Finance

DeFi’s first isolated lending protocol that optimizes yield-bearing receipt assets, and much more!