New yield strategy: fixed-rate lending on Notional Finance

[twoodward]

Summary

I propose that Angle protocol allocate some of its capital to fixed rate lending on Notional in order to boost and reliably stabilize its returns. The extra yield that Notional offers would improve the experience of veANGLE holders and Standard Liquidity Providers. Additionally, Notional is a low-risk protocol, the yield is organic and not dependent on token prices, and the strategy would be straightforward and easy to implement as it does not involve selling any incentive tokens.

Full disclosure: I am the co-founder of Notional.

Introduction

ANGLE protocol has at the moment only one yield generating strategy (simple AAVE/ Compound lending). So far, the returns have been suboptimal versus what could be achieved with other DeFi protocols. For example, the current USDC rate on Compound is only 2.25% well below the 5.7% offered by Notional Finance for a 10M USDC 4 month lending. In addition, the returns received are linked to the price of the COMP and AAVE tokens (incentives). Therefore, it makes sense for the protocol to boost its yield and diversify its risk by implementing other strategies.

Thanks to its stable source of capital, ANGLE can get higher rates of returns by lending over longer maturities. Notional Finance offers fixed term lending for periods from 1 to 12 months. This would allow ANGLE to generate an additional predictable source of revenue on its collateral. Predictable yields allow for better risk adjusted yields and attractiveness for veANGLE holders and Standard Liquidity Providers.

We propose that ANGLE lends 10% of its total reserves ($20m) into Notional Finance with maturity June 2022, as a starting point for a discussion with the community. Here is an analysis of the annualized profits ANGLE could generate by implementing this treasury management strategy (data as of Feb 28th 2022):

Amount	Maturity	Compound Rate (with incentives)	Notional Rate (net of fees and slippage)	Annualized Extra Profits	Extra APY for SLP	Extra APY for veANGLE holders
10m USDC	June	2.25%	5.67%	$342K	0.24%	3.42%
10m DAI	June	3.35%	6.98%	$363K	1.09%	3.63%

Calculations are based on 30% of interest being distributed to SLPs and 50% to veANGLE holders. 24m ANGLE tokens locked with a ANGLE price of $0.22.

This allocation would bring significant benefit for veANGLE holders, generating an additional 7% p.a. to the yield received by veANGLE holders.

If you’re unfamiliar with Notional, you can read and follow the links shared immediately below to equip yourself for the decision.

About Notional

Notional is a decentralized, Ethereum-based protocol for borrowing and lending at fixed rates and fixed terms with more than $470M of TVL and $325M of historical trading volume.

fCash: fCash is Notional’s zero-coupon bond instrument. fCash tokens represent a claim on a positive or negative cashflow at a specific point in the future. As an example, 100 Dec 1 2022 fDAI would be redeemable for 100 DAI upon maturity.

Yield generation mechanism: Notional yields do not rely on incentives or token prices. The rates received by lenders are paid by borrowers or what we call “organic yields”.

Early withdrawals: Borrowers & lenders can close their Notional positions before maturity at the prevailing market interest rate.

Slippage: Notional currently enables users to execute $1M stablecoin trades at 0.1% interest rate slippage and $5M trades with less than 1% interest rate slippage.

Fees: Fees on Notional are currently 0.3% on the annualized interest rate. This means that the transaction fee scales with time to maturity. Ex: If a DAO lends for 1 year it will pay roughly 0.3% of its principal in fees, while a 6 month lending position would only cost 0.15% of the principal.

Credit risk: Notional is an overcollateralized protocol and is therefore not subject to credit risk. The protocol is still subject to undercollateralization risks although these risks are mitigated through Notional’s conservative governance parameters.

Reinvestment risk: Upon maturity, lending positions on Notional auto-convert to earning the variable interest rate. Thus if a DAO does not automatically reinvest its treasury allocation in the newest maturity it will still earn the variable rate.

Smart contract risk: Notional is subject to smart contract risks. Multiple security audits and initiatives have been undertaken to mitigate these risks:

• ABDK audit
• Certora formal verification
• Code4rena
• Immunefi $1M bug bounty program

Notional’s smart contract risk can also be insured using Nexus Mutual.

Resources

Website

How Notional works

Long Term integration Opportunities

Besides improved yield opportunities for ANGLE and SLP, a closer integration with Notional would unleash several opportunities for all the partners of the ANGLE ecosystem. The most important would be the creation of agEur fixed-rate borrowing pool bringing security/visibility to agEur borrowers. This could lead to the first ever on-chain EUR/USD FX forward!

There is currently a lending market of agEur on Rari Capital and Euler Finance, however, the liquidity is quite low on these platforms (c. 10 000 € on Rari). We believe that the lack of fixed rate security is a major deterrent for institutional users.

[sogipec]

Thanks for this cool proposition! Improving strategies is the easiest thing that can be done to provide more value to veANGLE holders, and so this is most welcome. We at the Core Team are currently actively developing new strategies!

Some considerations for what can be implemented by the protocol + some questions on my side:

• developing a strategy takes time and requires some dev work: protocol funds are not manually handed but by audited contracts approved by governance
• this is something which could be discussed but the funds of the protocol need to be available for withdraw at any time (in case people come to burn stablecoins for collateral). One question I have about Notional therefore is how easy can funds be pulled from strategies if there are here for a fixed term. Like if I invest in a strategy with a 6month maturity, will these funds only be available in 6 months? I understand that there can be early withdrawals, but how do the withdrawn assets compound yield and so on? Ideally, yield accrues on a block by block basis to fit in the current system
• the protocol has an impact on the yield it gets upon investing in strategy: if we were not on Compound, lending yield would certainly be higher. The question I therefore have is: what are the yield strategies implemented by Notional and do these scale well?

I would really welcome the opportunity to have an agEUR integration on Notional! On the short term, I believe that this integration could provide value to the protocol, just have to figure out how complex it’s going to be to implement a strategy on top of it!

[twoodward]

Thanks for your questions! Happy to answer them. Here are comments:

• I fully understand the time it takes to develop and test an automated strategy. The Notional team has experience with this in our recent Yearn integration and we would be happy to support you in doing this as well.
• fCash is freely redeemable, however unlike something like cTokens, redemption does incur a transaction cost. So a strategy that effectively utilizes fixed-rate lending to boost returns would only keep a portion of its assets in fCash such that it can be highly confident that it will not need to exit the fixed rate lending position early. The stable nature of Angle’s deposit base makes you a strong candidate for this in my opinion. But to be clear, in the event that you do need to redeem, you can.
• Notional is a smaller protocol than Compound, so naturally it can’t support as large a strategy as Compound can. However, Notional can support a materially-sized strategy. For example, we recently completed an integration with Yearn and they have allocated $30M to fixed-rate lending on Notional as a start and are likely going to increase that allocation shortly. Here is the current slippage table for DAI lending on Notional:

As you can see, you could put 20M DAI across the 3M and 6M tenors and still receive an average interest rate of 6.4%.

Please let me know if anything is unclear or if I have missed any of your questions!

[sogipec]

Thanks for answering!
Several questions then:

• What’s the transaction cost for exiting a fixed rate strategy? And can you give examples of withdrawing different % amount of what’s initially been invested across different times between maturity
• And now the key question: how does Notional make this yield? Is it by lending to Compound/Aave? Or by doing some sort of folding, or single-sided staking on Curve? Curious to hear that

[twoodward]

Sure.

The first thing to understand is that fCash is like a zero-coupon bond - it entitles you to receive a fixed amount of the underlying, like DAI, at maturity. The interest rate you see on our website is actually a function of the exchange rate between cash and fCash. The more fCash you can buy for the same amount of underlying, the higher your fixed interest rate.

When you lend, what you’re actually doing is purchasing fCash on Notional’s liquidity pool. To exit your position, you need to sell your fCash and receive underlying in exchange. The slippage, or transaction cost you incur upon exiting is a function of the amount of fCash you’re selling and the total amount of liquidity in the pool. Again, you can refer to this chart to see the current slippage, by size and tenor, for lending DAI:

This denotes the slippage in terms of the annualized interest rate, not in absolute terms. For example, if you lend for six months and get slippage of 1.5%, the “cost” you incur is roughly 1.5% / 2 = 0.75%. If you lend for only one month with the same 1.5% slippage, the cost you incur is only 1.5% / 12 = 0.125%. So the absolute cost of exiting approaches zero as the loan approaches maturity. Happy to expand on this by the way, just let me know.

How notional makes its yield:
Notional’s interest rates are market-determined. Every time a lender lends, the rate goes down. Every time a borrower borrows, the rate goes up. In other words, Notional’s rates are higher than other platforms because borrowers have borrowed at those rates.

When you lend, you are trading with the liquidity pool. So it is the liquidity provider who takes the other side of your lend. For your reference, the liquidity provider earns the baseline cToken supply rate by depositing cTokens into the liquidity pool + transaction fees (discussed above) any time a lender lends or borrower borrows + NOTE liquidity incentives.

Any other questions?

[sogipec]

Ok makes sense thanks for all these details!
So another question, what’s the incentive for people to borrow on Notional rather than on another platform where yield can be allegedly smaller?

[twoodward]

Part of the attraction is that they can fix their borrowing rate. The other big reason is that Notional allows you to borrow against your nTokens. nTokens are what liquidity providers get when they provide capital to Notional, and they are incentivized with NOTE. So some LPs have been borrowing against their nTokens.