Currently, the DeFi yield curve is flat. In other words, there is no benefit for investors “locking” their capital in a single investment for 5 days vs 5 years.
In the short term, this isn’t a big deal. However, in the long term, this may pose a challenge in attractive traditional institutional fixed income investors.
All of the investment opportunities in DeFi, for the most part, are extremely short duration, but in order to integrate a structure that supports a yield curve concept requires just a little bit of structuring.
If you have a tokenized DeFi yield fund that acts as a liquid pool of investments with no lock-up, then without external economics/incentives, there will be an ever-looming concern of the “stickiness” of that capital. This becomes an issue when you have significant concentration of capital from a small number of investors. So what is the best way to incentivize investors to stay “sticky”?
This idea hinges on a treasury fund to co-invest in that tokenized fund. Perhaps this could be the reinvestment of the spread between the tokenized fund payout and the underlying assets, or fees on daily withdrawals, or both.
The treasury fund would just co-invest in the same investments as the tokenized fund, essentially creating excess spread.
This excess spread will be earmarked for distribution to the investors in the tokenized fund, but in a certain way:
- firstly, this assumes that this tokenized yield fund issues security tokens that work like bonds (i.e. some distribution of cash interest). Perhaps this is done by a soft peg of the value of the tokens to a dollar (i.e. par value), and monthly airdrops of additional tokens reflecting interest collected. Note that this token could function like a stablecoin, but only if the underlying collateral (i.e. the investments in the fund) perform. In that sense, I’d say these tokens operate more like bonds. Or, if airdrops don’t work, then they could be held in custody by the platform, and available for the investor to claim.
- secondly, the investors in the tokenized fund will only see what their return would look like as a pass-through of their prorated portion of their tokenized fund investment. Essentially this is the short end of the curve, as the duration of these fund tokens will be pegged to the duration of the underlying (which, if the investments are DeFi investments, the duration would essentially be 0 days).
- concurrently, on the backend (hidden from the investor’s view), the platform will “hide” the excess spread allocation to this investor. The investor does see a separate field, perhaps we call it “stability premium” or “liquidity premium”
- the longer the investor holds their tokens, the more of the liquidity premium/excess spread is released. Perhaps this could be on a linear basis, or some logarithmic curve to mimic TradFi yield curves.
- when investors withdraw their funds, they claim their interest tokens, and the portion of the liquidity premium tokens that were released to them. The unreleased liquidity premium tokens are then re-allocated back to the platform’s treasury.
Some weaknesses/potential hurdles:
- the flexibility of how steep this DeFi yield curve can get will be limited to the amount of excess spread that can be generated by the platform’s treasury’s participation in the fund. In other words, if the platform’s treasury is only 5% of the TVL from external investments, there’s very little excess spread to be distributed.
- the volatility of the underlying assets may affect the token’s ability to stay at or above par value. Even if the underlying assets generate yields of 40%+, if the value of the digital assets drop by 60%+, then the bond token would be underwater. Perhaps the best solution would be some degree of diversification across staked stablecoins, tokenized yield generating RWA, and staked non-stablecoin tokens.
- high potential for user error — if an investor fat-fingers a $10mm withdrawal when they meant for a $1mm withdrawal, it would be quite a manual process to undo the error and reinstate the liquidity premium lost on the $9mm error.
- who would care about a yield curve? Forcing a yield curve to exist in DeFi may bear some fruit down the line, particularly when it comes to integration into everyday life (i.e. beyond crypto-to-crypto investments). However, this would be a hard sell to investors who don’t have a strong understanding of fixed income concepts.
