Unipool tokens in MakerDAO Vaults - wise choice?

MakerDAO has recently reviewed and passed several proposals that allows users to open vaults with Uniswap LP (Liquidity Pool) tokens as collateral.

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Samyak Jain
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MakerDAO has recently reviewed and passed several proposals that allows users to open vaults with Uniswap LP (Liquidity Pool) tokens as collateral. In this article we'll explain some details regarding vaults using LP tokens and compare that to the standard single asset collateral vault as well as discuss some of the risks and benefits.

Let's review and discuss the following vault collateral types:

  1. Single Asset ETH-A or WBTC-A vaults (Liquidation Ratio for both is 150%)
  2. Uniswap-LP ETH-DAI Liquidity Pool vault (Liquidation Ratio is 125%)

Benefits of using a Liquidity Pool as Collateral

  • Uniswap-LP tokens are composed of 50% of two assets. For liquidity pairs that include a stablecoins like DAI or USDC the volatility of the pool is heavily reduced.
  • Capital efficiency and an increase in liquidity will create better swap rates and shines as an example of composability. The same assets can be more properly utilized as liquidity in AMMs and as Collateral.
  • Instadapp users can leverage their liquidity pools to increase their exposure to AMM fees and earn additional fees. Through leverage users can earn up to 5x the normal Uniswap trading fees.

Liquidity Pools as Vault Collateral

The use of Liquidity Pool tokens offers a unique opportunity for users. Users can be both providing liquidity to the larger swap market, earn fees and have the ability to generate the stablecoin DAI. Liquidity pools offer their own risk factors as well, and combining the two products also has some unique benefits and risks.

Generally using a liquidity pool token as collateral should carry a smaller risk of liquidation than vaults that are backed by a single asset such as ETH or WBTC.

Currently Maker Vault accepts ETH/WBTC, ETH/USDC, ETH/DAI and many more LP tokens. While a sudden or big change in the price of one of the underlying assets of the LP token can cause the vault to become undercollaterized, LP tokens continually earn fees which give them steady growth and market forces work to keep the LP tokens reflecting the actual market price.

For ETH/USDC and ETH/DAI the inclusion of a stablecoin reduces their volatility. These factors help make Uniswap LPs a sustainable collateral.

Example Math & Comparing Single Asset Vaults to UNI-LP Vaults

The following examples assumes initial liquidity of $10,000 and ETH price at $2,000.

One of the unique features of LP tokens being used as collateral; is that users can leverage the LP vault to gain more exposure to Uniswap fees and returns. In fact leveraging LP tokens proves to be less risky then leveraging single asset vaults. Let's explain why in the following example.

These calculations do not take debt accrual & LP UNI vaults fees into consideration which will make LP UNI vaults comparatively less riskier.

Leverage 2x ($20,000 Collateral & 10,000 DAI debt)

  1. ETH vault liquidation at $1500/eth (vault value at the time of liquidation = $5000)
  2. UNI-ETH-DAI vault liquidation at $845/eth.

Leverage 3x ($30,000 Collateral & 20,000 DAI debt)

  1. ETH vault instant liquidation.
  2. UNI-ETH-DAI vault liquidation at $1388.88/eth (vault value at the time of liquidation = $5000)

Leverage 4x ($40,000 Collateral & 30,000 DAI debt)

  1. ETH vault not possible.
  2. UNI-ETH-DAI vault liquidation at $1757.8/eth.

Leverage 5x ($50,000 Collateral & 40,000 DAI debt)

  1. ETH vault not possible.
  2. UNI-ETH-DAI vault instant liquidation.

In the example above we see that taking a 3x leverage on UNI-ETH-DAI vault is less risky than 2x on ETH-A vault. The example above does not take into account the interest charged by Maker or the interest earned from Uniswap which will eventually make UNI-ETH-DAI comparatively less riskier than ETH vaults.

Why leverage a Uniswap-LP Maker Vault?

For users who want to provide deep liquidity, earn fees and put their assets to work, leveraging a Uniswap LP offers some unique benefits and potential returns. Providing liquidity to Uniswap has it's own properties and risk factors. If you would like to learn more about how returns are calculated when providing liquidity to Uniswap you can read more about it here.

The Uniswap-LP tokens have the potential to be more 'stable' then single asset vaults due to trading fees, making them an ideal candidate for leverage. However, it can become quite difficult to calculate these returns so lets walk through an example:

We will assume initial liquidity of $10,000 and ETH price at $2,000 We'll compare a 2x Leverage on an ETH-A Vault and a 3x Leverage on UNI-ETH-DAI vaults as the vault value at the time of liquidation will be $5000 but still the UNI-ETH-DAI vault is less riskier than ETH vault.

To calculate proper benefits we need to take different instances of price w.r.t to time.

Initial Values

  • ETH-A Vault: Collateral = $20,000 & Debt = $10,000
  • UNI-ETH-DAI Vault: Collateral = $30,000 & Debt = $20,000

Calculating Uniswap-LP token fees and and LP token growth

Taking current stats Uniswap-LP ETH/DAI normally has a 30-40% APY fee accrual, in this example we will not calculate Maker's stability fee which is set at 1% for UNI-ETH-DAI & 3.5% for ETH at the time of this article. Let's add these 30-40% and calculate the returns. For easy calculations we will just add the fee amount on the final position's collateral with simple interest.

Initial ETH price at $2000/ETH

  • ETH-A Vault value: $10,000
    Collateral - $20,000
    Debt - $10,000

  • UNI-ETH-DAI: $19,000 - $22,000
    Collateral: $30,000
    Collateral with 30% fee: $39,000
    Collateral with 40% fee: $42,000
    Debt - $20,000

If ETH price 2x ($4,000/ETH)

  • ETH-A Vault value: $30,000
    Collateral - $40,000
    Debt - $10,000

  • UNI-ETH-DAI: $35,120 - $39,360
    Collateral: $42,400
    Collateral with 30% fee: $55,120
    Collateral with 40% fee: $59,360
    Debt - $20,000

If ETH price 3x ($6,000/ETH)

  • ETH-A Vault value: $50,000
    Collateral - $60,000
    Debt - $10,000

  • UNI-ETH-DAI vault value: $47,548 - $52,744
    Collateral: $51,960
    Collateral with 30% fee: $67,548
    Collateral with 40% fee: $72,744
    Debt - $20,000

If ETH price 4x ($8,000/ETH)

  • ETH-A Vault value: $70,000
    Collateral - $80,000
    Debt - $10,000

  • UNI-ETH-DAI vault value: $58,000 - $64,000
    Collateral: $60,000
    Collateral with 30% fee: $78,000
    Collateral with 40% fee: $84,000
    Debt - $20,000

If ETH price 5x ($10,000/eth)

  • ETH-A Vault value: $90,000
    Collateral - $100,000
    Debt - $10,000

  • UNI-ETH-DAI vault value: $67,100 - $73,800
    Collateral: $67,000
    Collateral with 30% fee: $87,100
    Collateral with 40% fee: $93,800
    Debt - $20,000

Conclusion

In a year, if you believe that:

  • ETH will remain stable then, UNI-ETH-DAI vault is a better choice.
  • ETH will 2x then, UNI-ETH-DAI vault is a better choice.
  • ETH will 3x then, both vaults are equal, but UNI-ETH-DAI vault is less risky making UNI-ETH-DAI a better choice.
  • ETH will 4x then, ETH vault is the better choice.
  • ETH will 5x then, ETH vault is the better choice.

Instadapp provides powerful tools, deep liquidity and ease of use to access these new type of Maker Vaults and perform powerful strategies like leveraging. The inclusion of Uniswap-LP as a collateral for MakerDAO Vaults offers a unique an exciting evolution for Decentralized Finance. Liquidity pool tokens as Collateral for the largest decentralized stablecoin DAI adds immense composable and capital efficiency. For liquidity providers and everyday users, this creates a new way to access stablecoins and earn on their assets through AMM fees.

Leverage long Uniswap LP token here: defi.instadapp.io

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