Picking Up $100s in Front of a Steamroller: Leveraged Yield | Lee Mount - Euler Labs

[Music] hey everyone my name is Lee uh I'm an engineer at Oiler Labs uh as well as doing some BD work um I'm here to talk a little bit about the defi yield Market just kind of an overview and some of the uh kind of interesting risks and dynamics that have come into play over the last couple years as it's uh you know approaching some more maturity um title being you know picking up hundreds in front of a steamroller uh kind of a play on the classic picking up pennies but um yeah we'll just jump right into it and also none of this is financial advice uh so talk a little bit about kind of a brief history of of defile yield markets and uh you know lead into where we are today talk about uh you know what the risks of that are and how this might all blow up someday uh and then talk a little bit about how Oiler fits into all of that so brief history of uh defi yield markets uh so start with you know what is yield and I'm sure most people are kind of familiar with what it is in general but yield is essentially you know a payment to allow somebody else to use your Capital uh while you don't have access to it today uh really coming down to time value of money you know a dollar today is worth more than a dollar tomorrow thanks to opportunity cost you know I'd rather be able to do something now than I would in the future but somebody else might uh pay me to make up for that um there's different ways to kind of assess how much you should be paid for that uh and that depends on a lot of different factors such as who you're lending your money to what they're doing with it how long you need to uh not have access to your Capital um but all those things are kind of you know calculable risks um and then yields in defi in particular uh there's certain things that you know I and weed Oiler like to think of as more real yield and other things that are I would say not so real yield um real yield being kind of things coming from sort of the real world being you know treasury yields uh dividend yields um and also you know more specific to Define crypto things such as staking yields for proof of stake and validators and whatnot um and then there's things that are not quite as real yield uh teral Luna being one of the classic ones and you know other protocols that we've seen over time where you have these kind of you know issuance of whether it's governance tokens or other kind of payment that is sort of floating kind of willy-nilly value but uh people kind of like to think of that as a real yield even though underlying it might not necessarily be that real uh one thing that defi has done a really good job of noticing is that people really like yield um and like to do sometimes silly things to get access to that yield uh you know defi summer is what everybody always likes to remember where you can you know be earning thousands and thousands of percent apy um on some you know silly tokens and making tons and tons of money and taking on a ton and ton of risk to do that um without either paying attention to it or acknowledging it and just not caring and doing it anyway so um yeah I would say you know the the kind of the peak of this was in the defi summer as I said and over the last couple years it's uh settled down a little bit and started to kind of mature into a more developed Market where um you know risks are or reals are starting to look a bit more real uh people are starting to understand the risk a little bit better uh we've had some interesting Evolution over the years of what that specifically look like so you know it started with kind of the shift to the proof of stake system and you know the classic you know Stak eth versus eth trade where you're earning yield on your Stak eth uh against kind of an underlying eth product without yields uh but that's evolved over time because that trade kind of went out um you know the classic one nowadays is the the points meta so we can thank Blair and blast and Pacman for uh kicking that off and now everyone and their brother has a uh a points program that they want to do and and it still works so people are still doing it um and nowadays I would say kind of the yields are settling down into in that sort of 20% range for stable coins is uh you know 10 15% for eth and 5 10% for Bitcoin which is still not bad it's pretty good um it's a good way to kind of put you know unused Capital to use so where does that bring us to today um there's a lot going on uh in the the uh the D5 markets there's Point systems there's kind of leverag carry trade systems there's uh Oiler and a and Moro and Pendle and real word assets and you know the classic governance token trades and carry and anything that you can think of someone is doing it and someone is doing it in a leveraged way um and building up bigger and bigger positions and earning more yield on top of it but uh there's a lot of options now nowadays uh one of the things that's been very popular recently is uh sort of assets that are trying to breach into kind of more real world um you know yield generation use cases such as you know Athena or USR where you have something that's uh an underlying spot versus a you know a shorted per against it to do sort of a delta neutral carry trade which you know originates in the finance World kind of the the interest rate carry trades are super super popular um and we've seen them be very very successful in defi nowadays um similarly we have a lot of these uh kind of staking based tokens where uh they might have a time lock component to them that people are either not realizing or not paying attention to or not sort of thinking about what the kind of risk associated with that might be as well as you know more complicated uh kind of aggregated yield baskets that you know might look like sort of one thing where they're you know getting a nice juicy yield on it but not really sure what's going on under the surface but again it doesn't matter cuz you're getting paid out a nice nice amount um and we're starting to see a lot more of these you know being used as collateral in lending protocols and other protocols to you know thought of as kind of safe yield bearing assets when uh in reality a lot of these under the surface are really just kind of tokenized sort of funds and kind of discretionary trading strategies that are a bit more risky than they seem um and you know similarly one of the other Evolutions we've seen is a big focus on Capital efficiency and what mean by that is kind of better ways to put Capital to use uh so that things are not just sitting idly and uh allowing more of your assets to earn more yield and everyone's making more money and we're all happy so uh it definitely leans into you know where we're getting more and more D gen in the defi space as some of the yield numbers have been shrinking relative to what they were in defi summer and people are trying to like grasp at anything that they can um and you know if I want to lend my collateral and somebody wants to borrow my collateral that's better because I'm earning yield on my collateral maybe double um and it's more efficient and you know there couldn't possibly be any problems to this and I'll repeat this until you know repeat until I'm sufficiently leverage for my personal risk tolerance if anybody remembers the uh Wall Street bets days um people are getting more and more like I said they're either not paying attention to the risk or they are and just ignoring it because the yields are too good uh one thing that you know we at Oiler and a lot of lending protocols and kind of Risk Managers do like to think about as regards to these sort of things is how do these trades fit into the market as it stands um how do you think about sizing your positions how do you think about the liquidity that's available on chain what's an appropriate size what's a not appropriate size for both an individual level and a protocol level um primarily for you know these yield bearing assets or even the non-yield bearing assets or really anything coming into a lending protocol um and then thinking about kind of more unique risks at an asset level so things that might have a like a Time based unlock or you know Redemption period uh to them and for now you know as far as we've seen uh people do a decent job of thinking about this um and kind of gauging and sizing positions appropriately um yeah and you know as these markets mature more and more we're starting to see a lot more institutional players kind of start to think about getting into the D5 markets which is going to be interesting as it grows more I would say they're not quite here yet um but the the size and the behavior of the institutional players is a little bit different from kind of how you know your traditional def player works you know we like to think about TBL and sizes in the billions and they tend to think about sizes in the trillions and it'll be an interesting growth of the market as you start to capture and sort of handle larger and larger sizes as you know institutional plays and rwas move more and more on chain hopefully maybe um and just kind of seeing how the system can handle that over time and making sure that people are kind of positioned appropriately and ready for that so where does this lead us to and why is this risky and kind of worse than we all think it is like I said bigger markets bigger players more and more people getting in and really grasping at anything they can to juice yields pick up more returns um and as I started with you know the the classic kind of saying for I would say trades like this in the traditional Finance world is picking up pennies in front of a steamroller which sort of analogy for you know you can find some tiny little yield and continue to you know pick it up over time but eventually you got this massive kind of Steamroller risk behind you that's going to come crush you when you're not expecting it uh fortunately for us in defi the pennies are more like $100 bills uh with yields being what they are relative to what you'd get in the normal Finance world doing some interest rate Arbitrage trade um and for now it seems worth it like you know if you can get a 20% yield on a stable coin and level that up 5x 6X and get to you know 100 100% Plus in your yields why wouldn't you do that as there's a risk that it blows up it if it's a .01% risk then that's kind of worth it at the time um so people are starting to to more and more kind of Leverage up and kind of take advantage of it while they can uh we'll take a step a little bit into kind of the the trafi markets a bit um talk a little about kind of the 2008 and what happened there and it's sort of a nice analogy for uh kind of the way that the the normal you know the traditional Finance system broke down and had kind of its own little explosion um as most people are familiar with this kind of originated with mortgage back Securities and subprime loans and um everyone thinking that these trades were amazing and safe and kind of structured in a way that could never possibly blow up um and then it did uh S&P was down 50% over 2 years uh we had trillions of dollars wiped out from the global economy a massive recession um and it was sort of an interesting way in which that happened in the markets it sort of was a builtup kind of uh understanding that things were going to blow up and you know talking with people who were on the trading desks at the time it became kind of literally a Markt Market standoff where everyone knew that all the assets they held on their book were not quite worth what they thought they were but nobody wanted to be the first mover to actually take that hit um because they would have to be you know the first one to take the loss and then sort of knew that that would start this Margin Call Cascade across the entire industry which you know led to what happened where we had the bankruptcies of the banks and kind of this giant recession that uh sort of impacted the entire world for many years following it now what about D5 um we've seen kind of tastes of this I would say over time uh a couple of the big ones being you know the Terra Luna explosion uh from a couple years ago where uh you know again these were these massively leveraged positions and people with uh sizes that I think they were not prepared for and a like C you know liquidation Cascades and unwind that people were not quite aware that that was a risk um in hindsight I think to everyone it seemed sort of obvious that this was what was going to happen um but at the time again it was too good to to ignore so uh everyone was in it I you know my myself was in it a bit and uh you know uh I think that you know that's sort of the prime example you know we've seen it we've seen hints of it a couple other times recently where um we have these kind of yield bearing assets again massively leveraged against these non-yield bearing assets uh building up risk to a level that people are not as aware of even on just like the straight up asset basis and then when you start to pair that with uh you know these assets that really are leverage trades under the surface to generate that yield on them you sort of get a multiplying effect of when a per Market starts to unwind you start to have issues with uh you know assets that are relying on that per Market um and yeah it just it will get it could get ugly at at times whenever this uh whatever triggers that unwind um you know we're in the hundreds of millions now but as I said as this Market continues to grow and we get into the billions and hundreds of billions that are in these assets that gets very very sort of explosive um in a way that we're not quite ready for um some other things that we've seen hints of it you know there was the the bar Stone kind of risk or uh you know incident from last month where uh we had a little bit of Market wobbliness on its own which then led to uh you know people kind of getting scared and wanting to get out of any sort of locked uh EV Vault position um and that kind of triggered its own unwind which triggers a dpeg which then triggers more unwind um and it kind of Cascades upon itself um and then another one that's you know very topical and very relevant to the last couple days is the the bibit incident where fortunately it sort of didn't have any kind of cascading effects but um you know there's some serious uh chances of this being uh something that could have you know a heavy impact on assets that are relying on those things when you don't quite know where sort of the underlying assets are being held so for instance had one of these kind of you know delta neutral trading positions had everything held at bybit bybit loses all the funds all of a sudden this yield bearing stable coin doesn't actually have any asset backing anymore that blows up deegs um and then sort of triggers a you know cyclical downfall from there um yeah again talked about this a little bit but like I said over the last couple years we've seen people more and more willing to take on these risks and consider these assets to be safe when in practice they're not quite as safe as they think they are so uh we've seen kind of lending protocols continue to uh grow their caps grow their sizes which is great you know we love to see more usage of uh lending markets and and things like that but I think there's sort of a little bit of a lack of awareness to the kind of true level of safety of kind of what's Happening under the surface with these yeah and um sort of the big kind of thing that this comes into is when everyone starts to kind of do their own risk assessments and build their own positions and from a protocol level start to think about how uh they need to think about the risk of these positions and what happens when they start to unwind and set ltvs and caps appropriately it tends to be done I would say a little bit at kind of an individual protocol level um which is great for the protocol but becomes less great for the protocol when there are 10 protocols also doing that and everyone sizes their you know Max unwind or you know Max deposit at whatever they think the market can handle without realizing that everyone is going to be unwinding at the same time that they are um and that's when you really start to get into the cross contagion risk where uh if everyone has to unwind you know if 10 protocols have to unwind 100 million of some asset uh because there's 100 million of liquidity available in the market then all of a sudden you've got a billion dollars trying to sell into 100 $1 million market and you start to look elsewhere and kind of hedge that risk or sell out of it appropriately and everything starts to Tumble together uh this is you know not necessarily specific to a leverage unwine but kind of the most recent I would say Market explosion um that we saw in the beginning of February where you had sort of some uh rockiness to the market and things really started to Cascade and liquidation started to stack up and I think you know we dropped 20% over the course of an hour which is a lot for a market and I think kind of the the crypto world we forget to uh we kind of forget how big of a move that is um and it became you know this was on mainnet where you know this was uh you know we internally at Oiler we're literally looking at kind of liquidations happening and how expensive stuff was and gas spiked to 600 which was sort of the biggest I've seen in a while and that on its own causes some interesting kind of Market freezing problems um but again you pair of this with everyone trying to unwind at the same time and this is sort of a very clear direct impact of that where everyone is trying to hit the chain at the same time get out of these positions and then all of a sudden no one can do it because liquidity is dried up it's too expensive to interact with um and you drop 20% in an hour uh fortunately the market actually handled this one pretty well I would say uh it did feel like a little bit of a you know kind of a Red Scare where we were it looked like it could keep going down but yeah you know as these positions go up and up and Leverage continues to build over time this is just going to get worse and worse um yeah so to repeat like this these trades are still kind of working at the moment which is kind of an interesting dilemma because you can still go get 20% you can still go lever that up and get 100% on these trades um and it's going to continue to work until one day it's not going to work anymore and it's going to um it will be you know a blood bath basically of whenever this uh this really starts to unwind and you know this is a you know the reason I was titling this section A Black Swan is because these are sort of considered a Black Swan event where it's you know it's a 0.001% chance that it happens but as we all know in defi if it can happen it will happen um and it's just really a matter of time um kind of the you know the way that I like to think the best ways to avoid those things are just to you know adjust your personal risk tolerance to what you think is appropriate um be aware of these risks um and then from a you know a protocol level size you know Vault size positions and size caps accordingly set the risk parameters to something that's appropriate for the market and what you think the market can handle um and kind of take the whole dynamic of the market into account and not just your individual protocol so where does Oiler fit into this um in both the good and the bad uh so for those unfamiliar with with Oiler um Oiler V2 is a lending platform it's a interconnected Vault system uh built in a modular way that allows kind of anyone to build and piece together any lending Market that they want um it's structured where the kind of minimal unit is a vault and vaults can be enabled as collateral for other vaults to sort of restructure recreate any uh any sort of lending Market whether that's isolated pairs or as sort of whole Market clusters um and Oiler allows for a collateral rehypothecation system which means if you have asset a and asset B you can enable them as collateral for each other then that means that your collateral can be borrowed out at the same time you're using it as collateral to borrow out another asset um Michael our CEO wrote a really good article about this um you can find on our blog on sort of the trade-offs associated with that um which we talk a little bit about but um you know there's like I said there's been a big kind of focus on um Capital efficiency and reducing cost to borrow and allowing kind of scaling these positions up which is great because again everyone makes more money it's there's more uses we can kind of bring more people um into using lending markets but again this comes with a problem where um you might run into situations where you're trying to unwind a position with some collateral and that collateral might not actually be there uh so what do we do uh you know initially it's it's really all about kind of setting the risk parameters appropriately making sure that uh sort of understanding this as a risk and setting sort of the caps and the LTV ratios to allow for that um and then when it comes to what happens in practice is uh you know when there's something where things are starting to unwind uh and you're trying to take out collateral it will you know as collateral gets withdrawn and the utilization ratios go up interest rates will go up for both depositors and borrowers sort of really heavily incentivizing borrowers to pay back their position because they'll start to get charged you know hundreds of percent um and maybe incentivizing other suppliers to get back in as well um and you know a couple other things on top of that that I'll talk about sort of next uh in the next couple slides um yeah so how do we deal with this and how do we think about this at Oiler uh the big one for us is uh setting up markets appropriately from the get-go um fortun you know one interesting kind of feature about Oiler as I said uh it's sort of a very flexible system that allows the building and the setting up of isolated markets so you can have kind of one whole cluster that exists as all of the E derivatives and you have a cluster that exists as all the stable coin derivatives and those can exist completely separately from one another so if there's something that happens where uh you know there's one of the you derivatives blows up it's not going to impact kind of anybody else in any other asset um and uh like I said we have a very sort of dynamic interest rate system where when utilization starts to to change around interest rates are going to change around appropriately with that allowing for sort of the market to determine what's an appropriate level of uh utilization and deposits and borrows in a vault um going back to kind of how these are set up from the get-go there's a lot of thorough analysis done by kind of us and external Risk Managers on what ltvs should be what risk parameters should be what interest rate models should look like uh you know so that we can sort of avoid any kind of catastrophic scenarios in the best way that we can um and also one kind of uh feature that we've uh worked on a bunch is sort of whether or not things are governed or ungoverned and fortunately we allow for both um which allows for you know on the one hand doing fully ungoverned immutable markets but on the other um allows for Governors to retain the option to kind of change parameters appropriately as market dynamics shift around which can mean you know um raising and lowering caps as more liquidity comes in and out raising you know changing interest rate models and and things along those line to to sort of best match what the the current market scenarios are uh one other big feature that uh helps kind of uh Oilers stay safer in these scenarios is our uh liquidation system which I think a lot of people might be familiar with but it operates is kind of a reverse Dutch auction is what we like to call it which is essentially kind of a scaling liquidation bonus as accounts become unhealthy um and what that means is that liquidations can happen very quickly and very early at a very low cost to uh the borrower um in our V1 I think the the penalty was less than 1% for positions over $10,000 uh which is pretty good um and it sort of you know it scales as positions go more and more underwater which really incentivizes kind of Liquidators to get in um and kind of clear these positions out and keep the protocol safe in kind of a quick efficient way um again as I mentioned uh sort of quickly or you know uh carefully scaling uh deposit caps and Market sizes um and then on the other hand we're also like to take sort of a fully customizable approach to kind of interesting new trades and markets that are uh emerging over time that uh you know we think pose interesting opportunities for people but again done in a careful way where you can sort of start small and kind of scale into it as it uh you know becomes more and more stable um and that's sort of it um feel free to uh pop into our Discord or uh check us out at app. o.f Finance or follow us on Twitter or uh we'll be around we have a booth here uh for the main conference and uh yeah thank you