Before we get started, this is not a recommendation or endorsement to buy any token mentioned.
Previously, we have covered the DeFi fixed lending protocol Notional Finance. Launched in 2020, Notional grew lending pools to nearly $1B in 2021 before experiencing a fairly severe drawdown in liquidity during the bear market, now just $50M.
This reflects a lack of product-market fit still to be found with DeFi fixed income. However, I think Notional has returned with a clever product to reignite interest in their protocol–leveraged ETH vaults.
Given the market driven interest around ETH liquid staking derivatives (LSDs), Notional has launched Leveraged Vaults based off the Balancer wstETH/ETH LP staked in Aura Finance, allowing users to borrow ETH from Notional, deposit that ETH into the Balancer wstETH/ETH pool, stake the LP tokens on Aura, and then harvest the incentive rewards. The vault converts borrowed ETH from Notional into wstETH and both are provided as liquidity to the Balancer pool.
Currently, there are 5 rewards/fees driving the yield for Notional Leveraged Vaults:
- Trading fees in Balancer
- BAL rewards
- LDO rewards
- AURA rewards
- Underlying ETH staking yield (wstETH)
Leveraged Vaults allow for up to 12X leverage and require a minimum debt of 100 ETH, meaning users might deposit as little as 8.33 ETH at 12X leverage.
Here’s an example provided in the Notional docs, where a user deposits $100k of ETH, borrows $400k of ETH on Notional at a net 3% interest rate for 6 months. Then, they LP the $500k in the Balancer wstETH/WETH pool and deposits the BPTs in Aura. If the Balancer pool generated 1.5% in staking APY, 0.5% in swap fees, 5.0% in BAL, 0.5% in LIDO, and 12.5% in AURA, the strategy would generate $50K in pool rewards. When accounting for the borrowing interest cost of $6k, the strategy would net $44K over 6 months, or 88% annualized.
While this looks like leveraged yield farming by Alpha Homora or Gearbox, this setup has an advantage because Notional Leveraged Vaults allow users to benefit from the fixed interest rates paid for borrowing and leveraging ETH vs the variable rates common in other DeFi which can lead to unpredictable liquidations. With Notional, users can choose from the maturity dates available (currently either May 23, 2023 or June 21, 2023). This means users are able to only use a leveraged vault through a fixed date. At maturity, debt is automatically closed out against the proceeds of the strategy, unless users close the vault sooner. Tossing aside some less common language, it means users don’t have to manually unwind their leveraged vaults–Notional vaults take care of this at end date.
With these vaults, liquidation is still a risk, and subject to some exchange rate risk as the stETH to ETH exchange rate is variable (see June 2022 stETH de-peg). Specifically, if the price of stETH depreciates against ETH, the value of the BPTs one holds in this strategy, will decrease, increasing the vault’s leverage ratio, putting users at risk of liquidation.
Today, I’ll demonstrate how I can spin up a leveraged wstETH/ETH vault with Notional Finance and net ~17-20% expected yield by depositing a minimum of 7-12 ETH with 10-12X leverage. Keep in mind this is an expected yield (aka…
DeFi Dad is one of the earliest power users of DeFi, having worked with early Ethereum startups going back to 2018, including Zapper.
