Key Insights
- Ratio Finance creates collateralized debt positions (CDPs) that algorithmically adjust reserve ratios according to a weighted-portfolio risk management strategy.
- Users create a CDP position by depositing LP tokens in Ratio vaults, which will allow them to mint USDr, Ratio’s stablecoin. This system allows users to still receive yield from their LP positions, creating negative interest loans.
- Ratio Finance will look to continue leveraging partnerships and integrations within the Solana DeFi ecosystem to maintain their initial growth since launching earlier this year.
- Ratio Finance is developing the Peg Stability Module for Q4, which will help peg USDr close to $1.
Stablecoins are a key pillar in decentralized finance (DeFi). They are safe haven assets in bear markets and a leverage product in bull markets. There’s a variety of stablecoins, each with a different purpose. One of these varieties is the Collateralized Debt Position (CDP). First developed by MakerDAO, CDPs allow users to maintain custody of their assets, while also using them to gain leverage denominated in a stablecoin. The CDP product has been widely successful with MakerDAO on Ethereum, inspiring other teams to extend the project’s design onto other blockchains.
Like MakerDAO, Ratio Finance is a decentralized protocol that creates CDPs on liquidity provider (LP) tokens. It covers LP tokens offered on Raydium, Saber, and soon other DEXs in the Solana ecosystem. Similar to MakerDAO’s design, when users create CDPs, they mint a stablecoin (USDr in the Ratio Finance system) against the deposited collateral. However, Ratio differentiates itself from MakerDAO by currently focusing solely on leveraging LP tokens as the collateral assets. Furthermore, Ratio has adopted a risk assessment strategy with crypto-native CDPs that is relatively novel.
Ratio Vaults
Ratio Finance’s CDPs allow liquidity providers to maximize the use of their LP tokens. A user deposits their LP tokens into a CDP vault and mints the USDr stablecoin. In Ratio’s case, the user deposits LP tokens on protocols native to Solana in Ratio’s vaults to mint USDr. To bootstrap the system, users can swap USDr for USDC in the USDr-USDC Atrix liquidity pool or on Orca. They can also provide liquidity to the pool and stake the LP token to earn SRM rewards, or RATIO and ORCA on Orca. Comparatively, when a user deposits their collateral in MakerDAO, they mint DAI which can be used in various DeFi applications across the ecosystem.
USDr Peg Stability
Given the nascency and overcollateralization of USDr, its peg stability is primarily a function of the underlying collateral assets. In addition, the peg is held through the supply and demand of USDr and incentivized by rewards and arbitrage. For example, the Atrix USDr-USDC pool allows liquidity providers to earn SRM tokens by staking their LP tokens. This incentivizes liquidity to form in this pool, allowing users to swap between USDr-USDC at a near 1:1 ratio.
As Ratio Finance and USDr continue to scale up, the liquidity pool incentives will become costly for the protocol and may become a source of sell pressure on the token used for incentivization. To create a relatively frictionless mechanism for exchanging $1 for USDr, Ratio will look to employ a Peg Stability Module (PSM) in Q4 2022. The PSM will follow the MakerDAO model. Under the MakerDAO model, users can swap their USDC directly for DAI as opposed to creating a CDP. For Ratio Finance, the module would theoretically allow USDr to peg as close to $1 as possible during demand spikes.
Ratio’s Risk Assessment Strategies and Ratings
Because Ratio’s CDPs hold LP tokens as collateral, risk assessments and ratings for liquidity pools and LP tokens comprise the protocol’s overall risk. Ratio’s team assesses the risk of its LP token pairing as if it were a two-asset equities portfolio. The strategy recognizes that the portfolio value of the two assets would be non-stationary because liquidity pools rarely maintain the same asset breakdowns. To adjust for non-stationarity, Ratio employs a Monte Carlo simulation, where more details can be found in its public whitepaper.
Tokenomics
RATIO
RATIO is currently used for on-chain governance and the team has plans to expand its use as a reward for liquidity pools. RATIO token holders can draft and vote on governance proposals regarding governance rights, liquidity provision incentives, new product updates, roadmap items, and more. Ratio Finance’s current market capitalization is $4.3 million with a $43 million fully diluted value. There is approximately 10 million RATIO in circulation.
B180RATIO
As of late August 2022, 100,000 of Ratio’s Bb180RATIO governance tokens were available through swapping with RATIO tokens on Socean Streams. Users were able to exchange RATIO for B180RATIO at a discount via a continuous Dutch Auction.
B180RATIO is purely a governance token which may be acquired by locking up the RATIO token for 180 days. This model is somewhat similar to the veToken model, but includes additional features making it a more flexible option from a governance perspective. For example, the current model allows users to lock up RATIO tokens in return for B180RATIO, but in the future the DAO may accept LP tokens or USDr.
Holders of B180RATIO can, for instance, vote on grant proposals, adjust Ratio Risk Ratings parameters, or propose new collateral for Ratio vaults. Additional B180RATIO sales will occur in the future.
Traction
Ratio’s true value proposition is its ability to offer releveraging. For example, when users mint USDr, they can swap it for USDC in the Atrix USDr-USDC pool, then pair the USDC with other stablecoins (such as USDT) to create LP positions. From there, users can deposit the LP tokens as collateral in Ratio vaults and repeat the process.
The TVL across Ratio Finance has been on a steady rise since mid-June this year. As TVL rises on the platform, this naturally allows more USDr to be minted. Currently, across the 6 vaults listed on Ratio Finance, there is a total of nearly 3.66M USDr that has been minted.
The vault with the highest USDr debt, totaling nearly 1.48M, is the USDT-USDC vault built on Raydium’s platform. Given that the USDT-USDC pool is a stable pairing, Ratio provides LPs a fairly low-risk mechanism to continue earning yield off the underlying pool, while being able to seek additional yield opportunities with their minted USDr. The current percentage of USDr debt from this vault relative to the overall liquidity in the USDT-USDC pool on Raydium is ~31%, indicating users are taking advantage of these additional yield opportunities.
One of the current yield opportunities for USDr is the recently announced Whirlpool integration with Orca. Users can provide liquidity to either the USDr-USDC, USDr-USDT, or USDr-SOL pools on Orca and receive a combination of ORCA and RATIO token rewards. Since the announcement on September 8th, there’s been a total of nearly 170K USDr added to these pools.
Alongside the initial TVL growth on the platform, Ratio Finance acquired seed capital from Alameda Research, Solana Labs, and other notable investors. Furthermore, the platform continues to build integrations and other partnerships. As noted, In August 2022, Ratio announced an integration with Raydium to offer Ratio vaults with Raydium’s LP pools.
Challenges
To scale its CDP product, Ratio Finance is betting on the continuous growth of liquidity providing and LP tokens, as well as its ability to mint more USDr.
LP Token Growth
DeFi heavily depends on a healthy and growing core group of primitives, with DEXs serving as a critical one. As the space continues to mature, so will the strategies deployed by market makers and liquidity providers on DEXs. The amount and type of exposure LPs and market makers look to hold will vary depending on current market conditions.
Since Ratio Finance only allows LP tokens as collateral, the protocol will naturally feel the pressures associated with market cycles and the subsequent effects LPs’ willingness to take on leverage. Nonetheless, DEXs have generally found product-market fit in DeFi, with no signs of slowing with regards to volumes and TVL. As such, Ratio Finance should have a wide and growing addressable market in the long term.
To give a comparison, MakerDAO also allows for a select few Uniswap LP tokens to act as collateral in their CDPs. These LP tokens have been a major boost to MakerDAO’s overall TVL, with a specific stable pair LP token accounting for over $1B in collateral in MakerDAO’s CDPs at the end of Q2 this year. This is a strong indication that Ratio Finance will see continued growth given their current stable pair LP token strategy.
Maintaining USDr’s Peg
As pegged stablecoins look to increase their scale, they naturally face demand volatility along the way, leading to pressure on the peg. Compared to protocols that accept volatile LP tokens as collateral, Ratio maintains a more stable system by currently only accepting stablecoin LP tokens. The risk assessment strategies (and therefore the collateralization ratios) will be crucial as more volatile LP tokens are onboarded as acceptable collateral.
As countless other stablecoin protocols have found, redemption mechanisms are necessary for absorbing peg volatility. MakerDAO developed the PSM to provide DAI to users in periods of high DAI demand. This setup effectively allows users to swap stablecoins for DAI (and vice versa) for a small fee. Ratio Finance will also explore a PSM in the future, which will further address risks around USDr peg stability.
Growing Organic UDSr Demand
Right now, USDr’s demand is almost completely reliant on the USDr-USDC liquidity pool on Atrix, but is also seeing growth on Orca’s DEX. This concentration in a small number of liquidity pools is natural for a growing stablecoin protocol, but it exposes USDr to solvency risks through a couple of attack vectors. Ratio’s team recognizes this risk. They are working to expand the use of USDr as a payment stablecoin, payroll stablecoin, and pursuing further integrations with lending markets to increase opportunities for USDr holders.
Roadmap
In Q4 2022, Ratio Finance will focus on expanding its ecosystem to include liquidations, auto-leverage, and integrations with more DEXs. Furthermore, the protocol will start offering volatile token-pairing liquidity pools in addition to the stablecoin-based LPs on its platform.
One of the most pressing product upgrades for Q4 2022 is the Peg Stability Module, which should strengthen the protocol’s ability to hold USDr to $1. MakerDAO used the Peg Stability Module to allow arbitrageurs to take profits off price discrepancies, which pushes the price back to $1. Under the PSM, users can swap their assets to mint and own new DAI (not just merely borrow it). arbitrageurs can use this mechanism to keep the DAI peg tight around $1. Ratio Finance plans to allow the same arbitrage opportunities through its Peg Stability Module.
Going into 2023, Ratio Finance is looking to create new use cases for USDr, including its use as a payment stablecoin offered through payroll systems and features through its integrated partner protocols. The protocol will also roll out auto-strategy vaults that run on algorithms calculated through ratio risk ratings.
Conclusion
Ratio Finance differentiates its CDP product by adopting a popular, market-tested TadFi portfolio risk management strategy for DeFi CDPs. The protocol has found initial traction by strategically partnering and integrating with other DEXs and DeFi protocols in the Solana ecosystem. To maintain this traction, Ratio Finance will need to focus on a few areas:
- Keep growing TVL within the system by onboarding new LP vaults. These will likely include volatile asset pairs, which will battle test the risk management strategy of the protocol.
- Maintain a strong USDr peg. The Peg Stability Module should have a positive impact towards this effort.
- Drive adoption of USDr in the wider ecosystem. Integrations with lending markets on Solana will play a key role in driving organic demand for USDr.
Without a clear market dominator for CDPs on Solana, Ratio has the opportunity to strengthen its product and position itself to capture market share in the future.
