Archimedes Leverage Engine — Comparing Existing Solutions

At Archimedes we’re working diligently to bring a new financial primitive to DeFi, leveraged yield-bearing stablecoin strategies composable through NFTs. What does that mean, and how is it different from existing solutions?

Leverage in DeFi is nothing new — in fact, it was one of the first value propositions offered by the earliest DAOs. With any money market there exists the possibility of default and being stuck with bad debt. Currently the solution to this is to include a higher collateral ratio on assets to give the bots and liquidators time to auction off and sell bad debt before the protocol gets stuck holding the bag.

At Archimedes, we can structure leverage differently due to our protocol design, let’s take a look!

On-chain Leverage 101

First, let’s quickly review on-chain leverage as it currently exists. There are two actors involved, the lender and the borrower.

Typically a borrower will arrive on a platform with some “blue chip” asset like USDC, ETH or WBTC. Their goals can range from drawing liquidity from their assets without triggering taxable events to simply wanting to lever up into a trade. Regardless of their motivation, they are taking on debt in the form of a loan using collateral that is desirable to the lender or protocol.

Both users are exposed to risk:

• The borrower risks not being able to repay the loan and having their collateral liquidated by the lender.
• The lender risks the collateral value falling faster than they can liquidate the collateral to cover the borrowers debt.

For the borrower, currently there is no risk mitigation, they are welcome to do as they please with the loan they received from the protocol. This is in contrast to a traditional brokerage where you are allowed to trade on margin, but not allowed to withdraw those assets from the platform to buy a home instead of Apple stock for example.

For the lender, there is risk mitigation in the form of a high collateral ratio. For simplicity, the idea here is that if you deposit $100 of ETH, you can only borrow $50 against it. This gives your debt position a $50 buffer before your loan amount becomes worth more than your collateral, therefore defaulting on your loan. (Why would anyone pay $50 to get only $49 back?)

Current on-chain implementations show us that leverage is not heavily controlled — it is heavily collateralized instead. This creates some level of protections for the lenders, but not the borrowers.

In addition, the incentive to create these markets are for speculation and liquidation purposes. Most on-chain money markets implement penalties for liquidations to incentivize liquidators to auction or sell debt before it goes bad, but also to incentivize borrowers to add more collateral preventing it from going bad in the first place.

Conditional Leverage

Archimedes leverage is “conditional”.

You are only allowed to deploy the capital into whitelisted strategies. Archimedes’ leverage engine allows users to take on up to 10x conditional leverage, similar to having a collateralization ratio of only 10%.

How is this possible? Using an example with on-chain money markets, a user can borrow tokens and do whatever they want with it. Leverage farming on Convex, buying a home, anything goes.

However, when you take leverage from Archimedes, not only does that leverage not leave the platform, you are bound to a specific asset or strategy. Archimedes is able to offer high leverage because the debt you take on, never leaves the “platform.” Similar to the comparison drawn above about a traditional brokerage, they are able to offer you higher leverage because they have control over the assets and strategies you employ with that leverage.

Overview of an Archimedes Strategy

Archimedes accepts over-collateralized, yield-bearing assets as collateral. This collateral is looped through the Archimedes leverage engine back into the principal yield-bearing asset, increasing the depth of liquidity for the asset while providing leveraged yield. As you already know, there are two sides to this architecture, the lending side and the borrowing side. Here’s how it works:

a) For Lenders

lvUSD is minted 1:1 with stable collateral. Only Archimedes can mint lvUSD and this way we control the equilibrium of our Curve pools. Lenders are incentivized to provide liquidity to Archimedes supported Curve pools like 3CRV/lvUSD due to the naturally high yields they provide. Borrowers are required to pay for access to leverage with ARCH tokens.

The yield for Archimedes’ Curve pools are sourced from real economic activity and usage. Opened and closed positions are routed through these Curve pools for settlement. Another source of yield for liquidity providers comes in the form of token incentives by projects looking to boost liquidity on Curve through Archimedes.

b) For Borrowers

A user selects their collateral asset, desired leverage, and when to unwind their position, which is valid for ~12 months. We’ll use OUSD as collateral, and the borrower will pay for access to this leverage with ARCH.

1. The borrower deposits OUSD with Archimedes.
2. Archimedes then swaps lvUSD for OUSD corresponding to the amount of leverage desired, through the OUSD/lvUSD Curve pool.
3. The OUSD is then wrapped into an NFT representing the user’s leveraged OUSD strategy and minted to the borrower.

Why NFTs?

So why hasn’t something like this been built before? With the advent of NFT token standards and the ease of their development, it’s now possible to represent a position or strategy through an NFT’s metadata. What’s important to know is that these are similar to the “IOU” style of LP tokens we’ve come to know and love in that they represent the holder’s claim to a pro rata share of assets in a pool.

However; in order to allow users to trade their positions without unwinding them, Archimedes wraps their positions in an NFT until their loan ends after 12 months or the borrower unwinds it. This structure allows yields to remain sustainable, while also giving investors a liquid exit. When users sell the NFT and not unwind the position, the liquidity stays with the leveraged protocol which creates a really sticky TVL. It also provides traders and market makers the opportunity to reprice positions in the secondary NFT markets. Some of these NFT trading fees can be routed back to the lvUSD LP’s to further boost lending APY.

Risks

So what gives? What are the risks? As with anything in crypto there are always considerable underlying risks ranging from counterparty risk to smart contract risk to general market risks. As these are ever present, I will only focus on market risks specific to Archimedes for this section.

There are two main risks for Archimedes:

1. A collateral asset we support loses its peg. In this instance, because Archimedes positions cannot be liquidated, users are welcome to reprice their distressed positions in the secondary NFT market however Archimedes will work closely with the collateral issuer to restore the peg to normal. This is why it is important that Archimedes only supports high quality, battle tested collateral.
2. If lvUSD loses its peg. This would look like an imbalanced Curve pool where there is too much or too little lvUSD relative to the other asset pair. Archimedes solves for this by carefully managing the amount of leverage available to its users. When the price lvUSD is above $1, Archimedes increases the leverage cap which increases the amount of lvUSD in the pool, restoring the peg. Similarly, when lvUSD is trading below $1, there is a strong incentive for the borrower to close their position as they can essentially purchase lvUSD for less than $1 and use it to repay $1’s worth of debt.

Come Join Archimedes!

Hopefully by the end of this article you understand a little more about how Archimedes is creating a sustainable, high leverage lending protocol that enables users to access yield opportunities in a “safe” (safe is an oxymoron in DeFi) environment.

If you liked this article please visit the website and join the Discord to get involved! Follow Archimedes on Twitter to stay up to date on all news.

Archimedes is an experimental protocol and carries significant risks: Smart contract risk, economic model risk, risk that the assets Archimedes introduces and many other types of known and unknown risks. Archimedes’ team never provides investment advice. This article is NOT financial advice. DYOR. Participate at your own risk.