Single Treasury Model - The Foundation of DeFi Legos

This article is from Deribit Insight, authored by Jacob Goh, and compiled by DeFi Dao.

In recent months, innovations in the automated market maker (AMM) space have fueled the growth of decentralized exchanges (DEXs).

Uniswap released its V3 version, introducing concentrated liquidity, which improved capital efficiency by 4000 times compared to its V2 design, while Bancor V2.1 introduced an interesting token economic model to address the pain points of impermanent loss, enabling the provision of unilateral liquidity.

Other DEXs have been innovating in different directions, with the single vault model being increasingly adopted.

SushiSwap's BentoBox and Balancer V2

In March 2021, SushiSwap launched its single vault, BentoBox, where all users can deposit their tokens into this box—a decentralized "app store" that can be accessed by many different applications. For example, funds in BentoBox can be used for flash loans while yield farming on Onsen, and in the future, even provide liquidity on SushiSwap's AMM.

Similarly, Balancer also introduced its single vault in their V2 announcement. Balancer's protocol vault aggregates and manages the tokens added to each Balancer pool. The AMM logic is separated from token management and accounting, which is handled by the vault, while the AMM logic is executed individually by each pool.

Lego Base

The single vault can be seen as a Lego base, allowing other Lego pieces (different DeFi applications) to be built upon it. Protocols like Uniswap focus on building a good Lego block, while protocols like SushiSwap and Balancer take a different approach—synthesizing these Lego blocks.

The base securely stores tokens and automatically generates yield on underutilized assets to reduce opportunity costs. Developers can build directly on top of the base, and the DApps they develop can leverage the underlying assets, attracting more users to enhance the overall adoption of the protocol.

The holy grail of DEXs is to provide LPs with maximum capital efficiency and yield. In this article, we will attempt to explain how the single vault model optimizes this goal.

Advantages of the Single Vault Model

Gas Efficiency

SushiSwap's core frontend developer Omakase described BentoBox as "a 1.5-layer solution where everything is kept in a single token vault." The single vault allows for internal token balances to be maintained within the vault, thereby ensuring gas efficiency by reducing unnecessary token transfers.

Today, gas fees are wasted on multiple approvals of the same token. This situation does not occur in a single vault. Once a token is approved for the vault, it can be used across all protocols built on the vault.

Previously, the increased gas fees due to the complexity of Balancer's smart order routing algorithm overshadowed the potential savings from lower price impacts. The new model completely resolves this issue and optimizes pricing.

With Balancer's new vault, trades can be executed across multiple pools, with only the final net token amount being transferred back and forth between the vaults. This will reduce the number of transactions under the hood, saving users a significant amount of gas.

High-frequency traders can also avoid posting any short-term ERC20 trades, which is particularly useful for DEX aggregators.

Additionally, by utilizing flash loans, arbitrageurs can profit from trading information between pools, allowing them to arbitrage even without holding tokens, thus improving process efficiency and reducing capital-intensive operations.

Source: Balancer Medium

Overall, developers can build dApps without worrying about gas overhead. At the same time, traders will choose to trade on these platforms because gas fees have a smaller impact on their profits.

Providing a Secure and Flexible Foundation for Applications

By separating the AMM logic of the pools from token management and accounting, the single vault model provides a strong foundation for developers' work. Low-level details can be delegated to the vault, eliminating any technical overhead for developers. This modular architecture allows teams to become more focused and efficient.

SushiSwap

The first dApp built on BentoBox is Kashi, which utilizes assets on BentoBox for lending and one-click leveraged trading. Since all tokens are stored in a central vault, the number of internal token transfer transactions and overall gas fees can be reduced. For example, through BentoBox and Kashi, shorting with over 1x leverage can be completed in a single transaction.

MISO will also be built on BentoBox. It is a launch platform for project founders to launch new projects on SushiSwap. MISO creates a set of smart contracts that allow founders without a technical background to easily launch their new tokens by providing liquidity and migrating to SushiSwap. The smart contracts include features such as creating new tokens for projects, time-locking token vault options, initial token offerings, crowdfunding, and a mining farm for the new token.

Balancer

Balancer's token vault can now serve as a launch platform for the team's AMM innovation strategies and DApps, with two official partners already established:

Element Finance, a fixed-rate interest protocol, will build custom trading curves on Balancer V2 to avoid the hassle of forking or building their own AMM from scratch.

"Element Finance needs to implement custom constants or trading curves but does not want the technical overhead of forking or building our own AMM with custom logic. To avoid these issues, we chose to build on Balancer V2." ------Element Finance, April 2021

The Balancer-Gnosis Protocol, a collaboration between Balancer and Gnosis, will bring Gnosis's DEX aggregator and batch auctions to market, aiming to alleviate miner extractable value.

Both BentoBox and Balancer's vaults will allow dApps integrated within the vault to connect with each other, providing synergies and leveraging the value of network effects. At the same time, dApps bring new users to the vault, driving growth in TVL and protocol adoption.

Capital Efficiency

Pools have complete control over the underlying tokens they add to the vault. This opens up vast design space for improving capital efficiency, allowing asset managers and dApps to build on the vault. Once nominated by the pool, external smart contracts with complete control over the pool's tokens can function by utilizing the underlying tokens for other purposes, such as voting, yield farming, and lending.

SushiSwap

Assets on BentoBox can be used to provide flash loans, even while the same tokens are being used for mining on Onsen. Even if the assets are not borrowed, users can still use their tokens to earn yield or LP fees. This allows users to maximize their earnings at any given point in time.

Kashi's target utilization rate is between 70-80%. This utilization rate refers to the percentage of currently borrowed assets relative to the total supply. It will attempt to achieve this target through a flexible interest rate that fluctuates based on changes in utilization.

Source: SushiSwap, BoringCrypto Blog

Balancer

Similar to BentoBox, assets in the Balancer vault can also be used for flash loans. Additionally, Balancer has partnered with Aave to establish the first Balancer V2 asset manager, allowing idle assets in V2 pools to earn yield on Aave.

The GIF below illustrates a scenario where only a small portion of assets in a liquidity pool are traded, while the majority of assets remain idle in the liquidity pool. Through the asset manager, these assets can be programmatically deposited into the Aave pool based on certain thresholds.

Over time, the proportion of assets in the pool becomes increasingly imbalanced, and large trades may fail. When this happens, the asset management company will automatically replenish the pool with DAI and send more WETH to Aave to maximize yield.

Currently, only a small portion of TVL in AMMs generates yield. We can expect that with the implementation of asset managers in the single vault, the liquidity utilization metric (the percentage of assets that can generate yield) can be greatly improved.

Source: Balancer Dashboard

Disadvantages of the Single Vault Model

When all assets are in a single vault, the risk of smart contracts increases due to complexity. Although the teams at Balancer and SushiSwap have made significant efforts to ensure the safety of funds, this innovation also represents a certain degree of risk.

In particular, dApps and asset managers have high permissions over vault assets and may represent other attack vectors, necessitating careful scrutiny of the complex logic involved.

Vision and Future Path

"The innovation of BentoBox lies in its effortless scalable design. Its scalar design allows BentoBox to serve as the infrastructure for future DeFi protocols on Sushi. Unlike other protocols, it creates a primary source of liquidity that any user can obtain liquidity with minimal approvals, minimal gas usage, and maximum capital efficiency." ------SushiSwap, May 2021

In addition to the various tangible benefits derived from the vault, an important factor to consider is that it brings significant competitive advantages to integrated protocols. Such advantages are hard to come by in DeFi, making the complexity of the protocol nearly impossible to fork and replicate.

Imagine Yearn and SushiSwap in the same vault, while Aave and Balancer are also united. These protocol complexes would effectively become entry points for participating in DeFi, creating sustainable yields for users' assets. This would also raise the barrier to entry, preventing other upcoming DEXs from eroding the market share of SushiSwap and Balancer.

In this transition, it is evident that SushiSwap and Balancer aim to be passive liquidity providers, as more active liquidity providers flock to Uniswap following its V3 upgrade. For retail liquidity providers looking to passively manage their liquidity, SushiSwap and Balancer are good choices, while Uniswap will offer more aggressive strategies to attract more mature participants into the space. If the single vault model achieves the goal of being the go-to place for passive liquidity providers, it would not be surprising to see a massive migration of assets.

The DeFi castle will be built with Money Legos. Source: TwistedSifter

Returning to the Lego analogy, SushiSwap and Balancer view AMM as a Lego block in their ecosystem. By taking cues from Polygon's approach—actively incentivizing mature DeFi protocols like Aave and Curve to deploy on their L2 platform—the next step will be to incentivize more Lego blocks to be built on the Lego base, filling the Lego base with countless Lego pieces.

Over time, this structure can become more complex with the integration of protocols, building an insurmountable moat for SushiSwap and Balancer. The Lego base will serve as a solid foundation for constructing a vast DeFi castle.