Ondo Finance: Making DeFi Yield Risks Controllable

In early 2020, the total locked value of DeFi contracts was less than $1 billion, while at the peak in 2021, the total locked value reached an astonishing $90 billion. The composability of DeFi protocols allows assets to move seamlessly between different protocols, generating incredible asset returns.

In traditional finance, achieving a 20% annual return is already considered remarkable, but in the DeFi space, annual returns exceeding 100% are commonplace. Where do such high returns come from?

On-chain yields primarily come from two sources: lending interest and trading fees.

For lending interest, users can deposit assets into lending protocols like Compound or Aave, where borrowers pay corresponding interest to asset providers. For trading fees, users can provide liquidity to trading pairs on decentralized exchanges like Uniswap or SushiSwap, where traders pay a certain percentage of trading fees to liquidity providers during transactions.

However, although the yields offered by DeFi protocols are substantial, the risks are also high. Especially due to the impermanent loss caused by the high volatility of crypto asset prices, as well as the commingled risk that may arise in lending protocols. These risks are unacceptable for users accustomed to traditional financial risk perspectives and risk-averse investors. Therefore, the yield risks in DeFi need to be controllable.

Allocating Different Risk Preferences for Investors in a Tiered Model

Ondo Finance has designed two different investment plans for investors with varying risk preferences: fixed income and floating income. Similar to the waterfall tier structure in traditional finance, all yields will first be distributed to fixed income investors, and then the remaining yields will belong to floating income investors.

Ondo Finance segments liquidity providers. Taking the DAI/ETH trading pair as an example, in this trading pair, fixed income investors only need to deposit DAI to provide liquidity, while floating income providers are responsible for providing the price volatile asset ETH. The strategist will set a minimum yield for the fixed income side.

Investors need to subscribe within a specified time frame, depositing assets into a designated vault contract. After the subscription period ends, the strategist will place the assets in the vault into a decentralized exchange to provide liquidity. On the investment maturity date, the strategist will withdraw the liquidity, first paying back the principal and yield to fixed income investors, with the remaining excess yield belonging entirely to floating income investors.

Different asset trading pairs and the segmentation of liquidity providers can maximize the satisfaction of different investors' risk preferences and yield demands.

Ondo Finance's Upcoming Subscription Products

From the image above, we can see that Ondo Finance will launch four subscription products on July 31. The investment cycle for these four products is one month, namely ETH/ALCX, USDC/ETH, USDT/ETH, and DAI/ETH. The last three products are quite similar to the examples we mentioned earlier; for fixed income investors, they only need to deposit stablecoins, while floating income investors need to deposit ETH.

However, the ETH/ALCX trading pair is different; fixed income investors need to deposit price volatile, lower-risk ETH, while floating income investors need to deposit higher-risk ALCX. This product carries higher risk compared to the other three products, which is why we can see that the estimated floating yield for ALCX can reach 509%, while the yield for fixed income ETH can also reach 50%.

As of the time of writing, the total locked value of Ondo Finance's first phase has reached nearly $3 million.

Initially, to reduce the losses investors might face after an attack on the protocol, the protocol will initially limit the investment hard cap for each product. Initially, the investment hard cap for the three stablecoin/ETH trading pairs is set at $1 million each, while the hard cap for ETH/ALCX is set at $2 million. In the future, the hard cap will gradually increase, eventually lifting the hard cap restrictions.

Similarly, Ondo's investment products will not set investment cycles in the future, becoming perpetual products. In terms of product variety, different strategists will design more diverse strategies for more assets.

The Present and Future of Ondo Finance

According to PitchBook data, Ondo Finance has successfully received support from Pantera Capital, although specific details have not been disclosed.

From a contract security perspective, Ondo Finance has passed audits from two third-party auditing firms, Peckshield and CertiK, and is awaiting the final results from Quantstamp.

As of now, Ondo Finance does not have a native protocol token and has no plans to release a token.