Vaults

The number of investors that are making use of the different DeFi ecosystems is rapidly increasing. New yield farming opportunities appear daily, and investors need to be there just in time to take advantage of them. As an investor on the Ethereum network, you might think "What about the gas-fees?". And as an investor on the hugely popular Binance Smart Chain, you may not know where to start. Vaults are here to change this.

What are Vaults

Vaults are, simply put, pools of funds with an assigned strategy. The goal of Vaults is simple: to maximize the returns of its assets.

The reason why Vaults are so popular is because they save a lot of researching time and fees for investors. Typically, it can take hours to find the best yield farming strategy, not to mention the high transaction-fees (when investing on the Ethereum network). Another advantage of Vaults is that, no matter how complex the strategy of the Vault, the investor always gets his initial deployed asset back from the Vault.

Vaults often have multiple strategies which are, in their turn, very diverse. This allows Vaults to interact with different DeFi protocols to maximize their profit. Vaults can, for example, supply collateral and borrow another asset against this and then deploy the borrowed asset on another DeFi platform. When a certain platform no longer offers high yield, the Vault can, if its strategy allows, switch to another platform for higher yields.

Not all assets are used in the strategies of the Vaults. There is always an amount of assets that remain idle in the Vault. By doing so, investors can withdraw their assets for lower fees from the Vault. This way, the assets do not have to be withdrawn from the DeFi protocols, which greatly reduces gas fees. However, if an investor chooses to withdraw their assets from the vault, they still have to pay additional fees to cover for the gas fees gathered by the Vault.

Usually, the strategies of the Vaults are developed by the community of the respective platform. The developers receive a small percentage of the fee paid by the investors when they withdraw their assets.

How Vaults work

To fully understand how Vaults work, let's use a hypothetical Vault as an example. Let's call this Vault the WBTC Vault. This Vault uses the following strategy:

  1. After an investor deposits its WBTC in the Vault, the WBTC is supplied as collateral on a DeFi borrowing platform. The Vault then borrows up to 50% of it's supplied collateral in USDC, creating a collaterised debt position. This means that if 1 WBTC with a price of $40,000 is used as collateral, the Vault can borrow $20,000 USDC.
  2. The borrowed USDC is deposited into a liquidity pool on a DEX platform. Suppose this platform gives extra interest through its own token: the example token. The Vault now earns both the extra interest in example token plus the trading fees of that specific pool.
  3. The WBTC Vault periodically swaps its example token for WBTC and uses the accrued trading fees from the liquidity pool to accrue even more interest.

As you can see, the Vault works extremely efficiently and cost-effectively thanks to its smart contracts strategy. Compare this to if an investor which has to perform all steps manually.

Examples of Vaults

Lately, an increasing number of Vault platforms have been developed. Below is a list of the most popular Vaults (+ their network compatibility) in the DeFi space.

Risks

Of course, Vaults don't come without risks. For example, the smart contracts of the Vault can be prone to bugs or hacks, or the stable coin used in the Vaults strategy can lose its peg to the dollar.

The biggest risk of Vaults is liquidation. This can happen, for example, when the WBTC in the Vault mentioned in the example above drops in value. As a result, the 200% worth of collateral can suddenly drop below 150%. If the Vault does not refill its collateral back to 200%, the Vault may be liquidated, resulting in a loss of all WBTC. Fortunately, Vaults are programmed to intervene in time should this happen.

Conclusion

Vaults are extremely useful for investors who don't have the time to look for new yield farming opportunities within the DeFi space. By depositing your assets once, the Vault can apply its strategy to maximize the returns. Because of this, it is expected that Vaults will continue to increase in popularity.