Silo Finance: An Isolated Advantage

The Power of Leverage

Lending protocols in DeFi aim to create decentralized, permissionless loans, which enable capital-efficient strategies for users. These opportunities exist for both lenders and borrowers. Users can lend their money out and, in return, earn interest yield. Borrowers can then directly take out a loan if they’re willing to pay the interest. This is called P2P lending.

Security Risks

Like all forms of leverage, the most front-facing risk comes in the form of liquidation. Once funds are deposited into a lending protocol’s smart contract, the depositor is assigned a Health Factor (HF). Your health factor represents the security of your initially deposited asset against the principal value of the borrowed assets. Initial HFs vary as each protocol differs in the risk parameters they use to define the liquidation thresholds for different assets. A simplified way to view it is that the closer a borrower’s HF is to ‘1’, the closer they are to defaulting on the loan.

If a default was to occur, the lending protocol seizes and liquidates the locked collateral to cover the underlying debt. On top of that, before paying out the remaining collateral to the borrower, a penalty fee is charged against the debt.  

Aave

Model used

Shared Lending Pools

First-generation lending protocols like Aave utilize a liquidity model called ‘Shared Pools.’ Assets deposited get put into a single  ‘shared’ pool that contains all the collateralized assets held by the protocol.

Risks & Consideration

While this model is technically more capital efficient than other more isolated protocols, it comes with a substantial risk increase. Since there is only one lending pool for numerous tokens, the entire pool is considered compromised if one token is exploited. As a result, these markets are more suited for short-tailed assets to avoid potential exploits.  We’ve seen these instances in examples such as the C.R.E.A.M. Finance exploit on October 27, 2021, which led to the hacker getting away with $137 million worth of crypto assets.

Rari

Model used

Isolated Lending Pools

Users can create their own isolated money markets called Fuse pools. These pools consist of many tokens, as pool creators can use any asset, oracle, or interest rate model. These pools consist of numerous tokens, creating an efficient money market model. 

Risks & Consideration

Isolated lending pools have improved security over shared pools. With that being said, each pool is still dependent on the individual security of all their assets. If one asset inside a pool is compromised, then so is the entire pool. Also of note is the issue of centralization. Each pool creator can adjust the parameters of the pool as they see fit, placing further pressure on the pool’s security. 

Kashi

Model used

Isolated Risk Markets

Users can provide liquidity and create a money market for any token asset they want.  

Risks & Consideration

This model achieves a high level of security due to each pair being completely isolated from the other. If one pair is compromised, it would only affect that specific pair. This level of isolation does come with its setbacks. Liquidity is spread throughout many pools. USDC, for example, has over 30 pools. This becomes an issue as the liquidity is fragmented, so borrowers need to pick and choose the suitable pools for their order size.

Euler Finance

Model used

Tiered Lending Markets

Euler utilizes Uniswap v3’s price oracle to create risk-based asset tiers to protect the protocol and its users. The three asset tiers are; Collateral tier, Cross tier, and Isolated tier.

Risks & Consideration

The main concern is oracle risk. Euler depends on Uniswap V3’s price oracle, which has been exploited multiple times in the past. 

Silo Finance

Model used

Isolated Lending Markets Variation

Users can create a money market for any token asset they want by utilizing a preset bridging asset(ETH). 

Risks & Consideration

Silo utilizes Uniswap v3 and Balancer price oracles. This means that market creation is limited to token assets with liquidity pools within one of those platforms. By isolating the different money markets, the risk also becomes isolated, enabling a high-security level by design. Each money market is paired up with what Silo calls a bridge asset. At the moment, $ETH is the only asset being used as a bridge asset. All transactions are routed through this asset; therefore, it is the only asset that needs to be trusted. If a token is compromised or exploited, the only ones affected are the bridged asset suppliers of that isolated pool ($ETH lenders).

Token Vesting & Allocation Schedule

Silo is offering 10% of its total token supply to the community through a public batch auction conducted on the Gnosis Auction platform. For the first six months, about  100% of Silo’s circulating supply will come from the genesis event. Over the next four years, 1B $SILO tokens will be minted. 

Silo Protocol Overview

Silo Finance is a decentralized, permissionless lending protocol that offers secure and efficient money markets by utilizing isolation elements. Silo was designed to address the primary pain points of existing lending protocols. The security flaws of shared pools are addressed by isolating each lending pool, similar to what Kashi does. The problem with Kashi’s model is that liquidity is fragmented between too many different pools. While this model ultimately achieves high levels of security relative to shared pools, it comes at the expense of efficiency.

Silo introduces an improvement on the isolated lending markets model by:

  • Whitelisting any token assets without the reliance of governance. Liquidity constraints are set by the market, not governance. 
  • Enabling deeper liquidity by having one isolated pool for each asset
  • Improved scalability by allowing any crypto asset to be listed as long as it can find a counter-party. 

Lending Design

The design itself is straightforward. When a supplier uses their collateral to borrow, the underlying process requires creating two positions.

Silo lending design model

An example of how this works:

  • John wakes up one morning and decides he wants to collateralize his $LINK, so he deposits his $LINK into the $LINK-$ETH Silo.
  • John then decides he would like to borrow against his $LINK and pick up $BAL.
  • In order for John to do this, two transactions need to happen. The first transaction requires John to borrow against his deposited $LINK. Since each money market in a Silo is paired with the trusted bridge asset ($ETH), that is the token he gets in return for borrowing against his deposit. 
  • The second transaction that John has to do is deposit his borrowed $ETH into the $BAL-$ETH Silo. From there, John borrows however much $BAL he wants against his $ETH collateral(relative to the allowed amount set by the LTV of the pool). By doing so, $ETH becomes the only trusted collateral in this entire process. In this case, if either $LINK or $BAL are compromised, the only ones affected are the bridging asset suppliers ($ETH lenders in the $ETH-BAL pool receive bad credit) 

One consideration to keep in mind is that due to the nature of this model’s process, it takes four transactions, which also means four transaction fees (gas), making it an expensive protocol to use for smaller investors.

Liquidity Bootstrapping

It is generally understood within the world of DeFi that an essential mass of liquidity is required for a well-functioning application. As a result, most new protocols bootstrap their liquidity by distributing their tokens in liquidity mining or yield farming programs. The issue here is that it’s proven to be unsustainable.

Bootstrapping liquidity through liquidity mining programs creates a negative feedback loop where once rewards start to collapse, mercenary capital starts to pull liquidity, and the selling pressure commences. This ‘farm and dump’ strategy is referred to as Mercenary capital.  Protocols should instead focus on incentivizing the right kind of actions that provide long-term value to the network.

Protocol Owned Liquidity (POL)

Silo took an interesting approach to how they’ve handled their allocation. Instead of creating liquidity mining programs, they’ve decided to take a page from Olympus’s book and build up their protocol-owned liquidity (POL). The benefits of Silo utilizing this model are:

  • Seed Liquidity in (Silos)
  • Non-dilutive for Silos token.
  • Earn fees directly to the treasury. The capital kept in the treasury acts as operational capital, continuously earning yield for the treasury.
  • Deflationary token buybacks
  • The DAO/Silo token holders have complete control over utilizing treasury funds.

Funds Allocation

  • Protocol Owned Liquidity: Up to 85% of the funds will be locked in the DAO’s treasury and controlled by the community through governance.
  • Development fund to cover operational expenses of Silo protocol such as payments to contributors, security services, infrastructure services, and many others. A minimum of $2.5M and a maximum of 15% of total funds raised will go to developing the protocol, giving Silo an ample runway to keep developing the protocol. The development fund is a Gnosis multi-sig controlled by multiple core team members.

Liquidity Incentives a la Curve

On March 6, 2022, Silo created a proposal to build a $SILO  pool on Curve V2 and incentivize liquidity through CRV emissions.

Silo Proposal on Curve governance forum.

Silo’s plan was the following:

  1. Start SILO: FRAX Pool on Curve v2 to drive liquidity
  2. Market buy $CVX tokens to gain voting power within the Curve DAO
  3. Use the newly obtained voting power to vote for CRV emissions to the SILO: FRAX pool.

The team immediately took action on this proposal and began TWAPing their CVX orders. Between March 4th and March 6th, the team had acquired $250,000 CVX, spending $4.41mm $USDC, with their average position size being $17. The price of CVX has more than doubled since then, meaning their CVX investment is now worth about $10 mm.

As a result of the success of their CVX purpose, they’ve exceeded their original goal. On April 14th, Silo intends to use their newly obtained voting power to vote for their SILO: FRAX pool.

APY Projections—Access spreadsheet here

Figure D. Projection Spreadsheet 

As shown in Figure D, the SILO: FRAX pool will yield a considerable APY. The actual numbers will vary depending on TVL. Theoretically, this will be a catalyst for the price of $SILO  as farmers rush in chasing the yield. With that said, it’s difficult to know how much of this has already been priced in, so building a position based on this speculation alone would be considered risky. 

Silo Stablecoin (SiloDollar, USDs)

Silo Finance is launching a stablecoin, SiloDollar. While there is no name yet for this stablecoin, it is sometimes called USDs. The stablecoin will be utilized as a bridge asset alongside $ETH. 

How will the SiloDollar work?

The current proposal states that the SiloDollar will be a basket of external stablecoins, such as Frax, DAI,  LUSD, USDT, etc. The idea behind creating a stablecoin that is pegged to other stablecoins is that it removes the need for the protocol to maintain the peg itself. This enables the SiloDAO to focus solely on building up liquidity and increasing token utilization. 

veSILO

Silo finance is launching a 12-week beta for a veSILO incentive program. This model integration aims to incentivize liquidity development for SiloDollar within Silos. Based on the program’s effectiveness in boosting demand for SiloDollar, It will be determined whether veSilo will be a permanent element of Silo’s architecture or not. 

Rewards are allocated to Silos according to weights determined by token holders. The voted emission weights are divided proportionally among borrowers within the Silo(lending pool). It’s important to note here that it’s been decided that only borrowers on USDs will be incentivized as of the time of writing. 

An example of how this works:

  • John deposits $200,000 FXS into the FXS-ETH pool. The pool is now at $1M TVL, meaning John owns 20%. 
  • A governance vote passed that enables a 1000 $SILO per day reward to the FXS Silo.
  • John decides he wants to borrow 100k USDs against his deposit. Since John owns 20% of the pool, he is now receiving 200 $SILO per day in yield incentives and any interest he’s gained from lending. 

Final Thoughts

  • Silo was a finalist in ETHGlobal2021. This was no surprise as they have a solid team with reputable backers such as Joey Santoro from FEI Protocol, Sam Kazemian from Frax, Santiago R Santos, Ameen from Reflexer, Tyler Ward from BarnBridge, Regan Bozman from Lattice, Sherwin Lee and Keith from PSP Soteria, AiRTX from 0xVentures, Don Ho and Quantstamp, Emile from XDEFI, ShapeShift DAO, recently announced. 
  • Silo Finance has just completed its second round of audits, with two more on the way. 
  • At the time of writing, $SILO token’s only use-case is for governance. The Silo DAO will use it for voting on proposals that include controlling pool parameters, directing DAO-owned liquidity, veSILO emissions, etc. There is currently no other incentives/utility built into the $SILO token. 
  • The price of $SILO is expected to be volatile over the coming weeks as the market seeks fair value. However, when liquidity incentives go live on the 21st, we should see volatility ease. 

In conclusion, Silo Finance looks to address the primary pain points present within the current lending platforms in DeFi. With their innovative isolated lending markets design, there is a high potential that Silo will be a leading competitor in the lending markets space. 


This report is not investment or trading advice. Please conduct your own research before making any investment decisions. Past performance of an asset is not indicative of future results. The Author may be holding the cryptocurrencies or using the strategies mentioned in this report.

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