Reflection: The Crypto Story at a Crossroads and the Middle Path for the Future

Written by: Paul Veradittakit, Founding Partner of Pantera Capital
Compiled by: Perry Wang

A founding team of technology experts from Goldman Sachs and Facebook has launched a new protocol to help users diversify risk and simplify the process of entering decentralized finance (DeFi) yield farming.

The relatively high volatility of DeFi is one of the biggest barriers to its widespread adoption, deterring the vast majority of investors seeking strong, stable returns while managing risk. Without the ability to offer fixed-income products that match the fixed yields of more traditional and stable financial markets, DeFi still struggles to prove itself as a universal wealth-building tool.

Ondo Finance is a brand-new permissionless fixed-income protocol that allows users to simultaneously hold fixed yield (FY) and variable yield (VY) positions, catering to investors with all risk appetites.

Liquidity providers (LPs) deposit assets into Ondo Vaults, which are "gun pools" that subsequently invest in individual automated market maker (AMM) trading pairs.

After the gun pool is created, there is a "subscription period" during which LPs can purchase FY positions, which can be one of the assets in the trading pair, and/or VY positions, which can be another asset in the trading pair. The gun pool initially requires equal amounts of FY and VY positions, meaning the asset value of the gun pool is evenly distributed between its two assets. LPs can purchase FY and VY positions in any ratio, allowing them to fine-tune their investment risk and return profile.

Once the subscription period ends, the assets in the gun pool will be invested into an AMM liquidity pool for a fixed term. Upon maturity, Ondo redeems the underlying LP tokens, first paying fixed returns to FY depositors, and then distributing the remaining assets to VY depositors.

So far, the protocol has launched five gun pools, deployed on Uniswap and Sushiswap, offering fixed annual yields (APY) of 7-10% through USDC, DAI, and USDT assets, and 40-50% fixed APY through ETH.

The team consists of seasoned professionals from DeFi and traditional banking, with backgrounds at Goldman Sachs Digital Assets, Microsoft, Facebook, various private equity firms, and more.

Ondo Finance has taken a significant step towards creating a DeFi ecosystem that serves risk-tolerant users by providing stable and high-leverage returns, which will accelerate mainstream adoption by demonstrating DeFi's ability as a stable wealth-building tool.

The Stalemate Caused by Volatility

One of the biggest barriers to attracting new users to DeFi is the significant market volatility. Most financial products offered by DeFi protocols are algorithmically driven and composed of highly volatile, rapidly appreciating digital assets.

In turn, users of these protocols often reap unparalleled returns (three-digit APYs) but must also endure considerable risk. In 2019, the interest rate for ETH lenders on Compound Finance dropped from 1.3% to 0.01%, severely diminishing returns.

This high volatility deters the vast majority of investors seeking reasonable, stable yields and measurable, clearly defined risks. In traditional finance, the fixed-income market (valued at approximately $100 trillion) far exceeds the stock market (valued at around $64 trillion). To attract mainstream and institutional users, DeFi must cater to more risk-averse investors and demonstrate its potential as a sustainable and reliable wealth-building means.

What is Ondo Finance?

Ondo Finance is a brand-new, permissionless DeFi protocol on Ethereum that serves both risk-averse investors seeking controlled risk and stable returns, as well as seasoned cryptocurrency investors looking for leveraged, high-risk exposure to earn substantial returns.

The protocol offers FY and VY positions, catering to users with all risk appetites. LPs can enter FY and VY positions in any ratio, allowing them to customize their risk and return profiles.

How Ondo Finance Works

The protocol provides FY and VY positions, catering to users with all risk appetites. LPs can enter FY and VY positions in any ratio, allowing them to customize their risk and return profiles.

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Specific Mechanism of Operation

LPs deposit assets into gun pools called Ondo Vaults, which utilize smart contracts to execute investment terms (such as the yield distribution between FY and VY positions). Each gun pool is unique and different from one another, meaning investors can clearly choose risk parameters such as minimum collateral ratios, total locked value (LTV) thresholds, and more.

Gun pools currently consist of two different assets, which are then invested into an AMM trading pair. Ondo provides an FY position for one asset and a VY position for another asset; for example, for a gun pool investing in the ETH/USDC trading pair on Uniswap, Ondo might provide an FY position in USDC and a VY position in ETH.

Each gun pool has a brief subscription period during which LPs can purchase FY and/or VY positions in the gun pool. The gun pool only accepts equal amounts of FY and VY positions, meaning each type of position ultimately accounts for 50% of the gun pool's asset value. Once the subscription period ends, the assets of the gun pool will be deployed into a single AMM liquidity pool.

After a brief investment period, Ondo redeems LP tokens for the assets of the gun pool, then pays fixed returns to FY investors and distributes the remaining assets to VY investors.

Through this mechanism, the investment in FY positions is secured by assets from VY positions (starting at 50% LTV when the gun pool launches), while VY positions gain 2x leverage in the AMM pool to effectively pay the "financing cost" for fixed-income assets.

So far, Ondo has launched seven gun pools (all with a 1-month investment term), deployed on Uniswap and Sushiswap, offering 40-50% fixed APY through ETH and 7-10% fixed APY through USDC, USDT, and DAI.

In the initial phase, the protocol implemented a cap on investment assets to protect LP deposits, but will soon introduce more diverse vaults. The project has successfully passed audits by Peckshield and Certik. The image below provides insight into some of the currently open gun pools:

Project Team and Investors

The Ondo team consists of experienced DeFi traders and banking professionals with deep insights into both institutional and retail markets, including founding members from Goldman Sachs Digital Assets, Facebook, Microsoft, Symbiont, and various private equity funds. The project has received investment support from institutions and individuals such as Pantera Capital, Genesis, Digital Currency Group, LAO, and Stani Kulechov (founder of Aave).

Concluding Thoughts

The evident risk profile of DeFi remains one of the most serious (and effective) criticisms faced by the sector, hindering widespread adoption among users unfamiliar with the crypto space, who are unlikely to take positions in extremely volatile or wildly profitable DeFi assets.

Managing risk could be the panacea for DeFi, providing a financial experience akin to popular traditional finance products like fixed-income investments, significantly reducing friction while ensuring stable returns and higher capital efficiency.

Ondo Finance marks a significant step towards creating a DeFi ecosystem that serves users of any risk tolerance. Gun pools are a clever structure that can provide strong, stable returns while also offering higher-yield leveraged exposure, allowing investors to simultaneously purchase fixed and variable yield positions, enabling them to fine-tune their risk and return profiles according to their preferences.

As crypto technology attracts more mainstream user interest, Ondo will simultaneously demonstrate the incredible potential of DeFi in creating wealth in a stable and rapid manner.