Risk Management for LPs
LEVEL is vigorously focused on risk management. We are excited to introduce user-elected credit exposure to LEVEL's Liquidity Providers. Developed entirely from scratch, the RMLP aims to tackle functional issues endemic to zero-price impact perpetuals. Creditor structure, a feature that is almost ubiquitous across traditional capital markets, is something that has yet to be adapted for digital assets. On LEVEL’s RMLP system, we built Tranches with varying risk profiles that reflect underlying exposure for LEVEL Liquidity Providers (LLPs), efficiently tackling and isolating long-tail risk.
What is a Tranche?
A Tranche has become a popularized financial term in traditional finance, most frequently in the context of mortgage-backed securities (MBS). Tranches are essentially pieces of a pooled collection of securities that are split up by risk in order to be marketable to investors with different risk appetites. Tranches usually range from the lowest-risk (AAA) super senior on the top of the credit structure, to the highest rewards (BB and lower).
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In the context of LEVEL, each tranche represents a pool of assets such as BTC, ETH, BNB, CAKE and stablecoins. By offering different risk profiles, each tranche allows LLPs to choose how much risk they are willing to take. LEVEL offers 3 tranches for LLPs:
- Senior Tranche (AAA) — lowest risk and lowest APR
- Mezzanine Tranche (AA) — medium risk and medium APR
- Junior Tranche (BB) — highest risk and highest APR
Tranche | Senior | Mezzanine | Junior | TOTAL |
|---|---|---|---|---|
BTC | 40% | 35% | 25% | 100% |
ETH | 30% | 35% | 35% | 100% |
BNB | 30% | 35% | 35% | 100% |
CAKE | 0% | 30% | 70% | 100% |
The table above represents the percentage of profit or loss attributed to each asset class across the three Tranches. In case of unexpected shortfalls resulting from adverse market conditions, or other incidents, the Junior Tranche bears the highest risk. To mitigate increased risk compared to the Senior and Mezzanine tranches, the Junior Tranche will receive the highest allocation of platform revenues and thus enjoy the highest APR. In contrast, the Senior Tranche bears the lowest risk but also earns the smallest share of platform profits.
As previously mentioned, there are 3 tranches, characterized by the assets composition and the risk exposure for each asset. Assume the current liquidity structure (deposited assets) in the LEVEL Tranches as follows:
Tranche | Senior | Mezzanine | Junior | TOTAL |
|---|---|---|---|---|
BTC | 200 | 200 | 200 | 600 |
ETH | 1,000 | 1,000 | 1,000 | 3,000 |
BNB | 10,000 | 10,000 | 10,000 | 30,000 |
CAKE | 500,000 | 500,000 | 500,000 | 1,500,000 |
USDT | 10,000,000 | 10,000,000 | 10,000,000 | 30,000,000 |
BUSD | 10,000,000 | 10,000,000 | 10,000,000 | 30,000,000 |
Trader Bob opens a position of 150 ETH. To make sure there is liquidity available to settle his trade, the protocol will need to reserve a total of 150 ETH in the pools as follows:
- Senior Pool: 150 x 30% = 45 ETH
- Mezzanine Pool: 150 x 35% 52.50 ETH
- Junior Pool: 150 x 35% = 52.50 ETH
Outcome 1:
Trader Bob is a good trader and makes a profit of 10 ETH on his 150 ETH position. In other words, Bob has decided to settle (close) his 150 ETH trade, and book a profit of 10 ETH. In contrast, LEVEL Liquidity Providers (LLP) will incur a loss amounting to -10 ETH. Then, the 10 ETH will be withdrawn from pools and paid out to Trader Bob's balance as follows:
- Senior Pool: -10 x 30% = -3 ETH
- Mezzanine Pool: -10 x 35% = -3.5 ETH
- Junior Pool: -10 x 35% = -3.5 ETH
Outcome 2:
Trader Bob is a bad trader and makes a loss of 20 ETH on his 150 ETH position. In other words, Bob has decided to settle (close) his 150 ETH trade, and book a loss of 20 ETH. In contrast, Level Liquidity Providers (LLP) will incur a profit amounting to 20 ETH. Then, the 20 ETH will be deposited to the pools and taken from Trader Bob's balance as follows:
- Senior Pool: 20 x 30% = 6 ETH
- Mezzanine Pool: 20 x 35% = 7 ETH
- Junior Pool: 20 x 35% = 7 ETH
- Total: 20 ETH -> gain for LEVEL LPs (plus fee income), loss for Trader Bob
After the initial period, the risk parameters can be changed according to proposals passed by the Level DAO.
Last modified 15d ago