[RFC] Generate stablecoin revenue for the DAO through POKT covered call lending

[contentropy]

Intro
Hey there! I’m Denis aka contentropy - I’m on the team of MYSO, a peer-to-peer lending protocol built on the EVM.

I would like to present an innovative treasury strategy to allow the DAO to generate stablecoin revenues by using part of its idle $POKT holdings for covered call lending - this strategy would employ idle tokens to be lent out with custom terms (duration and upside cap) to generate upfront revenue for the treasury which can be subsequently used to fund new and ongoing initiatives.

I am sharing this RFC proposal to gauge interest prior to making a full proposal for employing these on-chain covered call strategies through MYSO (https://myso.finance/ | https://app.myso.finance/)

Idea
The idea is to leverage a portion of Pocket’s treasury through on-chain covered call lending. This approach involves lending out a smaller part of currently idle $POKT tokens. By doing so, the DAO can generate significant upfront revenue in USDC. The earned USDC can be immediately utilized for community needs. And unlike a simple token sale, covered call lending enables the treasury to diversify its holdings into stable assets without an immediate market impact. All loan execution happens through MYSO’s 3x audited smart contracts and is trustless and fully transparent with full on-chain traceability

Benefits
• Idle $POKT tokens can be used to generate upfront USDC revenue
• Immediate revenue and liquidity for operational and developmental activities
• Diversification of the treasury into stables
• Tokens don’t need to be sold, thus there’s no immediate market impact

Example Scenario
The diagram below shows indicative upfront premiums (as of Jan. 24, 2024) that the DAO treasury could earn across various loan duration (Days to Expiry) and upside cap (Relative Strike Level) combinations

For instance, let’s say the Pocket treasury lends $100k worth of $POKT for 60 days at a 120% upside cap. In turn, the DAO treasury gets approx. $21.3k USDC upfront - the treasury keeps this no matter what happens at loan expiry.

Now, at the end of the loan period, two outcomes are possible:

i) If the $POKT price remains below 120% after the 60 days, the originally loaned $POKT is returned.
ii) If the price of $POKT exceeds the 120% cap, the DAO treasury receives $120k USDC

As mentioned earlier, the upfront premium ($21.3k) is paid out upfront and is retained no matter the outcome of the loan

Conclusion
This proposal outlines how the Pocket treasury can generate USDC stablecoin revenue by using idle $POKT treasury for covered call lending. This approach not only diversifies the treasury but also avoids market impacts that could arise from outright selling $POKT tokens.

Would love to hear feedback and comments from the DAO and community and would be happy to answer any questions. Looking forward to putting together a full proposal outlining each of the above points, the process for facilitating this trustless, on-chain covered call, and describing MYSO, the proposer, in more detail.

[doctorrobinson (Zak)]

Hey @contentropy - I’ve connected you and @Dermot . Being that DeFi is certainly more his realm than mine, I’ll be leaning on Dermot to help guide this and see if it’s valuable and in line with our DNA.

[creepto (Mehrdad M. Sadeghi)]

Quite an interesting proposal I must say, and kudos to you because of this clever mechanism. I actually fell down the MYSO rabbit hole and watched the YouTube videos and played around with your app which spawned some naive questions in me.

Question 1
I assume this upfront payment is received when and if someone borrows and the asset locked for lending is actually under utilization, correct?
Question 2
As mentioned in the videos, the price is determined by the loan provider (is not pulled from oracle) as well as the cap and upfront cost which is fixed with zero prospective liquidation since the cap is below liquidation point (speaking under correction here). Doesn’t this become a hassle for the loan provider due to the volatility (as we’ve seen POKT grew over 1000% in last quarter)? The mechanism is great for low volatility tokens like ETH and BTC.
Question 3
Can we consider borrowing a token that might grow pass (collateral + upfront cost) an incentive for the borrower? This way (I assume) due to zero liquidation factor lender can claim the collateral in the end of the term.

[contentropy]

Hey @creepto thank you for taking the time to check out the DApp and doing a dive into how the protocol works! I’ll address each question below:

1. Yes, so the upfront fee is earned immediately once a borrower comes in and the loan is actually taken out - this upfront fee or premium is immediately claimable to be withdrawn from the lender vault
2. Yes, the loan terms are fixed once you create a loan offer and with volatile assets the optimal terms are typically changing. You can change the loan offer terms or delete stale ones at any time. However we also have optional oracle integration if you want to set a fixed LTV for your offers so that if the price of the collateral in the offer shifts, the LTVs you’ve set for your offers is fixed.

For the ‘classic’ case of Zero-Liquidation Loans, we’ve seen that typically users lend stablecoins against volatile assets - however, in this case, Pocket would actually lend out POKT and accept stablecoin as collateral from a borrower and essentially enter a ‘covered call’ position I’ve described above. If you’d like me to go into more detail about this here I certainly can

3. So in the setup I’ve described above, the borrower would want to pledge stables as collateral. All matchmaking and sourcing a counterparty borrower would happen from our side (we have a network of institutional clients) so no hassle with figuring out who the borrower would be and no idle POKT sitting around not being utilized.

In essence this proposal is actually not to create a POKT-collateral market (though we can integrate it and do that as well) but rather a way for the Pocket treasury to lend out POKT and earn nice upfront yield with potential to diversify the treasury as well

Happy to elaborate and answer any more questions you have!

[shane]

These kinds of platforms always come with risks. I would love to see the risks expounded upon. This is the first time I’ve heard of MYSO, and while the benefits may sound exciting, I would want a realist perspective on the risks.

Could you provide a full breakdown of the risks that would come from such a strategy?

[contentropy]

Hey @shane!

If you’re referring to the risks in using MYSO itself, we’re a fully on-chain lending protocol meaning that of course there is some level of smart contract risk (and that’s true of any smart contract platform) - however, we’ve undergone three thorough independent security audits on our codebase with some of the most reputable security teams in the space, including Trail of Bits, Omniscia, and Statemind.
I’ll link all of these audits here:

Trail of Bits - https://github.com/trailofbits/publications/blob/a2ab5a1cab59b52c4fa71b40dae1f597bc063bdf/reviews/2023-04-mysoloans-securityreview.pdf
Omniscia - Omniscia Myso Finance Audit
Statemind - https://github.com/statemindio/public-audits/blob/98695f853f2e87ca8a59e5b4d49a3d5c00db9ed2/Myso%20Finance/2023-08-15_Myso_v2.pdf

W.r.t. risks involving covered calls, it depends on what your perspective is on the short-term price movements of POKT along with treasury strategy as a whole.

A covered call strategy is attractive because you can earn high upfront premiums for lending out your token (and as I mentioned, recent POKT vol is high so you can get really nice premiums), but you set an upside cap meaning that if the price of POKT moves above this cap, the rational borrower wouldn’t want to repay and you’d get a stablecoin equivalent to the upside cap (this means you still earn nice revenue but lose out on token upside).

So the risks of the strategy itself really depend on short-term positioning and what you expect will happen with the price of POKT within the loan duration. However the beauty is that the DAO has control over the terms it sets so you can really be flexible in customizing the loan duration, the upside cap, etc.

Also wanted to mention that covered call strategies are common within the crypto space and typically carried out with off-chain agreements between protocols/DAOs and market makers, etc. which comes with obvious counterparty risks. However, by using MYSO, all loan execution is facilitated on-chain in a transparent and verifiable manner, so there is no counterparty risk, eliminating the need to trust the borrower with fulfilling any part of the agreement.

[BenVan]

@contentropy I watched the borrow and lend videos. But I’m still unclear on exactly how the loans close.

Q: I a borrower choses to pay back the loan instead of letting it expire, does he do so at the initial loan price per token? or is he able ( in the case of the price of POKT falling) able to close the loan and keep the USDC difference.

[contentropy]

Yeah so the borrower has the right but not the obligation to repay the loan so that’s the underlying optionality. So essentially the borrower can reclaim their USDC collateral at any point prior to the fixed loan expiry, whether that be 30, 60, 90 days etc.

So to answer your question, the repayment amount is fixed to the amount of POKT (not in $ terms)

If the price of POKT were to fall, the borrower would want to reclaim their USDC because it’s worth more than the value of their borrowed POKT. They’d have to do this prior to expiry, and if they don’t, then the USDC they pledged as collateral would be unlocked and the lender i.e., POKT treasury in this case could claim the USDC.

[msa6867]

Question for PNF - would a DAO vote be needed to perform active treasury management, whether that includes trading POKT for stables, writing covered calls, etc, or does PNF have the authority to manage treasury without need for DAO vote?

Re the proposal, here are my thoughts: re the general concept of PNF writing covered calls on treasury POKT (this thoughts are platform agnostic as I do not know enough about MYSO to comment on security risks, illiquidity risks, etc).

1 The benefits of writing covered calls are exactly as stated in the proposal
2. The risk of writing covered calls vs keeping treasury in POKT is loosing the upside in case POKT makes big jumps upward in price. This is a very manageable risk as the treasury is in much sounder footing now at current prices than when POKT was tradng at $0.025. If we sell off allocated POKT at strike prices (plus premium) it’s a sufficient price point to conduct current DAO business. We definitely would not have wanted to write calls when price was in the $0.03 range
3. The risk of writing covered calls vs direct swap of same amount of tokens for stables is loss of locking in current prices in case token price drops back to $0.03 range… but at least a premium is collected to slightly mitigate such risk.

All in all, I think direct swap for stables and writing covered calls are both useful tools of active treasury management. If we were to make only a single foray into active treasury management, I would suggest prioritizing swapping a certain portion of exisiting and incoming POKT to stables over the writing covered calls, but I see no reason why we can’t pursue both.

As to comments I’ve seen on TG in the vain of “DAO should stick to it’s primary focus and not get sidetracked into derivatives”, I would counter that this proposal is not about sidetracking efforts to some spurious dev effort, but simply about treasury management. And prudent management of treasury is always one of the primary responsibilities of a DAO.

[Dermot (Dermot O'Riordan)]

@msa6867

Question for PNF - would a DAO vote be needed to perform active treasury management, whether that includes trading POKT for stables, writing covered calls, etc, or does PNF have the authority to manage treasury without need for DAO vote?

Good question.PNF cannot actively manage the DAO’s treasury without explicit consent. If the DAO wants to give such authority, I would highly recommend that any such consent be limited to a specific amount of POKT and be time bound.

@msa6867

All in all, I think direct swap for stables and writing covered calls are both useful tools of active treasury management. If we were to make only a single foray into active treasury management, I would suggest prioritizing swapping a certain portion of exisiting and incoming POKT to stables over the writing covered calls, but I see no reason why we can’t pursue both.

I largely agree.

I think that this is an interesting proposal from @contentropy, but I’m not sure if it’s the right time for POKT’s DAO. However, I’m keen to hear the community’s interest in this as we all have a collective responsibility to steward the DAO’s treasury.

The two open questions I have are:

1. What additional benefit does the DAO believe we get from writing covered calls right now, given that PNF is already ensuring we have sufficient USD spending from the ERA budget to get us to the Shannon launch by selling POKT OTC to long-term investors?
2. Does it make sense to add another treasury management tool to the mix, given the admin overhead it will create and the fact that it will make things more complex for both the DAO and PNF to communicate and track?

I understand that @contentropy plans to join the Ecoysystem call on Wednesday, so that should be a good forum to discuss this further then

[ArtSabintsev (Arthur Sabintsev)]

Largely in agreement with what @Dermot and @msa6867 have said about swapping a small portion of POKT for stables.

I’d probably go one step farther and lock them up in some yield bearing vehicle, like Aave or Compound as well. However, I agree that now does not seem like the appropriate time. Assuming we’re in the early innings of a bull market, this seems like a conversation that should be revisited later on in the year or even next year.

[contentropy]

Hey there @msa6867 thanks for the reply!

Would 100% agree with you that both swaps and writing covered calls are valuable for treasury diversification.

I’d say that covered calls carry the added value of always producing a +EV result if the token price doesn’t exceed the strike (upside cap) as the upfront premium will always an added yield buffer to the token you get back. Especially right now with vol on POKT being quite high, annualized yields from the upfront stablecoin premium would be quite juicy.

Really depends on what POKT has in mind in terms of guidance of the treasury and diversification efforts along with expected price action.

[contentropy]

Hey @ArtSabintsev thank you for the comment and also want to loop in @Dermot @msa6867 here - if the DAO is planning on swapping/selling POKT OTC for stables, is performing a covered call strategy not also an enticing proposition?

This would allow the treasury to generate upfront stable premiums while also potentially swapping if the strike (upside cap) is hit prior to expiry. Of course I understand if the DAO doesn’t want to give up upside, but if a sale/swap is already planned then I don’t see why a covered call strategy wouldn’t be attractive

[contentropy]

Hey @Dermot thank you as well for your insights and feedback.

I will def be on this Wednesday to talk about the RFC, MYSO, and answer any questions you, the community, and PNF have with regards to everything we’ve mentioned in this RFC thread.

In terms of treasury management and diversification efforts, I feel that covered calls could be a sustainable way to generate stablecoin revenue for the treasury without actually having to sell/swap tokens. Obviously if you expect the token price to appreciation greatly above the strike or upside cap then maybe a covered call is not the right strategy for the DAO to undertake atm.

However, I’ll also say that if the DAO is planning on doing a swap/sale for stables, performing a covered call would allow you to do so without any immediate selling pressure while also generating upfront stablecoin yield.

[Cryptocorn]

So I’m cautiously pro this idea.

1. I think we would need a DAO vote to agree on a ceiling amount that could be put into this vehicle per month - i.e. up to 5% of the DAO treasury or 100k POKT/Month. We wouldn’t have to commit that amount each month, but as a maximum, depending on demand and management.

2. While in theory I believe like most that we are at the start of a bull run, POKT price will go much higher etc etc, we also all believed that in Jan 2022. We can’t time the market, and it’s better to DCA slowly and consistently. At small amounts - 3-5%/mo, I think this is the sensible, long term option.

3. Compared to OTC sells, this would seem to offer a premium in the relatively high upfront payment. As such it seems more profitable than simple OTC.

[Patrick727 (Patrick Maguire)]

Probably should avoid lending pokt until deeper liquidity or else people just short token with it which is no good for project despite USDC returns