DeFi Money Market (DMM) Introduces mETH — Earn a stable 6.25% on ETH Deposits
The DeFi Money Market (DMM) Foundation is pleased to announce the launch of mETH, an interest-bearing token created by depositing ETH into the DMM Ecosystem. mETH tokens, like all other mTokens, are backed by interest-generating real world assets which initially include car equity loans, but as demand rises we plan on expanding the DMM Ecosystem to include a more diverse array of assets in aviation, construction, real estate, and more.
“Many crypto and traditional investors are looking for stable, secure, passive income. Gregory Keough and the team at the DMM Foundation leverage blockchain to allow users to earn passive income.”
The DMM Advantage
In a world where interest rates are rock bottom at zero percent or even negative, market-wide hunger for high yields has been stronger than ever before. DeFi has heeded these calls by offering new permissionless financial products that can offer lending rates substantially higher than that of the traditional financial system. However, current DeFi applications typically only offer lenders variable interest rates which can wildly swing as supply and demand in the DeFi ecosystem changes. For example, the DAI Savings Rate (DSR) from MakerDAO has decreased from 8.75% in February to now 0% in March in order to drive more borrowing demand for DAI. Wild fluctuations in interest rates like these have been the norm in DeFi as a whole, not just isolated to the DSR.
This is where the DMM comes into play and offers users something new in DeFi. Instead of the traditional smart contract based money market like Compound and Aave, where supply and demand is largely driven by users leverage trading cryptocurrencies, user funds that are deposited in the DMM Ecosystem are instead converted to fiat and used to transparently purchase a basket of interest-generating real world assets. This process is initially being performed by the DMM Foundation, but the long term goal is for this to be managed by the DMM DAO.
Both the off-chain assets and interest revenue generated from these assets target overcollateralization protecting depositors. Being backed by real world assets also means mTokens in the DMM Ecosystem can offer investors a much more stable and reliable ROI on their deposited funds. DMM’s stable interest rates are uncorrelated with the rest of the DeFi market and its wild fluctuations of demand from crypto traders, common in many of the existing DeFi applications today. It will be interesting to see how yield seekers will arbitrage between the stable interest rates offered by the DMM and the variable interest rates offered by the rest of the DeFi lending market.
With the launch of mETH today, DMM currently offers the highest interest rates on ETH across both Decentralized Finance (DeFi) and Centralized Finance (CeFi) at a stable 6.25% APY!
At launch, ETH deposited by users will stay in the mETH smart contract to ensure there’s ample liquidity for user withdrawals during this beginning growth phase (also currently true for mDAI and mUSDC as well). As the ETH liquidity in the mETH contract grows to a healthy amount, the DMM Foundation will then withdraw portions of the ETH deposited, up to the reserve ratio (currently set at 50%), and use those funds to be reimbursed for the initial ~$8,500,000 of real world assets already purchased and afterwards to purchase more real world assets. We will deposit more ETH into the smart contract as it accrues more user deposits and grows in net interest gained. mETH earns ETH depositors a stable 6.25% APY meaning if you deposited 100ETH today, in 365 days you could cash in your mETH tokens to withdraw 106.25ETH.
For our other mTokens, mDAI and mUSDC, selling the underlying stablecoins DAI and USDC for real world assets is no issue as these cryptos are stable and can be later repurchased at the same value it was sold for. For mETH however, this is a very different story as ETH is highly volatile. By selling ETH for real world assets, we are effectively entering into a short position on ETH, as we have to repurchase ETH at a later date and deposit it back into the mETH contract if liquidity drops due to user withdraws and falls below the reserve ratio (or the reserve ratio is raised). This returns the users’ principal plus interest earned both denominated in ETH.
The interest payments generated from the real world assets backing mTokens are accruing in stable amounts of fiat but need to be paid out to mETH holders in stable amounts of ETH, so for the beginning of this bootstrapping period, the DMM Foundation will shoulder the price volatility of ETH in order to bootstrap a healthy liquidity pool and grow user trust in the DMM Ecosystem. However, once mETH liquidity grows and ETH is begun to be withdrawn by the DMM Foundation (eventually by the DMM DAO) and sold for real world assets, the DMM Foundation will need to hedge its exposure (or lack thereof) to ETH.
How will we hedge against this volatility?
The answer is derivatives, namely options contracts. Options are a financial product that gives buyers the right, but not the obligation, to buy or sell an underlying asset, at an agreed-upon price and date. The DMM Foundation will be purchasing call option contracts on ETH/USD. This effectively means we are opening up a long position to cancel out the short position we are taking from selling ETH for real world assets.
Example time; Let’s say there is 200ETH in the mETH contract and the DMM Foundation withdraws 100ETH (resulting in a reserve ratio of 50%) and sells it on a cryptocurrency exchange for stablecoins at the market rate of $100 per ETH which totals up to a $10,000 sale. We then redeem those stablecoins for fiat and use those funds to purchase $10,000 worth of interest-generating real world assets.
At the same time the DMM Foundation will purchase a 1-year call option contract (in practice could be a shorter or longer time period) which gives us the right to purchase 106.25ETH (initial principal + 1 years interest, in practice could be more or less coverage) at the current market rate of $100. The premium/fee for the options contract is paid for by DMM Foundation, but eventually it will be paid for by the DMM DAO using funds from the excess interest generated. In a year’s time when the real world asset-backed loans have expired and are fully settled in fiat, which netted more than initial $10,000 due to the interest gained, the DMM Foundation will need to purchase 106.25ETH to pay depositors back their principal plus interest.
(In reality if the mETH contract’s ETH liquidity is already at or above the reserve ratio, these fiat funds can just be reinvested into more real world assets along with another options contract hedge, but let’s say worst case scenario everybody now wants to withdraw their original deposit plus earned interest)
At this point, three situations can occur:
- If the price of ETH rose (say it doubled to $200), then we can exercise our options contract to purchase 106.25ETH at the previously agreed upon rate of $100 per ETH costing us only $10,625 instead of the market rate of $21,250. We just successfully hedged our previous “short” position on ETH with a long position and repurchased ETH at half the current market rate. 106.25 ETH is then deposited back into the mETH smart contract and token holders can now withdraw their ETH (principal plus 1-years interest).
- If the price of ETH crashed (say fell to $50), then our options contract expires worthless, but this is okay because we can purchase 106.25 ETH off the market for only $5,312, roughly half of what we initially sold the 100 ETH for! The remaining amount of fiat can then be reinvested into more real world assets increasing the system’s collateralization or it can eventually go to the DMM DAO to be reallocated, potentially to the DMG governance token holders themselves. 106.25 ETH is then deposited back into the mETH smart contract and token holders can now withdraw their ETH (principal plus 1-years interest).
- If the price of ETH stayed the same at $100, then our options contract also expires worthless, but again this is okay because we can purchase 106.25 ETH off the market for the same price we initially sold it at. Such a situation would be rare in the volatile world of crypto, but it is still a possibility. 106.25 ETH is then deposited back into the mETH smart contract and token holders can now withdraw their ETH (principal plus 1-years interest).
Notice how the end result is the same no matter how ETH/USD performs, mETH token holders in each case earn their stable 6.25% interest denominated in ETH!
While we will be initially purchasing these options contracts on Deribit, a centralized cryptocurrency exchange, we are looking into more decentralized solutions recently launched like Opyn and Hegic (currently only offering puts instead of calls). These DeFi-based options contracts are still very new and as such do not currently have enough liquidity for our needs. We imagine this will change as DeFi as a whole continues to quickly expand in overall liquidity.
We will be watching the ETH markets over time so we can continue to fine tune the amount of coverage purchased for deposits so we can strike the right balance between ETH volatility and the upside protection cost of purchasing calls. While these hedging parameters are currently being adjusted by the DMM Foundation, the long term plan is for the DMM DAO to decide and determine the most cost effective way to hedge risk. As deposits grow and more ETH is deposited, more solutions to this volatility can be introduced.
These other solutions could include futures contracts, term deposits for withdraws, market maturity of new ETH hedging products, additional lines of credit, insurance, and/or even selling DMM’s governance tokens to cover debt like the MakerDAO system. Currently both the assets and interest generated from those assets are overcollateralized to minimize risk. Today the system is incredibly overcollateralized at 20,000% due to the initial tranche of $8.5M in real world assets backing DMM tokens earning approximately more than double 6.25%. So while ETH exposure risk (or lack thereof) is minimal for the time being, our methods of hedging risk will continue to evolve. We are keeping a close eye on this space!
Hopefully now you have a well rounded understanding on how the mETH token works and how users can earn a stable 6.25% APY denominated in ETH. If you have any more questions, please feel free to drop into our Discord or Telegram channels to acquire more information. Our goal is to be as openly transparent as possible as we build and perfect the bridge between the traditional financial system of today and the decentralized financial system of tomorrow.
On this note, the DMM’s smart contracts are currently undergoing a security audit by SECBIT, and we are also working with a highly-respected consulting agency with specialized knowledge on the DeFi space in order to create an ongoing verification scheme which will provide a secondary and independent confirmation of the DMM Foundation’s (and eventually the DMM DAO’s) ownership of these real world assets. We plan on sharing more details as this comes to fruition.
DeFi Money Market (DMM) is an ecosystem built on the Ethereum blockchain that bridges interest-generating real world assets into the Decentralized Finance (DeFi) ecosystem in a transparent, trust-minimized, overcollateralized, and permissionless manner.
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DeFi Money Market (DMM) Introduces mETH — Earn a stable 6.25% on ETH Deposits was originally published in DMM DAO on Medium, where people are continuing the conversation by highlighting and responding to this story.