What is Waterfall DeFi?

What is Waterfall Defi and the state of decentralized financial markets

Waterfall DeFi is a platform that offers true risk diversification through tranching of yield generating DeFi assets.

The rise of decentralized finance (“DeFi”) has taken the cryptocurrency markets to a whole new level. Over the past 3 years since the initial coin offering (“ICO”) frenzy started in 2017 and brought the market into a 3 year bear trend, we’ve witnessed many developers either continue to build or pivot from nonsensical projects to platforms that add value to the financial ecosystem within crypto.

Some of the early projects that gave birth to DeFi was MakerDAO; a stablecoin that is backed by cryptocurrency as collateral (“DAI”) and its governance token (“MKR”). Then came along Compound (“COMP”), a platform similar to MakerDAO, but instead allowed direct borrowing and lending of selected cryptocurrencies with a marginalized system to control collateral risk. Many of the borrowed capital went into leveraged trading within Defi - the likes of derivatives platform Synthetix (SNX) and the notorious decentralized exchange Uniswap (UNI) that is powered by the Automated Market Model (more on this later). The early DeFi platforms started off slowly until the first billion dollar was locked in the market back in June 2020 - since then the market grew close to 50 fold within 9 months:

Fast forward to the Defi market we see today, many of the yielding products surround one of the four variations:

1) Vanilla lending / deposit programmes: For the average Defi users that already are hodl-ing their cryptocurrencies where they have been sitting in their wallets for a long time, users can deposit or lend out their tokens in return for a yield. The yield usually comes from the borrowers taking the lent funds for margin trading or reinvestments whereby the borrower pays the lender a funding fee. Terms are open ended and rates are variable subject to supply and demand. Sometimes certain platforms also provide their own platform tokens as additional pickup yield (i.e. Curve).

2) Liquidity Pool staking: For those who are familiar with decentralized exchanges most of these platforms run on Automated Market Maker (“AMM”) systems whereby price is derived through users staking their tokens into a Liquidity Pool (LP) with the price determined by variations of a bonding curve. Stakers earn a fee whenever there are Defi users that use the LP to trade, as well as earning additional governance tokens as yield (which is to be used for voting power on any proposals happening on the platform).

3) Yield aggregators - Similar to 1) certain defi platforms offer ‘strategies’ within vaults whereby once Defi users deposits the cryptocurrencies the smart contract automates and divests in multiple venues to earn yield, whereby some would ‘optimize’ return through constant reallocation to higher yield vaults and attempts to save gas fees in the process.

4) Other yield enhancement products - selling derivative products (ie options) or providing insurance cover for yield. The aforementioned products provide the base (first derivative) of defi products for the mass market. Each product caters to different Defi users with a different risk appetite: those who are more risk averse would go for stablecoin vaults earning a stable but lower yield compared to other more ‘degenerate’ users who would go for the higher implied yield in Liquidity Pool ‘farming’ which in turn would have a chance to experience impermanent losses. What if risk averse users could invest in higher risk products but also be protected from possible principal losses, which could then enjoy a higher yield pickup than vanilla low risk products?