BakerDAO Explanation Ⅳ:The vault of the Borrow system(August 19,2021)

Thursday, August 16, 2021

What are Vaults?

The Vault is a core component of the BakerDAO Protocol, which facilitates the generation of BAI against locked up Collateral.

Vault usage collectively alters the total supply of BAI. Users create BAI by generating it against their Collateral and in-turn destroy BAI when repaying their generated BAI balance. This process happens on-chain, which enables full auditability of circulating BAI and the Collateral backing it.

Vaults are required to be overcollateralized and have a Liquidation Ratio that Vault owners need to uphold to avoid the Liquidation of their positions. Additionally, a Debt Ceiling is imposed globally on the BakerDAO Protocol, as well as individually on each Vault type.

How does a Vault work?

Any user who wishes to generate BAI may deposit Collateral into a Vault and do so, paying a Stability Fee on the generated BAI balance.

Vault users are free to generate or pay back BAI and can add or withdraw Collateral with no time-constraints. As long as Vault owners maintain a minimum Collateralization Ratio, specified for each Vault type as the Liquidation Ratio, they may interact with their Vaults freely. If a Vault’s Liquidation Ratio is breached, the position gets Liquidated. If a user wishes to reclaim the full amount of their Collateral, they will need to pay the full amount of Generated BAI back along with the Stability Fees owed.

Who can open a Vault?

This depends on the type of Vault. While some Vault types are permissionless others may carry requirements. Typically there are no requirements related to prior borrowing history or cumbersome application processes since Vaults are configured according to the risk profile of the underlying Collateral that is being used. Vaults are owned by the BSC addresses that create them and can be transferred between wallets freely.

Are there fees for using a Vault?

Yes. Vault owners are required to pay a Stability Fee on their generated BAI. The rate is expressed as an APR that compounds annually in practice.

If a Vault becomes undercollateralized, as specified by each Vault type’s Liquidation Ratio, it can be liquidated and have its assets automatically sold to cover the generated BAI. If a Vault is liquidated, a Liquidation Penalty is applied to the Generated BAI balance.

The Stability Fee and Liquidation Penalty vary according to the Vault type.

What is the Collateralization Ratio?

The Collateralization Ratio is the ratio between the value of the collateral and the value of the Generated BAI on a given Vault.

For example: Let's say the ETH locked in a user’s Vault is worth $150 and 50 BAI was generated. This means the Collateralization Ratio is 300%. For each 1 BAI, there is $3 worth of collateral value backing it. In the BakerDAO Protocol, your Vault may be liquidated if it falls below the Liquidation Ratio, which is the minimum Collateralization Ratio. The Liquidation Ratio varies by Vault type.

What risks are associated with owning a Vault?

Owning a Vault is inherently risky. There are four major categories of risks to consider when creating a Vault: Market Risks, User Risks, Systemic Risks, and Parameter Variability Risk.

Market Risks: Using a Vault involves generating BAI and transferring ownership of your assets to a smart-contract that can sell your assets in the event of a market downturn. Any Vault with Generated BAI has a Liquidation Price, the price of the underlying asset at which one's Vault would be liquidated. Using a Vault for leverage introduces additional risk. The potential for reward is higher through leverage, but the potential for loss is magnified as well. It is a common practice among users to maintain a high Collateralization Ratio to protect from Market Risks and thereby Liquidation.

User Risks: These are risks associated with user errors. BakerDAODAO does not possess the ability to reverse any transactions or recover funds sent to incorrect addresses or contracts.

Systemic Risks: There are many potential risks facing the successful and continuon of the BakerDAO Protocol. The following non-exhaustive list highlights some of these risks:

A malicious hacking attack against the smart-contract infrastructure.

A Black Swan event in one or more Collateral assets.

Failure of centralized infrastructure. E.g., failed internet connections, MetaMask bugs, etc.

Parameter Variability Risk: It's important to note that Vault owners are subject to changes in the Risk Parameters that govern the system. This equates to financial risk for the Vault owner. Below is a partial list of parameters that are subject to change:

Stability Fee

Debt Ceiling

Liquidation Penalty

What are Common Practices to limit risk?

Market risks can be mitigated by using price alerts, maintaining a higher Collateralization Ratio, monitoring the health of your Vault regularly, and keeping enough reserves outside of your Vault to payback Generated Dai or to add to your deposited collateral. Many people can find themselves over-extended or may find they tend to make risky bets on market movements. This can lead to the Liquidation of their Vaults resulting in financial loss.

User risks can be mitigated by using small test amounts beforehand, and by thoroughly checking which addresses one is interacting with.

What are the benefits of using Vault?

Flexible repayment conditions: Vault has no time and minimum repayment restrictions. As long as users want, they are free to lend BAI or add additional collateral.

No credit history: No need to go through the tedious application process and submit credit documents. Anyone with a BSC address can use the Vault system.

No third-party risk: The system operates based on automatic smart contracts, and users interact with a transparent financial system without trusting third-party institutions to manage or issue assets. All transaction records are recorded on the public blockchain and anyone can review.

Decentralized margin trading: Users can mortgage BNB, BUSD, ETH, BTC and other assets, lend BAI, and then purchase more collateral to add to the vault, with a leveraged position.

Why create a vault?

There are many reasons to create a vault. Based on user experience, we have collected the following scenarios:

Decentralized leverage: Users believe that the value of a certain asset will increase, so they use existing collateral to lend BAI and then purchase the asset. If the asset increases in value later, they can sell the asset to get more BAI, and after repaying the principal of the BAI, they can earn the difference.

Flexible credit: The user wants to buy a car, but cannot obtain a loan from the bank or the interest rate of a traditional lending institution is too high. Users can pledge ether, lend BAI, buy cars, and then repay debts according to their own plans.

Re-loan to repay debts: Users owe high-interest debts. Instead of selling all the assets in hand to repay the debts, it is better to pledge to lend BAI at a lower interest rate, convert BAI into legal currency, and repay part or all of the debt.

Creating a vault to borrow BAI also means that users are assuming debts and risks, including changes in stable rates and liquidation risks.

Is there a reason not to create a vault?

If you are interested in stablecoins but are not familiar with interacting with smart contracts, we do not recommend that you create a vault. You can choose to buy BAI directly on the exchange.

If you think the market will be down for a long time, you need to evaluate the costs and risks of creating and managing a vault. A long-term bear market may require continuous addition of collateral to the debt warehouse or ready BAI to repay the debt at any time to ensure that it is not liquidated.

What can be used as collateral?

In BAI, BNB, BUSD, ETH, BTC and other assets are the supported collateral types. The subsequent iterations of the Borrow system will support more collateral to generate BAI, and the new collateral type will be determined by BKR token holders through the governance process.

Is it possible to repay BAI from the exchange?

Not currently. You need to interact with the smart contract. This interaction can only be done through direct interaction with the contract.

Is it possible to repay BAI from the wallet?

Yes, you can repay BAI through the web3 wallet integrated with Vault.

How much can I mortgage?

There is no upper limit on the amount of collateral that can be deposited in the vault.

After I have locked ETH in the Vault, can I still receive airdrops from other projects?

Can not. After you lock the ETH in the vault, the ETH will be sent to a special smart contract, and this contract may not be compatible with the airdrop contracts of other projects.

What happens if I want to stake my mortgage quality in another project and also want to create a vault?

Once your collateral has been pledged or in custody, you cannot access the same tokens in another contract.

In the future, the custodian may issue certificates of deposit representing the collateral already in the system. BakerDAO ticket holders can allow these certificate of deposit tokens as collateral.

If my collateral appreciates, do I have to repay BAI?

If you want to get all the collateral back, you need to repay all debts manually, including the stability fee.

If the collateral appreciates, your mortgage ratio will also increase. As the collateral appreciates, you can withdraw part of the collateral while keeping the collateral ratio unchanged.

After being liquidated, can I still use the same vault?

Can. As long as you have collateral in your vault, you can borrow BAI. Liquidation does not close the vault, you can add collateral and start over.