Tranche Model

The primary source of collateral in the protocol is non-fungible assets purchased on credit. In order to mitigate higher liquidity and volatility risk stemming from such assets, all liquidity pools are separated into Senior and Junior tranches.

Senior Tranche — Less Risk, Less Rewards

Senior Tranche can be fully deployed and utilized in loans. In contrast, the Junior Tranche acts as first-loss capital. It is used to underwrite a part of the NFT collaterals’ volatility and is only deployed when liquidation proceeds are insufficient to make the Senior Tranche whole.

Junior Tranche — More Risk, More Rewards

Junior Tranche depositors are entitled to an outsized cut of interest paid by borrowers. The ratio of assets between the tranches is based on the implied volatility of the assets within the lock-up period (e.g., 5:1 if asset prices are expected to be within the +/- 20% range from the current floor price), and will be decided by governance and adjusted periodically as market conditions dictate. The liquidity ratio is defined as $LiR_t$.​

Accordingly, interest income accrued is split between tranches according to a predetermined ratio, set per reserve.

This ratio is currently fixed. However, we may adopt a PID-like mechanism defined by the following formula, should tranche balances frequently deviate from the optimal.

$$\displaystyle Y^t = \begin{cases} Y & if LiR_t = LiR_{s} \\ Y_{senior} \cdot \displaystyle\frac{\displaystyle1}{\displaystyle1+\frac{E(LiR)}{LiR_{optimal}}} & if E(LiR) \gt 0 \\ Y_{senior} \cdot 1+\displaystyle\frac{E(LiR)}{LiR_{optimal}} & if E(LiR) \lt 0 \end{cases}$$

This formula implies that the effective yield of each tranche is a function of the liquidity ratio and the optimal income allocation (expressed as a percentage) set by governance from time to time.

This is to ensure that the protocol can use market forces to dynamically incentivize depositors to reallocate funds when there is a deviation from the ideal liquidity ratio.

Comparison Table

The following table provides a more visual comparison of the two tranches with the actual current protocol parameters.

Feature	Senior Tranche	Junior Tranche	Notes
Usage	Fully deployed	Locked	-
Liquidity ratio	83.33%	16.67%	Ratio is set according to expected collateral volatility (floor price).
Yield allocation	50%	50%	Adjusted to maintain optimal tranche allocation ratio
Unbonding period	Flexible based on available liquidity. Capped at 28 days	28 days	-
Risk	Capital lost only when loss at default is greater than junior tranche allocation.	Capital is lost when exposure at default is greater than proceeds from liquidation and previous instalments.	Loss at default is only greater than 0 when the value of liquidated collateral is less than the default amount (principal).