Informational - No upper limit to Junior Tranche leverage or fixed yield #45
Description
The Gro protocol has no upper limit to the leverage that a Junior Tranche can take on or the fixed yield owed to the Senior Tranche. In theory, a Junior Tranche could have 10,000x leverage when borrowing from a Senior Tranche. It is also possible to create a Senior Tranche with exceptionally good yield but that is unsustainable. The stability of the protocol at such extreme leverage values or fixed yield amounts could result in unexpected behaviour.
Technical Details
Setting an upper bound on the leverage available to a Junior Tranche, and therefore a lower bound on the protection available to Senior Tranche depositors, may be prudent to avoid blatant misuse of the Gro tranche design. Additionally consider a limit on the fixed yield amount, which could be adjusted by the protocol owner depending on market conditions. Be aware that the yield in the tranche design is dollar denominated, so if the underlying asset drops in value, there could be issues in paying the fixed yield to the Senior Tranche.
We can take one example of the Junior Tranche taking 20x leverage by borrowing from the Senior Tranche, with a fixed Senior Tranche yield of 2%:
100% utilizationRatio * (20x leverage - 1x from Junior Tranche) * 2% Senior Tranche Fixed Yield = 38% borrowing cost owed to Senior Tranche
Due to the amount of leverage in the Junior Tranche and the yield promised to the Senior Tranche depositors, the Junior Tranche could easily see losses if it cannot continue to deliver the 38% yield.
Impact
Informational.
Recommendation
Set an owner-controlled utilisationThreshold maximum to prevent the Junior Tranche from taking an extremely leveraged position and providing too little protection to the Senior Tranche. A similar approach for fixedRate.rate yield maximum would help with overpromising Senior Tranche depositors with an unsustainable model. One approach might be to verify that the product of the Senior Tranche fixed yield and the leverage is less than a certain owner-controlled value (say, 50%). If the goal is to cater to yield farming degens, this limit may not be necessary.