Earthquake will be the initial product available on offer when Y2K Finance launches. This article will go over the basic vault mechanics and will be followed up by a second article that covers the payout calculations and the pricing model.
Earthquake is our flagship structured product that allows users to hedge, speculate and underwrite the volatility risk associated with various pegged assets. Users can take on these positions by depositing $ETH in fully collateralized insurance vaults that leverage a variant of the ERC 4626 token standard. In order to “buy” insurance and therefore receive a payout in the event that the underlying asset depegs users deposit ETH into the “Hedge vault”. Conversely in order to “sell” insurance users deposit ETH into the “Risk vault” earning yield and collect the premium from users that seek coverage.
Each pair of vaults has the following properties:
1. Asset: The specific pegged asset the vault is trading.
2. Epoch: The start and end date of the vault.
3. Strike: How far from peg the asset price needs to deviate in order to trigger a liquidation event and hence a payout to the “Hedge” vault depositors.
The Y2K treasury takes 5% fee on Hedge and Risk Vault deposits, and 5% on risk collateral yield.
Market participants can deposit into Y2K vaults at any time before the epoch start date, after which funds are locked for the duration of the epoch. During the Epoch the underlying pegged assets are monitored by Chainlink oracles, and in the event where an asset de-pegs to a degree larger than the strike of a vault pair, the contents of the risk vault are liquidated and awarded to the hedge vault depositors. In the event of no de-pegging over the course of an asset’s insurance epoch, both hedge and risk payments are delivered to the insurance sellers.
For example: If the epoch starts with 1 user depositing 1 eth in the hedge vault while there’s 5 eth in the risk vault if a depeg event were to happen the user in the hedge vault would receive all 5 eth as a payout. Conversely if the epoch ends without a depeg event the users who deposited in the risk vault would receive a portion of the eth deposited in the hedge vault proportional to the amount of collateral they deposited. It’s important to note that risk depositors receive premiums regardless of whether there was a liquidation event, and all cash-flows occur at the end of the epoch. This diagram below illustrates the cash flows of earthquake vaults.
Naturally, some uncertainty arises when the vaults are empty — the first depositors have limited knowledge of how many funds there will be on the opposite side of the trade, as well as how much their position may be ”diluted” as others join the same vault. In order to compensate initial depositors for this information asymmetry, they will receive boosted rewards decided by a bonding curve tracking each vault’s TVL. This encourages deposits at the beginning of an epoch, and solves the chicken-and-egg problem that arises with many structured product markets.
Depositors in the risk vaults earn a yield based on the amount of deposits in the hedge vaults. A portion of the funds will also be deposited in a diversified set of money markets in passive income strategies to earn extra yield for these vaults. Governance token holders will be able to vote on where and how these funds are deployed. In an efficient market, the “yield generated from depositing in either the vault should be reflective of the underlying pegged asset’s risk.” Meaning riskier pegged assets should have a higher proportion of ETH in the hedge vaults, otherwise arbitrage opportunities would present themselves.
This covers Earthquake’s basic functionalities as stated before the next article will dive deeper into the payout calculations and pricing mechanisms for the vaults. In the meantime you can follow our Twitter account @Y2KFinance and join our discord for updates and announcements.