Liquidity Unleashed - The Daily Gwei #170

Unlocking the true power of collateral and liquidity.

Recently MakerDAO on-boarded a new and exotic collateral type into its system - Uniswap liquidity pool tokens. The two LP token types that MakerDAO onboarded are WBTC-ETH & USDC-ETH and users can now use these LP tokens as collateral to draw DAI against.

This is really exciting and something enabled only by DeFi so I wanted to break down exactly what is happening here. When you provide liquidity to a Uniswap liquidity pool (say the USDC-ETH pair), you are issued an IOU token called a Uniswap liquidity pool (LP) token. This token can be transferred around on Ethereum like any other ERC20 and is used to withdraw liquidity from Uniswap once you’re ready to do so. Only the user holding the Uniswap LP token is able to withdraw liquidity from the pool so if you send yours to someone else then you no longer have a claim to your original liquidity position.

Now that MakerDAO supports these LP tokens, users are able to essentially provide liquidity to Uniswap, earn trading fees from doing that and then use their LP token as collateral on MakerDAO to draw DAI against. This is what Dan Elitzer originally wrote about when he coined the term ‘superfluid collateral’ - that is, using collateral from one system (Uniswap LP tokens) in another system (MakerDAO). There are other examples of this within DeFi as well right now such as being able to buy a Set from TokenSets and then put that Set (an IOU token) into a Uniswap/Balancer pool or take your yUSD and use it as collateral on Cream.

All of the above enables greater capital efficiency across all of DeFi which I think is going to be a big theme in 2021 as there is just so much latent capital sitting out there right now. A perfect example of this is the recently announced Iron Bank from Cream that allows for protocol to protocol zero collateral loans - something that directly taps into a huge amount of latent capital. Another example is being able to use staked ETH (stETH) provided by Lido inside of a stETH/ETH pool on Curve in order to earn trading fees, CRV rewards and LDO rewards.

Without Ethereum and DeFi’s openness, none of this would be possible. To do this sort of stuff in the traditional finance world requires so much overhead, paperwork, counterparty risk, regulatory burdens and so much more - it’d end up looking like an inefficient frankenstein. With Ethereum, all it took was for MakerDAO’s governors to approve the addition of Uniswap LP tokens as collateral - this is the real power of DeFi.

Have a great day everyone,
Anthony Sassano

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All information presented above is for educational purposes only and should not be taken as investment advice.