Gm Cega community! Today we will be discussing a topic that is both important to Cega users staked in our Bond + Options vaults and to everyone in DeFi/finance: Credit .
Credit plays an important role in powering economies by providing a bridge between lenders and borrowers (also known as creditors). In the case of Cega’s Bond + Options vault strategies, users act as lenders while market makers act as borrowers. This relationship drives crypto economic benefits for both parties and the overall ecosystem, as the credit received by market makers enables them to accelerate their strategies, operations, and research and development. Over time, by responsibly managing borrowed funds, market makers can build trust with their lenders which paves way for a continued relationship. On the lending side, users who deposit funds into Cega Bond + Options Vault strategies are earning interest on their money which puts their capital to work. This credit/borrowing cycle drives capital efficiency in the crypto economy and creates significant growth.
However, it is essential for borrowers to utilize credit responsibly and therefore lenders need to be aware of potential risks and consequences of defaults on credit obligations. If a borrowing counterparty defaults on their financial obligations, this can lead to significant losses and a long legal process to recover funds.
For Cega, borrowing/lending is involved in the “Bond + Options Vaults” which are Cruise Control, Genesis Basket, Autopilot, and Starboard. In this strategy, 100% of user deposits are lent to market makers (MM) during the 27 day trade and upon expiry, MMs return users’ deposited principal and pay yield made up of (1) interest yield and (2) the options premium. To recall, MMs are entities that provide liquidity in financial markets by buying and selling securities. MMs take the other side of Cega vault positions and buy options from Cega to provide insurance and hedge their books. If an MM who is trading Cega’s Bond + Options Vaults defaults, there is the risk that they may not be able to pay depositors the deposited principal or yield back, resulting in losses. Cega addresses these risks in numerous ways as described below.
Establishing the safety and security of user funds is our #1 priority and a core value. Cega has taken numerous actions to decrease and mitigate the risk associated with lending to market makers, oftentimes being the first in the crypto industry to lead such practices. At a high level there are 3 key initiatives that Cega implements to set up a strong foundation for risk management when trading Bond + Options vaults:
- Selecting and trading with verified MM counterparties
- Monitoring credit risk proactively using Credora
- Signing legal ISDA contracts with MMs
First, Cega carefully selects its MM trading counterparties based on their creditworthiness and ability to pass KYC (Know Your Customer) checks. For those who trade Bond + Options Vaults, Cega verifies MM balance sheets and a proven track record of risk management and diversification. This enables us to gain confidence that MMs have sufficient capital and processes in place to withstand market volatility and potential defaults.
Second, Cega actively monitors the balance sheets of its counterparties through the use of Credora, a credit analysis platform. By leveraging Credora, potential credit issues can be identified early, enabling appropriate action to be taken to mitigate risk. Credora’s comprehensive analyses provide credit ratings and credit limits on MMs which enables Cega to make informed decisions about which counterparties to trade with and at what levels. To learn more about Credora and how they play a role in Cega’s risk management process, please see this article: https://cegafi.medium.com/cega-announces-partnership-with-credora-to-reduce-counterparty-trading-risk-85f656030c8d.
Lastly, Cega utilizes and signs legally binding agreements known as ISDA contracts with every MM. An ISDA (International Swaps and Derivatives Association) contract is a legal agreement between two parties that sets the terms and conditions for OTC (over-the-counter) derivative transactions. ISDA agreements provide a framework for the legal relationship between Cega and its counterparties including the terms of the trades, the calculation of margin requirements, and the resolution of disputes. By signing these agreements with its counterparties, Cega is able to legally pursue recourse in the case of issues such as market maker credit risk or default.
Our commitment to the trust and security of user funds sets us apart in the industry and establishes us as innovators in this space. This was put to the test in real-time during the FTX crisis last November where we demonstrated a strong ability, above and beyond most DeFi protocols, to protect user funds. Despite Alameda being a participating market maker with Cega, we were able to recover all lent funds due to leveraging the ISDA legal contract and having strong risk management initiatives. To learn more about this event, please find more in our Twitter post here: https://twitter.com/cega_fi/status/1590502203986673664
In summary, credit is a powerful tool for finance but also creates risks for lenders regarding the risk of defaults. To mitigate this risk, Cega has implemented a range of initiatives including only trading with verified counterparties, using Credora to monitor credit risk, signing ISDA agreements, and carefully selecting counterparties based on their creditworthiness and ability to pass KYC checks. We remain committed to our core value of providing security and peace of mind to users.