Detailed Explanation of Vesta Finance: A Zero-Interest Lending Protocol on Arbitrum

Author: 0xivecott

TL;DR

Vesta Finance is actually a decentralized lending platform based on Liquity, improved on Layer 2. Currently deployed on Arbitrum, it will be deployed on more Layer 2s in the future.

Its features similar to Liquity include: over-collateralized minting of stablecoins, 110% Ethereum collateral ratio, and redeemable at any time. The project was incubated by OlympusDAO and is backed by investors and advisors such as 0xMaki, DCFGod, and the Lau brothers. The project went live on February 9, 2022.

Unique Features of Vesta

1. Diverse collateral: ETH/renBTC/gOHM can all be used to mint stablecoins, while Liquity only supports ETH as collateral;
2. Higher collateral ratio for gOHM: 175%. Liquity's ETH collateral ratio is 110% under normal conditions;
3. Flexible community governance: Over 50% of governance tokens VSTA are allocated to the community, and rates, liquidation incentives, etc., can be modified through governance. These cannot be modified in Liquity;
4. Deployed on Arbitrum, with plans to expand to multiple chains in the future. Liquity only supports Ethereum;

Similarities with Liquity

• Borrowing and repayment methods are the same: a minimum collateral ratio of 110% under normal conditions, applicable to ETH and renBTC (current minimum collateral ratio for gOHM is 175%). Borrowing incurs fees (which may vary) but no interest;
• Opening a loan means establishing an independent Vault (which is a Trove in Liquity);
• The redemption mechanism is similar: to maintain the peg of the VST stablecoin, anyone can redeem collateral worth $1 for 1 VST; VST will be used to liquidate users with lower collateral ratios, sorted from low to high (Liquity prioritizes liquidating the riskiest positions). Redemption is forcibly prohibited if the total collateral ratio falls below 110%, and the product will not allow redemptions for 14 days after going live. (It is unclear if Liquity has the same rule);
• The liquidation mechanism is consistent: stability pool liquidation, debt redistribution, Recovery Model, and redemption liquidation (which is also part of the auxiliary liquidation process).

Basic Principles of the Vesta Lending Protocol

Initially deployed on Arbitrum, Vesta Finance is a decentralized lending platform that supports multiple types of collateral, allowing users to over-collateralize ETH, renBTC, and gOHM to mint the dollar-pegged stablecoin VST.

The minimum collateral ratio for ETH and renBTC must not be lower than 110%, while for gOHM, it must not be lower than 175%, otherwise liquidation will occur.

This means: if a user deposits ETH worth $2,210 into Vesta, they can borrow up to 2,000 VST (reaching the minimum collateral ratio of 110%) and pay a fee of 10 VST. However, the actual amount the user can borrow will be less than 2,000 VST to avoid liquidation.

Minting stablecoins with a lower collateral ratio may improve capital efficiency but carries high risk, as even slight price fluctuations can easily lead to liquidation. However, even in the event of liquidation, the user's loss is limited to the difference between the collateral ratio at the time of opening the position and the collateral ratio at the time of liquidation, so as long as the market is not in extreme conditions, losses are manageable.

Regarding repayment deadlines, the platform has no deadline; users only need to maintain their over-collateralization ratio to avoid liquidation. When repaying, they return the stablecoin VST to retrieve their collateral.

How is VST Pegged to the Dollar?

Each borrowing user needs to open their own independent Vault to mint the stablecoin VST, and the Vaults record the user's debt. The minted VST is pegged to the dollar 1:1 through a "hard peg" mechanism enforced by the Vesta contract. This means that any user can redeem collateral worth $1 for 1 VST, a process known as redemption. This "hard peg" mechanism creates strong arbitrage opportunities when the VST price deviates, encouraging users to redeem or mint VST to maintain its price peg. Additionally, Vesta will dynamically adjust the fees for minting VST, indirectly using a "soft peg" model to anchor the price.

What Can VST Do?

As a dollar-pegged stablecoin, within the Vesta ecosystem, VST is directly treated as dollars; externally, if VST lacks recognition, users can exchange VST for the FRAX stablecoin in Curve's Factory Pool (more stablecoin exchange pools may open in the future) to use FRAX directly.

In the early stages of the project, Vesta also incentivized users holding VST to deposit into Curve to stimulate liquidity through mining rewards.

The VST pool in Curve is as follows: https://arbitrum.curve.fi/factory/19

VST/FRAX Pair data, Source: https://arbitrum.curve.fi/factory/19

What is Redemption?

In lending protocols like Vesta and Liquity, redemption is different from repayment. Redemption refers to any user holding VST (obtained through minting, purchasing on a DEX, transferring from others, etc.) being able to exchange VST for collateral in Vesta (of course, a certain fee will be deducted, which is automatically adjusted based on algorithms). These VST will be used to liquidate debts in other Vaults with collateral ratios below 110%.

Since most of these liquidated Vaults are still over-collateralized, the collateral will be distributed to the redeemer in equivalent amounts, with the remainder returned to the liquidated user. The basic principle of the liquidation order is to prioritize the liquidation of high-risk, low-collateral ratio positions, which is consistent with Liquity.

Repayment, on the other hand, is specific to each Vault opener; using the VST redemption function to exchange for collateral does not reduce their debt position and requires completing their repayment steps independently.

Two-Step Liquidation and Recovery Mode

This is essentially the same as Liquity, and this article will briefly introduce it. For specific rules, please refer to: https://docs.vestafinance.xyz/technical-overview/liquidation-and-the-stability-pool

1. Liquidation Principle: Stability pool first, if not feasible, debt will be redistributed.

Vesta has built a stability pool composed entirely of VST stablecoins as the first layer of protection for liquidating defaulted loans. Similarly, Vesta provides mining incentives to encourage the expansion of this stability pool.

On February 10, 2022, data from the stability pool for three types of collateral, Source: https://vestafinance.xyz/staking/stability

Users can deposit VST (stablecoin) into the stability pool to earn VSTA (governance token) rewards, as well as rewards from the collateral of liquidated Vaults (three types). Users can withdraw their VST at any time except when Vaults are being liquidated.

Since loans are over-collateralized, falling below 110% will trigger liquidation, so after using VST from the stability pool to repay loans, there will still be some excess collateral distributed to stability pool users. Participants in the stability pool who receive collateral rewards can choose not to withdraw the rewards but transfer the collateral to their Trove.

If the total VST in the stability pool is still insufficient to liquidate the loan, redistribution will be triggered. The debts and collateral from the liquidated Vault will be proportionally distributed to other users. The users receiving the distribution will gain net benefits while their collateral ratios decrease, for example (using Liquity's example for clarity):

Source: https://docs.liquity.org/faq/stability-pool-and-liquidations

1. Recovery Mode: As Sun said, a queue for execution mode.

When the system's total collateral ratio falls below a certain value (in Liquity, this value is 150%), the system enters a recovery mode: all borrowing transactions that will continue to reduce the collateral ratio will be forcibly stopped, and among the Vaults, any Vaults below 150% will be queued for liquidation: prioritizing the liquidation of the lowest collateral ratios until the system's total collateral ratio recovers to above 150%.

How to Use Vesta's Products?

Borrow Stablecoin VST

After linking a wallet to Arbitrum, users wishing to borrow can deposit collateral, input the amount they want to borrow, mint VST stablecoins, and open their borrowing position on the Portfolio interface of the Vesta official website. Each position corresponds to a Vault.

Source: https://docs.vestafinance.xyz/tutorials/lending-tutorials/opening-a-vault

The obtained VST can be used for: mining in the Stability Pool, forming a Pair with Frax for mining in Curve, or trading in Curve for Frax for other operations.

Participate in Liquidity Incentive Activities

Currently, there are three types: stability pool mining (as mentioned above), liquidity mining for the VSTA/ETH trading pair in Balancer, and liquidity mining for the VST/FRAX trading pair in Curve.

The participation method is simple: after providing liquidity on their respective platforms, deposit the LP Token into Vesta's Staking module. For specific tutorials, refer to: https://docs.vestafinance.xyz/tutorials/liquidity-incentive-tutorials/staking-your-lp-token

Mining yield data in Balancer and Curve, Source: https://vestafinance.xyz/staking/liquidity

Mining yields from the three stability pools, Source: https://vestafinance.xyz/staking/stability

Token VSTA

• Name: $VSTA
• Maximum Supply: 100,000,000 (100 million)
• Distribution: Community incentives: 51.0%; Core team: 11.0%; Future core contributors: 10.0%; Bootstrapping: 8.0%; Strategic round financing: 6.0%; OlympusDAO: 6.0%; Advisors: 4.0%; LQTY stakers: 2.0%; Whitelist: 2.0%

VSTA token distribution, Source: https://docs.vestafinance.xyz/tokenomics/vsta-tokenomics

Core Functions:

51% for community incentive rewards, including rewards from initial mining activities, distributed across the following five pools:

• VSTA-ETH (the community has successfully migrated the Sushiswap pool to Balancer): https://arbitrum.balancer.fi/#/pool/0xc61ff48f94d801c1ceface0289085197b5ec44f000020000000000000000004d
• Providing liquidity in Curve's Factory Pool: https://arbitrum.curve.fi/factory/19
• In the three pools of the Stability Pool: https://vestafinance.xyz/staking/stability

The remaining rewards will be allocated to future participation in liquidation, collaboration, and community incentive programs (up to 47% of the tokens will be used for this).

25% allocated to core contributors, with this portion of tokens locked for 6 months and released linearly over 2 years. The advisory team includes: 0xMaki, DCFGod, Lau Brother (Not3Lau Capital);

14% allocated to investors and partners, with this portion of tokens also locked for 6 months and released linearly over 2 years. The OlympusDAO community occupies 6%.

This is mainly because Vesta Finance is a project incubated by the OlympusDAO community, and using gOHM as collateral is also an effort to further promote OHM as a universal currency in crypto. 2% will be allocated to LQTY stakers, where LQTY is the governance token of Liquity.

About Early Supporters and Whitelist:

• Vesta offered relatively cheap limited sales of VSTA to early supporters of the community (from December 2021 to January 15, 2022): $0.375/VSTA, with 50% of the tokens released immediately after the liquidity pool goes live, and the remaining 50% locked for 6 months and released linearly over 2 years;
• These tokens account for 2% of the total;
• The whitelist consists of about 600 people;
• Based on their contribution ratios, the levels are as follows:

VSTA whitelist allocation, Source: https://docs.vestafinance.xyz/tokenomics/vsta-tokenomics/whitelist

Governance

Unlike Liquity, Vesta Finance allocates a larger share of tokens to the community, primarily to incentivize members to actively participate in governance. Members holding governance tokens can vote on parameters such as: interest rates, minting fees, and new types of collateral. Early projects will use snapshot for voting. The early VestaDAO used Barnbridge's multi-sign Genesis DAO model to prevent malicious actions by large holders.

In the official documentation, parameters that can be modified through voting are listed:

1. Liquidation ratio: including minimum collateral ratio and critical collateral ratio (which is the minimum collateral ratio under Recovery mode);
2. Specific liquidation details: including liquidation fees;
3. Opening loans and minting: including the minimum number of VST to mint when opening a position and the upper and lower limits of borrowing fees;
4. Redemption: including the minimum redemption fee rate.

Future Roadmap

• Support for more collateral types, run its own Chainlink nodes;
• Deploy to more Layer 2s and non-EVM chains beyond Arbitrum;