Once upon a time, there lived a people in a place called Earth. And in this Earth, the people used something called fiat currency in exchange for goods and services. Everything was great, and people were flourishing. Then, one day, these people built something called the Internet. And in this Internet, the people were able to communicate and trade with each other faster than ever before.
In this new Internet era, people were able to learn at a rate not seen before in their history, and so they realized that not everything was as great as they thought. Suddenly, in the year of legend 2008, in a calamitous financial crisis, the people learned that the Banks were taking too many risks with their hard-earned money. With that revelation, Satoshi Nakamoto spoke up and said, “Let there be Bitcoin.” And it was good.
Bitcoin let the people take control of their money without needing the Banks. Then, one day, seeing a need for something a little different, Vitalik and his band of merry compatriots said, “Let there be programmable money.” And thus, Ethereum was born, and it was good.
Ethereum let the people use smart contracts with their money so that they could build a more just world, without having to rely on the Banks quite so much. And in this shiny new Ethereum, groups formed, and they began to issue their own tokens for their own needs for the people to use. “But wait,” said the people. “There needs to be a standard. We cannot keep track of everything without a standard.”
And so, the people passed EIP-20, which bestowed upon Ethereum what are known as ERC-20 tokens. And it was good. These tokens let the people trade and bank with one another like never before. “But wait,” said the people. “We need a standard for our vaults. We cannot maximize our trade and banking without a standard for our vaults.”
And so, the people passed EIP-4626, which bestowed upon Ethereum the ERC-4626 tokenized vault. And it was good.
Now, of course, life isn’t actually a simple fairy tale, and things obviously were not always great in the olden days, one sometimes has to take a little artistic license when telling a story. And here, we are telling you, gentle reader, the story of ERC-4626. Well, not the story so much as what it is, why it matters, and how Alchemix may possibly use it in the future.
What is ERC-4626?
Among the many innovations in DeFi have been vaults and composability. Vaults are where users can deposit tokens to earn yield, and composability is the idea that different yield sources can be stacked on top of each other to earn the user yield from multiple sources. One simple and easy example of composability would be locking a token in a liquid staking vault, and then lending the resultant liquid staking token in a lending market. A liquid staking token is a synthetic token that is redeemable for the underlying tokens in the staking contract, such as rETH. With the above composability example, the user earns staking returns while also earning a market rate from lending. One may be able to characterize composability as the ability to engage in a form of rehypothecation. Users can, under their own prerogative, decide to take on further risk for the purpose of multiplying their yield. It’s one way of potentially flipping opportunity cost into opportunity earnings.
Until recently, there was no standard way for bridging the gap between vaults and composability. Before EIP 4626, every protocol and DAO was more or less left to its own devices to try to make this happen. But because there was no standard, each implementation introduced its own foibles and risks. Per the EIP, ERC-4626, “allows for the implementation of a standard API for tokenized Vaults representing shares of a single underlying ERC-20 token. This standard is an extension on the ERC-20 token that provides basic functionality for depositing and withdrawing tokens and reading balances.”
Why does ERC-4626 matter?
ERC-4626 matters because standardization allows for systems to scale, and scale brings with it economic activity and economies of scale. A lending market, for example, will have to devote fewer developer resources to building and maintaining their market if they only accept standards-compliant tokens. And token issuers can gain wider acceptance, and can take advantage of existing documentation, if their tokens are standards-compliant. Standards do not solve all problems, and they may sometimes introduce new problems, but they are generally considered to be a win-win for the industries into which they are introduced, be they character sets, WiFi protocols, or cryptocurrency tokens.
Additionally, the ERC-4626 standard includes the option for a user’s vault position to be transferable in the form of tokens. This introduces better standards for enhancing composability in the EVM world.
How can Alchemix use ERC-4626?
The ERC-4626 standard is still very new, as it was only finalized in March. However, Alchemix v2 vaults are already compatible with ERC-4626 tokens. Before going further, please heed the following caveat: The author is not a developer for Alchemix and does not have any particular insight as to what Alchemix developers have planned, nor does the author have any special influence or consideration with the Alchemix development team. All of the following is speculation and thought exercise. Absolutely none of anything that is written here should be construed by anyone as financial advice or so-called alpha. Do not be a brat and pester the development team asking them about this author’s ideas.
Having said that, consider the following possibility: Imagine staking a token and receiving a liquid staking token in return (such as stETH or rETH). Now imagine lending the liquid staking token in a lending market, and receiving a token representing your deposit in the lending market (such as Compound). Now imagine that there is a market for liquidity for this receipt token, such as on Sushiswap, and providing said liquidity. Now imagine depositing this liquidity into a yield optimizer that will autocompound your rewards for providing this liquidity, and getting a token representing your deposit.
Now, who knows if such a scenario would ever really exist in such a manner that truly made sense, but this example is a bit of hyperbole for the purposes of demonstrating a point. For one, with a standard for token vaults, such a scenario is a lot more possible than before, because all of the requisite steps could be built for that standard. For two, one can see that assuming Alchemix were to develop support for using the above example’s end-result token as collateral, many exciting new possibilities are introduced in terms of Alchemix harvesting yield deposits. In the above example, there are four layers of yield that can be used to pay down a depositor’s Alchemix debt.
So, to summarize, as the DeFi ecosystem builds out to the ERC-4626 standard, new opportunities will begin to present themselves to the Alchemix community for collateral types that will offer new, innovative ways of paying down debt.
Furthermore, the Alchemix development team recently introduced their plan for enhancing ALCX tokenomics (1). When it’s all said and done, there will likely be vote escrowed ALCX (veALCX), along with possibly other tokens representing voting power. Depending on what the technical needs and features of these will be, it is possible that some may be ERC-4626 compliant. If that’s the case, it will confer on these tokens enhanced composability, and it will imbue them with added trust and acceptance throughout the DeFi world. And it will be good.
1) https://alchemixfi.medium.com/new-alchemix-tokenomics-and-dao-d9210a364d11