September 26, 2023: Napier Protocol 🏴🔢
Napier Protocol joins Pendle, Notional in the tokenized yield wars
Recently, the crypto community was abuzz about Napier Protocol. It’s great to see this on many levels, if for no other reason than to perhaps raise the profile of its presumptive namesake, John Napier.
John Napier, a true Scotsman, was the inventor of important tools you may well use every day, like the decimal point and the logarithm. He also was a true honorary degen, with a colorful background as a practitioner of alchemy, necromancy and the occult.
Napier cultivated this mystical reputation to devise ingenious new ways to squeeze better work out of his servants. In one such example, he pretended that he had a magic black rooster which he’d enchanted to crow if touched by a servant had stolen anything from him. He asked them all to go into a dark room and pet the rooster.
In fact, he’d covered the rooster in a layer of soot. After the servants returned, he examined their hands. Anybody who didn’t have evidence of soot, having been too afraid to touch the rooster, he fired on the spot.
This story is quite good on its own, so as a family friendly newsletter we have no need to devolve into tawdry jokes about Napier making servants stroke his black…
Napier Protocol is throwing their hat into the tokenized yield space, popularized by Pendle.
Pendle Finance, of course, is familiar to users of Stake DAO, which was early to gain from Pendle’s success with their liquid lockers.
The concept of tokenizing and trading yield is a quintessential example of DeFi innovation. It’s getting more attention recently, given the rise of RWAs and high interest rates in T-Bills. Yet the theoretical groundwork of this space has been being fleshed out since as far back as 2020.
Yield Protocol has been at the forefront. Their white paper considers invariants like the Curve invariant, but finds that it has some trouble when applied to “yield space” as opposed to “price space.” They settle on a constant power sum invariant, which flattens as it approaches maturity.
This was improved upon by the Notional AMM, which utilizes a logit curve, also used by Pendle.
Notional is also beloved among the flywheel community for providing Llama holders an invite to test drive their Arbitrum v3 beta.
Core to Napier’s approach is the common approach of splitting the yield-bearing assets into two parts, the Principal Token and the Yield Token. For instance, an sDAI is equal to the Principal Token (raw DAI) plus the Yield Token (whatever is earned on top.)
For the Principal Token, Napier is planning to simply use Curve pools to handle liquidity. Napier is developing a new Time-Dependent AMM that borrows elements from both Notional and Yield to deal with trading the Yield Token.
For the Curve piece of this, the architecture is simple enough to follow. They plan to have some base pools, consisting of just the Principal Tokens. These base pools will allow for easy trading of the assets that are stripped of their yield.
Napier plans to create 3pools of more trustworthy Principal Tokens (their initial materials suggests AAVE, COMP, and MORPHO). By launching new Principal Tokens as metapools between the new token and this 3pool, it’s intended to isolate the risks in launching each new market (in a premise similar to Silo Finance).
With Curve handling the trading among Principal Tokens, the other piece of the equation that has to be handled is the Yield Tokens. This is handled with the piece of the architecture that Napier is building in their Time-Dependent AMM.
This AMM may be thought of as pools holding the Curve LP token (handling the relevant Principal Token, such as raw DAI) and its underlying asset (ie the full yield bearing sDAI).
Using such an architecture, it becomes seamless to trade between the yield-stripped DAI and sDAI directly in the pool. As it approaches the maturity date, one should expect that the remaining yield in the sDAI is worth closer and closer to 0, as the ratio of their prices approaches exactly 1:1.
This time component is what’s missing from Curve pools, and thus necessitates the research and development of this new type of AMM.
So far, Curve handles the Principal Token trading to other assets, and the new Napier AMM handles trades between the Principal Token and its original. You may be wondering where the Yield Token enters the equation.
This is the other big innovation of the Napier AMM. The Yield Tokens are traded directly into or out of the pool using flash swaps. The pool is capable of dissembling the asset and rebalancing the pool when a Yield Token is bought from the pool, or running the process in reverse when it is sold back to the pool.
It’s a clever ecosystem, and we look forward to seeing it in action. We met with the founder at Stable Summit, where he shared his enthusiasm for the Curve ecosystem.
He also since helped review this article for accuracy.
Of course, our smol-brained overview cannot cover the entire mechanics as comprehensively as the Napier team — it took us a while to unpack this! They’ve published some good Medium articles walking through this:
Their team will surely be happy to field additional questions, particularly about the details of the Time-Dependent AMM. If you have more questions, feel free to ask them directly!