Notional Finance has made the jump from the Ethereum mainnet to Layer-2 with the third iteration of its fixed-interest lending and borrowing protocol.
The new version 3 was publicly unveiled on Monday after a month of closed beta testing. It goes beyond simply borrowing and lending Bitcoin, Ether, and stablecoin to emphasize strategies that increase returns.
An initial series of leveraged vaults on Arbitrum allow users to borrow significantly against their initial capital. This increases their potential return when returns exceed borrowing costs while minimizing liquidation risk.
Read more: Arbitrum DAO wants to invest $40 million in network protocols
These vaults are designed for advanced DeFi users who are familiar with concepts like leverage loping and want to optimize their yield, Notional co-founder and CEO Teddy Woodward told Blockworks.
“We originally thought that people would use Notional to borrow against their crypto at a fixed interest rate, and then take that crypto to do something non-financial,” such as paying off a mortgage or car loan, said he. “And that’s just completely untrue.”
Instead, the biggest use case is leverage, whether for speculation or income generation.
Fictional strategies can be protocol specific or involve placing capital in external protocols such as Balancer. For example, a vault could deposit Ether (ETH) into liquidity pools and stake the resulting LP tokens.
Users must be aware of the risks associated with these leveraged positions. These include smart contract risk, the possibility of negative returns if yields are below borrowing costs, price volatility when borrowing or lending, and liquidation risk if collateral ratios fall sharply.
Notional’s lean 7-person team chose Arbitrum because it has the largest Total Value Locked (TVL) among Layer 2 networks and a DeFi-focused community.
“I think they’ve always been at the forefront of products, so it seemed like the natural choice, and while we’d like to be at other Layer 2 levels – and we plan to be at some point in the future “I’m going to focus on Arbitrum now,” Woodward said.
He remains skeptical of the promises of cross-chain interoperability advocates.
“If you’re talking about investing significant portions of your net worth, there’s still a real risk of spreading that across chains no matter how you do it,” he said. “It’s not as if funds will simply flow seamlessly between chains – at least not in the near future.”
Instead, Woodward predicts that emerging cultural differences between Tier 2 communities will persist.
“I just don’t think the underlying layer is being abstracted,” he said, arguing that attempting to do so carries risks and incentivizes token holders, regardless of their preferred chain, to prefer transacting within one specific Layer 2 network.
The role of Notional’s governance token, NOTE, remains unchanged in version 3 but may “evolve in the future,” Woodward said. Currently, the token can be staked in an 80/20 NOTE/ETH balancer pool while maintaining governance rights. Liquidity also acts as a protocol backstop, and in return, the protocol passes on a portion of the fees generated to stake note holders.
Woodward sees a problem in serving speculative use cases.
“In DeFi, there is an attitude that somehow we should be better [but] I think ultimately speculative finance use cases really drive the product market fit in DeFi, and you kind of can’t fight that.”
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