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Abstract

Valinor is a shared safety protocol designed to maximize lending market collaboration in the reduction of bad debt. It enables markets that want security to access it by tapping into the receipt tokens of lenders willing to stake them, which creates a system that strengthens resistance to bad debt for all.

Actors

There are three active entities on Valinor at any given moment:

• Markets - a credit network that needs to be protected. Can be as granular as a Morpho market or as broad as an entire lending market and everything in-between.

• Lenders - holders of assets and / or lending receipt tokens that are willing to lend them at the risk of slashing for extra yield.

• Curators - ecosystem managers, curators define which assets can secure which markets and at what risk premium.

Valinor's role in all this is one of enablement - the protocol brings additional security to web3 lending markets and additional use to lending receipt tokens by connecting the three parties.

What Is Valinor

Valinor is a shared security protocol for web3 lending markets. It enables markets that want extra protection against bad debt to build curated safety systems by connecting them with lenders all across the space willing to (re)lend their assets at a premium. Valinor enables the same asset to be both lent out on one market and used to protect one or more other markets, thus unlocking unprecedented efficiency in lending while bringing more returns to lenders and more security to markets.

Lenders participate by staking / lending their assets in vaults curated by professional risk managers, which in turn can better protect a variety of markets across the space. Valinor is safety for all, together.

How it Works

At its most granular, Valinor is a set of vaults dubbed safety vaults. Built on the ERC-4626 standard, these vaults accept only one token each and act as first-loss capital for the market they are protecting: in case of liquidation/bad debt, safety vaults take the loss first to protect the market.

Curators bundle a number of safety vaults at their discretion to create composable Safety Modules (sets of safety vaults). Since each safety vault can protect more than one market, this enables an interesting dynamic - shared safety. Curators can now protect several markets with each Safety Module, much like they can more granularly protect vaults or single markets within specific lending markets (e.g. Morpho, Euler).

Here's how it works in practice:

• Curators assemble Safety Modules composed of one or multiple safety vaults and define which markets they protect.

• Each market pays for this protection, with either a share of supply yield or incentives.

• Lenders then stake their lending receipt tokens or deposit their assets in safety vaults, where they will be earning yield and protecting the respective market(s) for as long as they are there.

Assets can be withdrawn from the vault by their depositors at anytime. Otherwise, they will only leave the vault in case of slashing.

Markets

Markets can choose which assets they want to have protecting them besides their own receipt tokens, as synergies may be unlocked by combining them with assets already present in their own market. They then work with either a single or multiple curators to define which stakes across Safety Modules protect them. All stakes protecting a market are the market's Safety Fund.

In this example, all markets have one asset of each curator's Safety Modules in their Safety Fund and each curator attributes a percentage of their Safety Module to each market. to note that, by accepting another market's receipt token as security, a market is incurring in contagion risk. As such, it is crucial that an adequate risk management approach is taken to curate each market's Safety Fund.

Markets may also already have their own safety funds arranged, which in that case can then be integrated with their overall Valinor Safety Fund.

Curators

Curators play a pivotal role in this architecture - they create and manage vaults which limit contagion while driving ecosystem synergies. Lenders deposit assets in the curators' vaults, which in turn protect all markets that have stakes in their vault.

In this example, market 1 is being covered by Aave USDC receipt tokens and market 3 is being covered by Benqi AVAX receipt tokens in the curator's vault. All three markets are being covered by DAI, meaning DAI depositors earn yield from all markets.

Compensation

Markets can choose to incentivize the safety vaults with rewards or assign a percentage of the market's supply yield that goes only to safety vault participants. To note, rewards are cumulative - a safety vault protecting two markets will earn rewards for both of them, as it is taking on extra risk.

Liquidity Extension

In the event that a safety vault has the same asset as the borrow asset of a market it is covering, the market can request the vault manager for a liquidity extension - enabling the movement of funds from the safety vault to the market, so they may be borrowed. This enables the safety vault to effectively act as a Junior Tranche, as its participants may also become lenders. Liquidity extensions need to be enabled per safety vault and the vault's asset must be the same as the market's borrow asset (e.g. a USDC vault covering a USDe/USDC market).

Liquidations

In case of defaults, first liquidation bots active on each market will participate to liquidate the market. Only in case they do not participate or the asset is illiquid will the Valinor liquidation process trigger. In this case, two things happen sequentially:

• First, Valinor Dutch auctions the collateral with whitelisted parties up to the asset's liquidation threshold. If all the debt is solved this way, the liquidation is thereby settled. If not, liquidation then falls to the market's Safety Fund.

• In this scenario, the Safety Fund's stakes absorb losses according to the market's realization mechanism. Upon realization, the respective receipt tokens are burned / withdrawn for their respective assets to cover the necessary debt. Valinor itself handles this process.

Realization Mechanisms

If only one insurance vault is associated with a single market, then it is immediate that it takes all losses that happen. However, it may happen that one vault is covering multiple markets or that one market is being covered by multiple vaults. In these scenarios, two realization formats are possible:

• Automatic realization: all vaults covering a market equally share the loss.

• Tiered realization: vaults cover a percentage of the debt proportional to the yield they receive per market, meaning highest-paid vaults get liquidated first. Let's look at two examples:

  • Let's say a single market is covered by two vaults, one of $5M earning 10% APY and one of $10M earning 15% APY (because the vault manager incentivized them differently). In this case, the vault earning 15% gets liquidated first in proportion to its yield difference. The $5M vault is still responsible to cover the debt, only a smaller percentage of it.

  • Let's say a single vault is covering two markets, and both get liquidated simultaneously. In this case, the market paying more to the vault gets prioritized and is covered first. If both vaults pay the same, then the vault equally covers both markets.

Markets decide which realization mechanism they want to apply in their Safety Fund.

Benefits

• Market lenders unlock additional utility on their receipt tokens while maintaining total transparency and control.

• Markets unlock new customizable security systems that combine different assets across vaults.

• Curators earn by taking a performance fee on yield generated by their curated vaults.

This whole architecture was built to be extremely flexible and scalable - new vaults can be added permissionlessly according to curator need. In addition, the whole system is extremely capital-efficient and modular, as the same asset can protect more than one market at the same time and risks can be closely managed according to curator and market preferences.