Disclaimer:
I recently stumbled into CAP and really liked the idea of what they’re building. So I thought I’d write an intro piece for anyone getting started with CAP here, including myself.
That being said, there are probably some inaccuracies in my post. If you spot something wrong or have questions, feel free to drop them in the comments!
Introduction
Despite DeFi’s maturity, most users remain locked out of its most lucrative yield opportunities. Tapping into MEV, arbitrage and complex yield strategies remains, for the most part, exclusive, limiting the average user’s choices to wrapped TradFi products and “player vs. player” schemes when pursuing yield.
Current solutions fall into two categories, each with distinct limitations:
- Single-strategy products, such as Ethena’s sUSDe focusing on funding rate arbitrage, leaving users vulnerable to changing market conditions.
- Modular solutions like Morpho connect users with yield curators but shifts risk assessment to users who often lack the qualifications for the task.
This isn’t, in any way, a critic to Ethena or Morpho ( both are great products imo) but rather the challenges facing the average user when pursuing yield on DeFi.
Not to add that both approaches share a critical flaw: users bear full responsibility for losses from exploits, insolvencies, or rugs, in return for a significantly limited upside potential.
Enters CAP, a Stablecoin engine attempting to solve these frictions through a three-sided marketplace:
- Lenders: Users deposit capital into asset-specific CAP Stablecoins
- Yield Experts: Vetted Agents compete to generate yield using deposited assets
- Guarantors: EigenLayer Restakers provide risk coverage in exchange for a share of the profits
In addition, CAP will leverage this marketplace to power native asset issuance on MegaETH, unlocking additional yield sources for CAP stablecoins.
That’s the what. Does it sound complicated? Only if you stop here. Read on to learn how CAP will achieve this, with illustrations.
Let’s start by addressing the elephant in the room:
Yield strategies on CAP - AKA where does the yield come from?
At its core, yield in crypto could be split into two categories:
- Endogenous yieldThis refers to revenue generated purely from in-protocol mechanisms. As an example, consider Maker’s DAI where the protocol relies on borrowing fees paid by direct users to generate yield.
- Exogenous yieldThis refers to out-of-protocol mechanics where the protocol exploits external market inefficiencies/ opportunities to generate yield. Take USDe as an example: Ethena deploys users’ capital to capture funding rate arbitrage opportunities and redirect revenue back to users, minus the protocol’s commission.
CAP focuses on exogenous yield generation (not exclusively, but more on this later). But instead of executing strategies directly, CAP creates a competitive environment where specialized yield curators (Agents) regularly bid for the opportunity to borrow assets deposited on CAP. Here’s how it works:
- Lending market Structure
- A separate market is maintained for each asset.
- A hurdle rate ( minimum acceptable return) is assigned to each market
- Competitive Bidding Process
- Agents submit bids specifying: desired loan amount and estimated return for CAP depositors
- Any bids that do not meet the hurdle rate are automatically filtered out
- CAP allocates capital to agents that meet the hurdle rate, prioritizing the highest-yielding bids
Below is an illustration of what the lending market for USDC, one of the assets backing CAP’s USD stablecoin, could look like:
Figure 1. Lending market of USDC on CAP
Implementing a hurdle rate, at least initially, will guarantee depositors a minimum return and filter-out any suboptimal bids from agents trying to get more favourable borrowing rates.
By prioritizing the highest bidders when allocating loans CAP ensures automatic capital reallocation to highest-performing strategies, regardless of market conditions.
At the same time, accommodating a diversified set of Agents solves yield’s biggest bottleneck, scalability:
Yield opportunities persist in all market conditions, but maintaining optimal exposure in an ever-changing market is challenging. CAP’s approach of an asset-specific, unified pool of capital which multiple agents, specializing in different domains, can concurrently tap into solves this and presents an optimal solution for scalable competitive yield.
CAP’s success will depend, significantly, on the protocol’s ability to attract borrowing demand. ie, why would agents borrow from CAP instead of other markets?
CAP’s value proposition to borrowers is analogous to flash loans - the backbone of many complex DeFi strategies - but with the benefits of extending the zero-collateral requirement from one block to a few days, and the possibility of deploying capital not just to a specific chain but anywhere.
Another competitive feature CAP’s design unlocks is allow protocols offering specific yield strategies to tap into the Cap’s large pool of assets by onboarding them as agents. Think of this as a better alternative for protocols to scale their proven strategies compared to the overhead and uncertainty of liquidity mining campaigns. For example, Ethena could borrow stablecoins directly from CAP’s pools to power their funding rate arbitrage strategy.
So what happens when an agent doesn’t repay borrowed funds? - Those of you who are still following
The short answer is CAP leverages EigenLayer’s economic security marketplace to cover defaulting risks. Keep reading for the long answer.
CAP’s productivity-based incentives on EigenLayer
If you’re not familiar with EigenLayer, I highly recommend checking CAP’s post before continuing.
So far, EigenLayer use cases have been limited to leveraging capital provided by Restakers to underwrite risk for technical tasks performed by Operators. However, with a TVL north of $23B and less than 60 AVS’, is it fair to assume the demand for validation services hasn’t been able to match the supply of capital deposited to earn yield by Restakers on EigenLayer.
If we zoom out, EigenLayer’s trust marketplace extends beyond mere validation services to one where restaked capital can underwrite risks for any type of productive activities.
CAP leverages this framework, by taking advantage of the yield-seeking idle capital on EigenLayer, to introduce a productivity-based service where Restakers delegate capital to underwrite risk for Operators focusing on generating yield.
In other words, CAP will use EigenLayer to allow anyone to be an Agent and source cost-free capital from CAP’s Stablecoins to generate yield, as long as they have enough economic security from restakers to cover shortfalls.
Sounds complicated? Let’s try with an illustration of an Agent looking to borrow ETH:
Figure 2. Illustration of productivity-based dynamics between EL Restakers, Agents and CAP
You would notice that the illustration used the worst outcome possible for the failure scenario: total loss of funds. This is highly unlikely ( but it helps demonstrate that even in the worst case CAP deposits remain safe.
Instead, I expect partial loss of funds and repayment delays to be the main failure reasons. In which case Restakers will be subject to minor slashing penalties.
Powering MegaETH with yield-bearing CAP stablecoins
So far we’ve covered yield sources and risk management on CAP, but nothing about Stablecoins issuance or MegaETH.
In this part we’ll explore CAP’s key role as the issuance layer for yield-bearing assets on MegaETH, and potentially powering all the chain’s native dApps.
Let’s zoom out for a bit and consider bridging: A bridge allows users to convert tokens that are native to one chain into a representation of those tokens on another chain. Take $ETH issuance on L2s as an example, it’s all done by locking the equivalent amount of $ETH in a smart contract on Ethereum mainnet. Thus, guaranteeing enough backing, even on worst case scenarios when everyone redeem bridged assets at once.
Similarly, assets deposited into CAP are also locked in smart contracts on Ethereum, and while they’re not idle assets they are always fully backed by Restakers’ collateral, if borrowers default.
Figure 3. Classic bridge vs CAP Stablecoins redemptions: Worst case scenarios
This enables the tokenisation of CAP deposits, and the yield they generate, on MegaETH.
From a design perspective, CAP is asset-agnostic and will accommodate any asset that could produce yield ( ie, with high-borrowing demand). But initially I would expect CAP to support for the following assets: USD, ETH and BTC. Let’s take a look at how that happens:
Minting stablecoins on CAP:
For every supported asset, a list of tokens to back CAP-token minting 1:1 are selected. For example, capUSD could be backed by deposits of USDC, USDT and potentially any other Stablecoin with high-borrowing demand.
Figure 4. high-level flow of minting CAP Stablecoins on MegaETH.
CAP Stablecoins will be deployed as EigenLayer AVS’, meaning that any deposits will take place on Ethereum mainnet but to simplify the UX, users will be able to do so directly from MegaETH where they will receive the issued CAP Stablecoin.
“Now that I’ve minted capUSD, does that mean I’m already earning yield?” - You, just now.
Not exactly, CAP adopts a dual-token design for every Stablecoin:
- stableTOKEN: A token pegged to the asset, backed by deposits 1:1 that does not accrue any yield from CAP.
- yieldTOKEN: A yield-bearing token with exposure to CAP exogenous yield.
Figure 5. High-level flow of Staking CAP stablecoins to earn yield, capUSD used as an example.
Why Two Tokens?
Each version enables different use cases and caters to different users
- yieldTOKENs are best suited for capturing passive yield, generated from borrowing demand from Agents on EigenLayer.
- stableTOKEN taps into active yield, enabled by native-MegaETH DeFi
Figure 6. Source of yield for CAP’s dual token design.
In addition to the most-competitive yield, CAP aims to leverage MegaETH to offer its depositors more utility and capital efficiency for their assets. This is where the dual-design comes in:
- Enable leveraged exposure to CAP exogenous yield on MegaETH money markets via borrowing stableTOKEN against yieldTOKEN
- Enabling CAP Stablecoins as borrowable assets and settlement assets to unlock additional sources of revenue for depositors ( this can only be done with stableTOKEN)
- Integrating CAP stablecoins deeply within all MegaETH dApps to offer users more utility for their assets
If succeeded, CAP Stablecoins will offer the most competitive yield for any specific asset, regardless of market conditions. This will quickly lead to substantial growth in deposits, as yield-seeking users rotate to CAP.
The tokenization of, both, deposits and yield will take place on MegaETH. This will lead to CAP-issued Stablecoins becoming the most liquid and most adopted versions of any asset, and CAP becoming the canonical bridge to MegaETH which, in turn, will lead to more yield.
Conclusion
The idea of using economic security to underwrite risk for collateral-free loans is intriguing on its own, but when combined with the tokenization of positions on MegaETH—a high-performing blockchain— CAP has the potential to redefine the DeFi yield landscape entirely.
Of course, this doesn’t come without caveats. CAP’s success hinges on the effectiveness of EigenLayer’s slashing mechanism, as it acts as the backbone for protecting users’ deposits. This dependency introduces a layer of risk.
Another potential hurdle lies in scalability. Currently, EigenLayer boasts billions in idle capital waiting to underwrite risk for CAP’s yield agents. But what happens when borrowing demand outpaces the available economic security? This scenario could present an inflection point for CAP’s growth. However, considering EigenLayer’s current TVL of $23B, this seems like a distant problem and a good one to have as it would mean CAP succeeded.
That’s it for now! If you’ve made it this far, thank you for reading and I hope you found this helpful!