Tranching is the process of resegmenting the volatility of an underlying asset into two or more assets with different volatility profiles. In this section we cover tranching in detail, please see the About SPOT entry for an overview of how tranching fits into the overall SPOT architecture.
To accomplish this the SPOT protocol uses an open tranching protocol called Buttonwood Tranche. The Tranche protocol accepts as its inputs:
- A Balance of Rebasing Collateral: A deposit of underlying tokens that can be used as collateral and unit-of-account
- Maturity Date: A future date & time at which tranches mature and become redeemable for the underlying
- Tranche Ratios: A list of values, adding to 1, that determines the distribution and order with which supply changes propagate to two or more tranche tokens.
When AMPL is deposited into Tranche, two or more tranches are created. We can illustrate this process with just two tranches, a senior tranche and a junior tranche, where junior tranches are more exposed to AMPL’s underlying supply expansion or contractions than the senior tranches. For a brief over view of AMPL please see the AMPL Overview.
When the underlying AMPL collateral’s supply expands beyond the amount initially deposited, the excess AMPL accrues only to the junior tranche. In the figure below, the junior tranche benefits from the underlying expansion, while the senior tranche is unaffected.
Senior and Junior Tranches Under Supply Expansion — Expansion Accrues to the Junior
When the underlying AMPL collateral’s supply contracts beneath the amount initially deposited, the supply reduction affects junior tranches first before senior tranches are affected. In the figure below, the underlying supply contraction propagates only to the junior tranches.
Senior and Junior Tranches Under Supply Contraction — Contract Propagates to the Junior
From the above sections we can deduce the following:
- Senior Tranches: Behave like “safer assets” that can be used as collateral because they are insulated from, but not immune to, AMPL’s supply volatility.
- Junior Tranches: Behave like “equity” because they are first in line to absorb AMPL’s supply expansions or contractions, which are in turn produced by increases or decreases in AMPL’s overall network demand.
- Conservation of Collateral: The total sum of AMPL tokens for which senior and junior tranches can be redeemed will always equal the number of AMPL that would have remained if the AMPL collateral were simply held over the same time period.
The key benefits of using Buttonwood Tranche are:
- Fully Transparent
- Non Custodial
- No Liquidation Markets
- No Oracle Risk
For more details on how tranche ratios and maturity dates are calculated in the SPOT system see About SPOT Configurations.