About Tranching

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.

$$A_i \rightarrow [Sr_i, Jr_i]$$

The junior tranche $(Jr_i)$ is more exposed to AMPL’s underlying supply expansion or contractions. The senior tranche $(Sr_i)$ is less exposed to AMPL's underlying supply expansions and contractions. Buttonwood Tranches are fixed-term tranches that mature back into raw AMPL after the maturity period.

For this reason, if a user were to hold $(Sr_i)$ and $(Jr_i)$ until maturity, this would be equivalent to holding raw AMPL over the same time period. To learn more about AMPL please see the AMPL Overview.

Tranches Under Supply Expansion

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

Tranches Under Supply Contraction

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

Putting it all Together

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.

Key Benefits

The first benefit we'd like to draw attention to here is that there are no liquidation markets used in the Buttonwood Tranche protocol. That is to say, when a user borrows against collateral by tranching, regardless of what happens at the end of maturity, there is no need to liquidate a debtor.

Moreover, there is no need to sell on external markets to pay back a loan because all debts are settled apriori. Tranches simply mature and the holders of seniors and juniors can redeem for the underlying asset. For this reason, systems built using Buttonwood tranches are by default free from risk of cascading liquidations and contained.

Buttonwood Tranches are:

• Fully Transparent

• Composable

• 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.

In the next section we'll expand on Minting, Redeeming, and Rolling Over.