Informational - Junior tranche lacks immediate withdrawal guarantees

[kitty-the-kat]

Depositors to the Junior Tranche not only are exposed to higher risk than the Senior Tranche, but are also exposed to the risk that their assets may not be possible to withdraw at all times. At worst, this could cause a "leach attack".

Technical Details

In order to deposit in the Senior Tranche, there must be sufficient value in the Junior Tranche to protect Senior Tranche deposits. This means that if the Junior Tranche protects the Senior Tranche 1-to-1 and there is 100% utilization, no Junior Tranche funds can be withdraw. In the event that all depositors to the Junior Tranche wish to withdraw, there could be a "bank run" where the first users to withdrawer receive their funds, but when the utilization ratio hits 100%, no Junior Tranche funds can be withdrawn because they are needed to protect the funds in the Senior Tranche. This behaviour is the norm for tranche structures, but users who have not interacted with such a pool design may not clearly understand the limitations of the system. This could be problematic for users if they have a loan in a protocol like Aave that is about to be liquidated and they cannot withdraw their funds from the Junior Tranche to increase their loan collateralization ratio.

A real scenario where this would be incentivized to take place is a "leach attack", when the fixed yield on the Senior Tranche exceeds what the underlying vault is capable of producing and the Senior Tranche depositors leach off the Junior Tranche value. If the Senior Tranche promised an absurdly high fixed yield, or if the underlying vault yield drops to a near-zero value, the Senior Tranche depositors would be more incentivized to keep their token in the Senior Tranche to receive the "impossibly good" yield, even though the yield the Senior Tranche is receiving is being taken from the token value of the Junior Tranche depositors (because the yield from the vault cannot cover the fixed yield amount). It is true that the tranche owner can set the fixed rate with setRate(), but there may be a delay before this happens (possibly a DAO vote), during which time value could be leached from Junior Tranche depositors and the Junior Tranche depositors would be unable to withdraw because 1. the utilization ratio does not permit it 2. the leaching causes a loss of value in the Junior Tranche which makes the utilization ratio even worse.

Impact

Informational.

Recommendation

Document clearly the lack of guarantees around immediate withdrawal for the Junior Tranche to try to prevent users from making poor decisions.

[kitty-the-kat]

acknowledged: Note that both utilization ratio and fixed rate can be changed to avoid these, on top of this yield distribution to the senior tranche stops once the distribution threshold has been broken, which doesnt guarantee that the senior tranche holders will pull out, but they have no economic incentive to stay anymore