Analyze the solution to the DeFi serial liquidation problem from three dimensions

The serial liquidation of liquidation from the DeFi lending agreement is one of the most significant systemic risks in the DeFi world. Due to excessive liquidation and insufficient market liquidity, every time the market changes drastically, it will cause further turbulence in the market, which not only leads to Mortgage borrowers incur additional losses, which also intensifies the volatility of market conditions.

So, how should we ease this major systemic risk? At present, the DeFi industry has seen a large number of practices addressing this pain point. Chaincatcher will summarize these explorations in this article, and analyze it from three dimensions, including optimization of liquidation mechanism, improvement of collateral replenishment efficiency, and reconstruction of borrowing logic.

Optimization of clearing mechanism

The liquidation mechanism and its algorithm are the core capabilities of the lending agreement, which directly determine whether the user’s collateral is liquidated and the specific price of the liquidation, so as to ensure that the platform and the lender will not suffer losses.

In terms of clearing mechanism, due to the many major market situations experienced in the industry in the past, the clearing mechanism of mainstream DeFi lending agreements is relatively mature and stable. However, since May of this year, Venus, the largest lending agreement of BSC, has a huge XVS liquidation worth hundreds of millions of dollars. In terms of events, many emerging DeFi lending agreements are still immature in this regard.

Specifically, the liquidation mechanism can be analyzed from three aspects: mortgage asset selection, mortgage rate setting, and price-feeding mechanism.

In terms of mortgage assets, lending agreements generally need to choose mainstream assets with high liquidity, relatively dispersed distribution, and difficult to be manipulated as mortgage assets, otherwise it may cause huge abnormal losses to the platform’s related asset lending users. The BSC loan agreement in January and May of this year has an abnormally large amount of liquidation incidents, both of which are to include CAN and XVS two high-control disk assets into the list of mortgage assets.

In terms of mortgage rate, the loan agreement needs to set a higher mortgage rate to ensure that when liquidation occurs, the mortgaged assets can be fully liquidated in the market at an appropriate price, so that the market depth is insufficient for liquidation and platform losses occur.

Taking ETH as an example, the minimum mortgage rate required by MakerDAO is 150%, the minimum mortgage rate required by Compound is 133%, and the minimum mortgage rate for other assets is often higher. In May of this year, Venus had a huge XVS liquidation incident. One of the main reasons was that the XVS mortgage rate was only set to 125%, reflecting the poor risk awareness of the platform.

In terms of price feeding mechanism, many DeFi lending agreements use external asset prices as a reference for liquidation, such as Chainlink, UMA, Coinbase, etc. However, single source and insufficient depth of price feed sources are easily manipulated, and then abnormal liquidation occurs. Therefore, stable and diversified price sources are very important to loan agreements.

On November 26, 2020, Compound had an abnormal liquidation volume of more than 100 million U.S. dollars. The main reason was that the price of Coinbase, the source of DAI’s price, was abnormal. The price rose to 1.34 U.S. dollars in a short period of time, which caused a large number of DAI positions to be mortgaged. Insufficient rate and then liquidation.

At present, a number of emerging DeFi lending agreements are trying to form a space for misplaced competition based on second-tier assets that the head lending agreement is unwilling to support and lower pledge rates. Although this can meet the needs of some users, it is still an unstable factor for the overall project ecology. .

Improve the efficiency of collateral replenishment

The fundamental reason for the liquidation of collateral lies in the user’s insufficient collateral, but in fact, many users do not have the willingness and ability to replenish the collateral. If most users can get the news of the insufficient collateral rate in time and replenish the collateral, it would be extreme The situation of serial liquidation of collateral on the chain under the market will also be greatly reduced.

Therefore, many projects are practicing to improve the efficiency of collateral replenishment. The main attempt is to provide automated liquidation protection, that is, to automatically help users replenish collateral when the user mortgage rate is insufficient, so as to avoid being liquidated, and users no longer need to pay attention to the market. Price, release more energy.

For example, the DeFi aggregation platform DeFi Saver, the project supports users to manage their debt positions in Maker, Aave, and Compound through the platform, and provides automation functions to help users automatically manage mortgage debt positions, allowing users to have a mortgage ratio of their positions lower than the configured Automatic repayment at the minimum value, that is, use the assets currently deposited as collateral to pay off their debts, and automatically increase the loan volume when the ratio rises above the configured maximum value, which allows users to borrow more to get more Mortgage assets.

Another DeFi aggregation platform, Instadapp, has a similar idea. By launching Instadapp Actions, it helps users to automate debt refinancing, and also helps users move their debt positions autonomously between MakerDAO, Aave, and Compound according to the best liquidation price. .

It is worth noting that this service provided by Instadapp was launched in cooperation with Gelato Network, which is an Ethereum smart contract auto-execution agreement that uses robots to automate the smart contract process. The project also recently cooperated with KeeperDAO to launch a Just-in-Time Underwriter (JITU) to continuously monitor the health status of users opening positions in kCompound. If the position falls below a certain threshold, JITU will immediately take action on behalf of the user and provide more collateral as a buffer.

In improving the efficiency of collateral replenishment, another attempt is to help users get the news of insufficient mortgage rate as soon as possible. At present, DeFi lending users cannot directly get the notice of insufficient mortgage rate of their positions, which also restricts them from adding collateral in a timely manner. Action on position health. The main explorers in this area are EPNS and HAL.

EPNS hopes to help DeFi users get on-chain notifications through wallets, APPs, etc. by establishing a decentralized notification layer on Ethereum, but the mainnet has not yet been launched. At present, EPNS has reached pilot cooperation with lending agreements/derivatives agreements such as Aave, Alpha Finance, bZx, UniLend, etc., enabling platform users to subscribe to alerts on clearing risks and decline in loan health.

HAL is less well-known than the former, but it has been launched in June 2020. It currently supports users to subscribe to nearly 10 head DeFi protocol notifications such as Aave and Compound, including loan health warning notifications, and supports sending users’ emails, Distributed by Discord, Telegram, and Slack accounts, and the number of users currently exceeds 4,500.

Some lending projects are also developing such services independently, such as the BSC lending project Venus. Users can choose to set warning notifications for their position mortgage rate on the account homepage. Once the mortgage rate reaches the value set by the user, the Telegram robot will send the user account Sending notifications, currently charges 0.06 BNB per month.

As more and more DeFi lending protocols integrate message notification services in the front-end in the future, users can choose to subscribe to warning notifications when lending, which may greatly improve their efficiency in replenishing collateral, while avoiding further liquidation pressure on the market .

Refactor DeFi lending logic

At present, most DeFi lending projects adopt an over-collateralization mechanism, which is the basis for liquidation of collateral under severe market volatility. However, in the past year, the DeFi industry has seen a number of projects based on credit loans/under-loan mechanisms. Product logic Restructure the DeFi lending business at the level, using the trust relationship between users or offline legal relationships as the cornerstone to build the lending business, so as to reduce the market risk formed by liquidation.

Aave launched a credit authorization loan service last year, that is, deposit users with idle borrowing capacity can authorize their credit limit to the address of their trusted user. The two parties have previously passed the legally effective smart contract agreement Openlaw the aforementioned agreement, the latter You can directly withdraw borrowed funds without collateral.

Another lending agreement, Union Finance, has a similar idea. Any user can set a credit limit and expiration date to a specific address on the platform. The risk of collateral liquidation is transformed into a trust relationship risk between friends.

ARCx’s idea is to determine the mortgage rate based on the credit score on the chain, that is, to score the credit according to the user’s loan history, asset scale, governance experience and other behaviors. The higher the score, the lower the mortgage rate (minimum 105%), that is, the more you use it. Less collateralized assets can get the same borrowing scale, and in addition, they can get farming opportunities with higher yields. The product hopes to encourage users to pay attention to credit history through big data behavior analysis and various welfare experiences, and to encourage users to repay loans with insufficient mortgages, thereby reducing the potential liquidation scale of the market.

Teller, which was incubated by a16z, also tried to provide users with loan services based on credit, but mainly by connecting users’ bank accounts and determining loan conditions and limits based on their historical records, people with good credit can get unsecured loans or insufficient loans. If a user defaults, Teller will reduce the user’s rating with the credit rating agency that it cooperates with in a specific way.

Truefi is also exploring unsecured loan solutions, mainly for institutional borrowers rather than retail users. Any borrower needs to conduct KYC and conduct a credit review. At the same time, each loan ultimately needs to be voted by the TRU holders of the platform token. If the borrower defaults on the loan, the platform will liquidate up to 10% of the TRU of the voting users and initiate legal proceedings against the delinquent party.

Physical mortgage lending is another solution. Projects such as Centrifuge and NAOS Finance are exploring bringing physical assets into the DeFi lending market and there have been many cases. The price of physical assets is often more stable, and the diversification of mortgage assets will also decrease. The pressure of collateral liquidation on the cryptocurrency market.

According to data from Dune Analytics, the size of outstanding loans in the DeFi market has reached US$28.2 billion, an increase of more than three times from the beginning of the year. At the same time, perpetual contract products based on borrowing logic are also developing rapidly, which means that the potential liquidation scale of the DeFi market is The pressure on the secondary market has also risen sharply, which has formed an important systemic risk to the cryptocurrency market.

The previous article analyzed the solution to the serial liquidation liquidation problem from three dimensions, optimized the product logic of the lending market from different perspectives, and reduced the probability of on-chain liquidation, especially Instadapp, DeFi Saver, and other automatic liquidation protection functions. The TVL of the project has been improving rapidly recently. These explorations and data will help to improve the health of the DeFi lending market and reduce the volatility of the crypto market.

As for the dimensions of reconstructing the borrowing logic, most of these projects are now in the early stages of development, and the user usage and recognition are not high, and further development is still needed.

From the current point of view, the issue of serial liquidation, as an important proposition for the industry, will receive more and more attention, and the overall effect of the aforementioned plan also needs to be tested by the next major market.

Author | Yu Gu

Posted by:CoinYuppie,Reprinted with attribution to:
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