Will BendDAO’s insolvent NFT finally usher in the subprime mortgage crisis?

Will BendDAO's insolvent NFT finally usher in the subprime mortgage crisis?

NFT weekly trading volume hit a record low (Source: Nansen)

Recently, the NFT market has continued to be sluggish, and the trading volume has continued to drop and hit new lows. According to reports, the weekly NFT trading volume (from August 9 to 15) reached 76,637 ETH, a record low, and has been below 153,000 ETH for 13 consecutive weeks.

At the same time, the decline in transaction volume was also accompanied by a decline in NFT prices. The floor price of BAYC fell from an all-time high of 153.5 ETH to less than 70 ETH, a drop of more than 54%. The drop in the floor price triggered the liquidation auction mechanism of the NFT mortgage lending platform BendDAO. On August 18, BAYC was liquidated and auctioned on BendDAO for the first time. The continuous decline in the floor price in the following days triggered more BAYC to be liquidated.

At the same time, a large number of funds that originally provided liquidity for the ETH lending pool in BendDAO were also quickly withdrawn. In just four days, the balance of ETH in the ETH lending pool dropped from more than 160 million to a minimum of 0.58, which was almost lifted.

BendDAO, the leader in NFT lending, was in a deep liquidity crisis, and BAYC, which had been the leader in the NFT market, was liquidated. The remarks such as “NFT market is about to start a death spiral” and “NFT’s subprime mortgage crisis is coming” were rampant, and panic spread rapidly for a while.

How did BendDAO’s liquidity crisis happen?

What is BendDAO?

Will BendDAO's insolvent NFT finally usher in the subprime mortgage crisis?

BendDAO’s mortgage lending business

BendDAO is the first NFT liquidity protocol based on a decentralized peer-to-peer pool, and mortgage lending is the core business of BendDAO.

Through BendDAO, lenders can provide ETH liquidity to the lending pool to earn interest, and borrowers can use NFT as collateral to instantly borrow ETH from the lending pool.

How does BendDAO’s liquidation auction mechanism work?

Will BendDAO's insolvent NFT finally usher in the subprime mortgage crisis?

Liquidation, redemption, auction process of BendDAO

The Bend protocol uses the “Health Factor” to evaluate the current lending situation. The “Health Factor” is a numerical representation of the security of the mortgaged NFT relative to the lent ETH and its underlying value. The safer the state of funds, the more resistant to liquidation risks. Its calculation formula is:

Health factor = (floor price * liquidation threshold) / debt with interest

When the floor price of the mortgaged NFT assets falls, causing the “health factor” of the corresponding loan to be lower than 1, anyone can trigger the liquidation of the NFT auction, and the 48-hour liquidation protection and the auction of the NFT collateral will be launched at the same time (Note: Currently The liquidation threshold for each NFT project in the above calculation formula is 90%).

At the same time, the Bend protocol uses the NFT floor price from OpenSea and LooksRare as the price feed data of the NFT collateral, and at the same time calculates the Time Weighted Average Price (TWAP) of the floor price to avoid the NFT price in the NFT market from sharply rising in the short term. The impact of fluctuations in order to ensure the accuracy of the floor price.

How BAYC Triggered BendDAO’s Liquidation Auction?

Will BendDAO's insolvent NFT finally usher in the subprime mortgage crisis?

BAYC’s floor price falls, causing BAYC#533 to become the first BAYC to be liquidated for auction on BendDAO

On August 18th, the floor price of BAYC fell to around 72 ETH, while the interest-bearing debt of BAYC#533, which had previously mortgaged and borrowed on BendDAO, was 66.97 ETH.

At this time, the “health factor” of this loan is calculated as (72*90%)/66.97 = 0.97, which is less than 1, which triggers the liquidation auction mechanism of BendDAO, and BAYC#533 becomes the first BAYC to be liquidated and auctioned on BendDAO.

According to reports, at that time, the BendDAO platform still had 20 BAYC health factors less than 1.1, and the cumulative 40 BAYC health factors were less than or equal to 1.1. According to the liquidation auction mechanism of the BendDAO platform, when the health factor is less than 1, the NFT liquidation auction will be initiated, which means that these BAYCs are on the verge of being liquidated auctions.

How is BendDAO’s lending pool emptied?

Will BendDAO's insolvent NFT finally usher in the subprime mortgage crisis?

The process of BendDAO forming a large number of bad debts

Under normal circumstances as envisaged by the Bend protocol, there are only two “optimistic” processes after triggering the liquidation auction:

1. Ideal process: The borrower repays the loan, interest, and fines within 48 hours, and then redeems its NFT; the borrower does not repay the redemption, and the highest bidder in the auction finally pays the debt and get this NFT.

2. Process in an unsatisfactory situation: Due to the sharp fluctuations in short-term prices, the borrower has not repaid and redeemed in the short term and no one participates in the auction, so just wait, or wait for the future borrower to repay the redemption, or wait for the future market After the price rebounded, there were liquidators participating in the auction.

Will BendDAO's insolvent NFT finally usher in the subprime mortgage crisis?

BendDAO’s loan pool balance (Source: Dune)

And the current situation is:

Due to the cold NFT market, the floor price of NFTs continued to fall, which caused more NFTs to start liquidation auction processes in the future. Lenders who lacked confidence or panic in the market chose to withdraw a large amount of ETH liquidity from BendDAO’s lending pool. , according to Dune data, in just four days, more than 160 million ETHs in the ETH lending pool were almost withdrawn. When the run was the worst, there were only 0.58 ETHs in the pool.

Will BendDAO's insolvent NFT finally usher in the subprime mortgage crisis?

BAYC#533’s debt is more than its floor price, and its liquidation auction has so far gone unbid

At the same time, the floor price of many NFTs has quickly fallen below its debt price, which is limited by auction rules (required bids must be 95% higher than the floor price and must be higher than the debt price), and most NFTs in liquidation auctions are either unable to bid. Either it is unprofitable, and the liquidators who have lost the motivation for arbitrage choose to wait and see, which leads to a large number of NFTs without anyone participating in the auction, which further aggravates this liquidity run.

Analysis of the cause of the accident

To a certain extent, this liquidity crisis is a “natural and man-made disaster” jointly caused by the NFT market and BendDAO .

First of all, the bad environment of the entire NFT market is an important reason. The NFT market is cold, and the transaction volume and price continue to fall, which makes a large number of NFTs that achieved large loans at extremely high floor prices hit the liquidation price line almost at the same time. At the same time, NFT investors lack confidence in the market outlook, and lenders withdraw in large numbers. Pool liquidity causes a run.

Will BendDAO's insolvent NFT finally usher in the subprime mortgage crisis?

BendDAO’s liquidation mechanism shows optimism for blue-chip NFTs

Secondly, BendDAO is too optimistic about the market, many mechanisms do not consider extreme market conditions, and fail to prevent/reduce the accumulation of bad debts in time when the run is just beginning.

Problems with the liquidation auction mechanism

The problem of the entire liquidation auction mechanism is caused by many factors such as the bid limit not considering extreme conditions, insufficient health factor early warning, and the auction liquidation time being too long.

Auction’s bid limits do not account for extreme cases

According to the liquidation FAQ in the official BendDAO documentation, there are three conditions for bidding on NFTs in liquidation auctions:

1. Must be higher than 95% of the floor price

2. Must be higher than the total accumulated debt

3. Must be more than 1% higher than the previous auction bid

And this auction mechanism has a big problem in the current extreme situation. The floor price quickly falls below the debt amount. As mentioned above, the inability to bid or unprofitable results in a large number of NFTs not participating in the auction.

Insufficient early warning of health factors and long auction settlement time

In the previous article, using the original liquidation threshold of 90% to calculate the BAYC loan with a floor price of 100E, there is only a difference of 4E from the floor price of 44E that triggers liquidation to the amount of debt that falls below 40E.

During the 48-hour liquidation auction, if there is a situation where the  floor price < debt amount + fine  , the borrower is very likely to lose the incentive to repay.

Will this lead to a death spiral/cascading liquidation across the NFT market?

In the short term, there will be no death spiral

In DeFi, bad news often causes the price of mainstream digital assets such as Bitcoin and Ethereum to drop, resulting in the liquidation of insolvent mortgage assets in some DeFi ecosystems. The liquidation and sell-off process triggered further declines in mainstream digital assets, which also resulted in more assets being liquidated due to insolvency, and this reciprocation led to a “death spiral” for digital asset prices.

The NFT market is quite different from the DeFi market.

Will BendDAO's insolvent NFT finally usher in the subprime mortgage crisis?

NFTs participating in BendDAO lending account for a very small proportion of their corresponding NFT series

First of all, the loss of BendDAO’s bad debts in this incident is currently borne by those lenders who cannot withdraw the ETH liquidity in the lending pool, and the volume of this part of the lending pool is relatively large compared to the NFT set involved and the entire NFT market. small.

Secondly, the NFT that is currently being auctioned and cleared is not a pending order to be sold on NFT trading platforms such as OpenSea, that is to say, it will not lower the floor price of the secondary market, and then re-feed the price to BendDAO’s oracle, resulting in a mortgage within the platform of NFTs are further liquidated.

In the long run, it may have an impact on the market outlook

Since a large number of blue-chip NFTs are currently in the state of liquidation auctions on BendDAO, and the NFT market is in a cold winter, there is not enough liquidity in the market to absorb all liquidations. If there is no redemption or auction, in the long run, a pending order wall similar to NFT trading platforms such as OpenSea will be formed, which will reduce the liquidity of other NFT trading platforms and may cause further declines in floor prices.

Epilogue

BendDAO was officially launched in April this year, at the time of the NFT bull market, and later took the top spot in the NFT lending market. Born in the bull market, it is too optimistic about the NFT market, fails to prepare for danger in times of peace, and does not consider extreme market conditions, which is an important reason for this liquidity crisis.

Will BendDAO's insolvent NFT finally usher in the subprime mortgage crisis?

The founder of BendDAO said that there was only a bad debt of 278ETH at the beginning, but this caused a follow-up run

“Confidence is more important than gold.” The poor performance of the NFT market caused the floor price to fall, resulting in a lack of confidence among NFT traders; at the beginning, the small bad debt problem was not resolved in time, causing panic among the liquidity providers of the lending pool. This is the objective reason for this incident.

Fortunately, after the accident, BendDAO’s official response was relatively timely, and quickly launched the BIP#9 proposal, which will adjust the liquidation threshold, auction cycle, bidding limit, basic interest rate, etc., and may cause misunderstandings in the UI interface. and panic display page improvements were made.

If this crisis is handled properly, it could be a “positive black swan” event for BendDAO. “NFT liquidation crisis” is something we have never encountered before. This is not only a test of BendDAO, but also a test of the consensus of blue chips such as BAYC, and a test of the entire NFT market.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/will-benddaos-insolvent-nft-finally-usher-in-the-subprime-mortgage-crisis/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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