Collateral damage: DeFi’s time bomb

As 2021 draws to a close, the first lineup in the DeFi landscape consists largely of Synthetic Asset Platforms (SAPs). An SAP is a platform that allows users to create synthetic products, which are derivatives whose values ​​are linked to existing assets in real time. As long as oracles can provide a reliable feed of price, synthetics can represent any asset in the world and take its price – be it a stock, commodity, or crypto asset. . .

As such, SAPs are finally bridging the gap between emerging DeFi platforms and traditional finance, allowing investors to place their bets on any asset anywhere, and all from within the comfortable bounds of their own limits. . preferred blockchain ecosystem. Decentralized and operating on the first layer of Ethereum, SAPs would be the next major catalyst for crypto growth. However, unlike solid money and verifiable works of art, in the world of secured loans, decentralization and secured ownership is only half the equation.

Secured debt

In traditional finance, secured debt securities are among the world’s largest financial assets, with a cumulative valuation of nearly $ 1,000 billion. Most people call them mortgages – a term that dates back to 13th-century France and literally translates to “pledge of death.” Perhaps morbid or melodramatic for the average individual, but for the millions of people who lost their retirement accounts, savings, homes, and livelihoods in the wake of the 2008 financial crisis, the words “put pledging “death” and “collateral damage” are not only appropriate but quite normal to convey the angst and agony that await those who participate in secured loans without first understanding the risks and ramifications who as a result.

Here’s the keystone: To secure a loan, a debtor offers collateral that becomes contractually blocked with a creditor, who can seize the collateral in the event the debtor becomes unable to service the debt. Unfortunately, servicing secured debt is not as simple as paying one-off interest, as the value of the underlying collateral can vary dramatically in response to broader market volatility, such as the sudden collapse of the market. Marlet. The American real estate sector in danger. If the value of a debtor’s collateral falls below a predefined threshold, the creditor – whether it is a large bank or a decentralized protocol – has the right to take possession and liquidate the collateral. at market value to recover the principal of the unpaid loan. . If the term promise of death is too hard to swallow, you might just call it the carpet of a lifetime.

Related: US Debt Ceiling Crisis: A Catalyst For The Ultimate Crypto Decoupling?

Whether issued on Wall Street or on the Ethereum blockchain, the risks associated with secure financial products cannot simply be decentralized. Liquidation triggers are fundamentally rooted in exposure to the volatility of a larger macroeconomic environment, which neither developers nor financiers can control.

MakerDAO’s lesson for the DeFi space

Take MakerDAO, for example, an exceptionally decentralized SAP whose guaranteed DAI stablecoin is meticulously pegged to the US dollar. On the surface, Maker presented an attractive opportunity for investors, who could stake their otherwise dormant crypto holdings to hit a synthetic dollar. As stable as the DAI is, the pool of distributed collateral that backs it is made up of some of the most volatile assets in the world, namely Ether (ETH) and Bitcoin (BTC).

To prevent the decline of the crypto market from triggering massive sales, the Maker Protocol requires 150% oversizing. In other words, users only get two-thirds of what they put into the protocol in dollars, a model that neither attracts traders nor supports adequate capital efficiency in the ecosystem. To add insult to injury, the ever-volatile crypto market proved that Maker’s high collateral requirements were insufficient in March 2020, when a 70% withdrawal liquidated Maker users at all. levels. for losses totaling over $ 6 million.

Learning from Maker’s struggles, major SAPs have taken additional steps to prevent catastrophic mass liquidations on their platforms. Or, more precisely, they’ve taken more of the same action: The mirror protocol demands warranty levels of up to 250%, and Synthetix demands a daring 500% from users. Of course, oversizing of this magnitude is barely enough to compete with traditional finance, where centralized brokers provide better workforce metrics. But there is also another problem.

For crypto traders for whom the exorbitant collateral requirements and liquidation risks are unpleasant, it makes more sense to ditch EWS altogether and buy stocks and synthetic commodities in secondary markets. Due to changing demand, significant price premiums now persist for many synthetics, eroding the real parity they were supposed to maintain and pushing users once again into mainstream finance where they need it. can. buy the assets they want minus the cheeky crypto markup.

The need for change

At this point, DeFi has plateaued and is stagnating. Significant advances require a radical symbolic model for collateral management that redefines the relationship between capital efficiency and risk exposure. As the eloquent Albert Einstein professed almost a century ago:

“No problem can be solved by thinking about the same level of consciousness that created it.”

On this deal, SAP currently remains focused on upgrading and improving warranty models, i.e. optimizing what already exists. No one dares to approach the field of radical transformation.

As 2022 dawns and crypto enters a new year, an innovative collateral model will take DeFi by storm. Rather than locking excess collateral into a contract, users will be able to burn collateral into TBEN synthetics at an equal ratio. This means that users dollar for dollar, sat-for-sat, one by one, withdraw what they put in – and they will never be liquidated or the margin called up.

The key element behind such a model is a native token with an elastic offering. When a user first etches a native SAP token on TBEN synthetics, there is little benefit to be seen. But when the same user burns synthetics to regenerate native tokens on exit, SAP’s Burn-and-TBEN protocol works its magic. Any discrepancy between the user’s original burnt warranty and knocked out synthetics will be taken care of by the protocol, which slightly extends or reduces the provision of the native token to cover the difference.

A radically new paradigm, the burn-and-TBEN collateral model removes the drawbacks of liquidations and margin calls without decimating the capital efficiency or price parity that gives synthetics their power in the first place. Over the coming year, as degens and number calculators of all faiths continue their quest for returns, mass market crypto capital will migrate to platforms that adopt various iterations of burning mechanisms. -and-TBEN.

As the DeFi landscape experiences its next major transition, all eyes will be on cash management. Deep liquidity is the essential element that will allow SAPs to facilitate massive outflows from their ecosystems without producing unacceptable volatility. On DeFi platforms where collateral management was a concern of the past, liquidity management will separate the next iteration of DeFi from top-notch SAP from those that don’t make the cut.

This article does not contain any investment advice or recommendation. Every investment and trade move involves risk, and readers should do their own research before making a decision.

The views, thoughts and opinions expressed herein are solely those of the author and do not necessarily reflect or represent the views and opinions of TBEN.

Alex ship is a professional digital asset writer and strategist with a background in traditional finance and economics as well as the emerging areas of decentralized system architecture, tokenomics, blockchain, and digital assets. Alex has been professionally involved in the digital asset space since 2017 and is currently a strategist at Offshift, writer, editor and strategist for the Elastos Foundation and ecosystem representative at DAO Cyber ​​Republic.


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