If you’ve been disappointed in DeFi lately, then you’re probably not alone. There are several problems with lending and savings in DeFi which have led to instability, liquidation, and losses. What if things could look different? Read on for a fresh, THORChain perspective.
The 2 main issues with lending
- Liquidation Risk — No one wants to be liquidated, plain and simple. Our friends over at Terra created the famous Anchor protocol which offered a money market with lending and savings services. On the lending side, you could take out a loan by deploying collateral, such as LUNA, with a loan to value (LTV) ratio of 60%. In an unbelievable series of events, the price of LUNA plummeted catastrophically, causing a vast number of Anchor borrowers to be liquidated. In other words, they lost all of their collateral.
- Variable Interest Rate (APY) — As a borrower, you can never step away and have peace of mind as the interest rate of your loan could skyrocket at any moment. As an example, the borrow APY on the BAT token crept up to 40%+. This led to some borrowers getting caught off guard as most of them weren’t monitoring the interest rates daily. Consequently, there were numerous liquidations due to the loans rapidly increasing in value relative to the collateral value.
The 2 main issues with savings
- Counterparty risk — Some individuals choose to save their bitcoin and other assets on centralized platforms, such as Celsius and BlockFi because they are convenient and have a user interface that is easy to navigate. However, this convenience comes at a cost, namely counterparty risk. For those unfamiliar with this terminology, counterparty risk is the risk that another party involved in a transaction may default on their contractual obligations. For example, if BlockFi were to become insolvent, as a user, you would be last in the line to receive your funds. As the wise saying goes — ‘not your keys, not your crypto.’
2. Low Yield — Once savers deposit sizable amounts of crypto, providers reduce the yield offering significantly. For example, BlockFi offers a trivial 0.1% yield on Bitcoin over 0.35 BTC.
The THORChain solution for lending and savings
Shortly, savers will be able to deposit bitcoin into non-custodial THORChain protocols, such as Lendscape, which will yield around 2%/3% on bitcoin balances of any size. For lenders, there will be no liquidation risk, and loans will incur a 0% interest rate.
Read that all again:
- Liquidation-free loans.
- Interest-free loans.
THORChain offers a promising value proposition that will shake up the DeFi space thanks to some pretty clever and sophisticated mechanics.
How do lending and savings work on THORChain?
- Introduction
The savings and lending platforms are two sides of the same coin. You can think of them as existing in a symbiotic relationship, where one helps the other achieve its respective goal—more on this below. - THORLending
Zooming out, it’s helpful to remember that THORChain is a protocol that enables the swapping of crypto-assets like BTC.BTC and ETH across different blockchains, i.e., it is a cross-chain DEX (decentralized exchange). A protocol of this nature requires deep liquidity to provide a reliable service. - Incentives
Due to the attractive characteristics of no liquidation risk and 0% interest, borrowers are incentivized to post collateral to take out loans.
Let’s run through an example:
Chad (“borrow user”) wants to borrow $1000. The current collateral ratio (CR) is 100%, which means he needs to post $1000 split evenly between BTC.BTC and RUNE (i.e., $500 of BTC.BTC and $500 of RUNE). He signals that he wishes to give up the yield he is entitled to as a Liquidity Provider (LP).
When the protocol (“lending module”) receives the LP collateral, it mints TOR, THORChain’s native “stablecoin,” which is then loaned out to the borrower (less a small fee to issue the loan). Note, when the protocol mints TOR, there is a small minting fee incurred by the borrower, which gets burned and sent to the treasury.
Now, the borrower can swap the TOR for another asset such as THOR.BTC. As part of the exchange process, the protocol must mint RUNE to complete the swap between TOR and the desired asset.
All loans must be open for 100 days to ensure the network produces yield on this LP collateral. For repaying early, a penalty is applied of 1% of the loan per day linearly across the 100 days.
- Collateralization Ratio (CR)
The CR depends on the ratio of non-loan collateral in the liquidity pool compared to the loan collateral, which is constantly calculated algorithmically on-chain. The first borrower of THORFi in any specific pool will get a CR of 100%. The CR will increase as more borrowers take out loans within each pool. The higher the CR, the less TOR you are loaned about the collateral you deposit. As loans are repaid, the CR will decrease. - Zero liquidations — are you sure?!
Since the collateral is independent of the loan, this is what enables there to be no liquidations. The protocol does not require liquidation of the collateral value that falls below the loan value. This is because the protocol is a DEX and can utilize the collateral to earn a yield that can be passed over to the savers. In other words, the protocol would prefer to keep the collateral than liquidate the position as the former enables it to utilize the collateral to produce a yield. Further, the loan is made whole (i.e., repaid) due to the RUNE burn pressure created on the savings side.
Key Takeaways
- The key incentives to borrow are no risk of liquidation and a 0% interest rate on loans.
- Lenders can deposit collateral, such as BTC.BTC/RUNE in an equal proportion to borrow TOR, a stable asset. Lenders are not entitled to the yield that their collateral generates; this goes to the savers.
- RUNE is minted by the protocol when loans are issued and swapped to TOR.
- The collateralization ratio of the pool determines how much a user can borrow. As the CR rises, the amount that can be borrowed concerning the collateral falls.
- The collateral is independent of the loan, and thus, there is no risk of liquidation. The protocol can cope with the collateral value being lower than the loan value because the protocol can leverage the collateral to drive yields in the liquidity pools distributed to savers.
THORSavings
THORFi is an ever-evolving piece of infrastructure.
At the time of writing, there was only one option for savings: utilizing the ‘Blue-Chip’ savings vault for assets such as BTC.BTC. Users can participate by locking an asset in the vault. To prevent capital from instantaneously moving to where the yield is highest, there is a 14-day adjustable lock-on deposit. The user can choose which asset they would like to lock up in a single-sided fashion to earn the respective yield in the denomination of the deposited asset. In other words, you can deposit BTC.BTC and earn yield in BTC.BTC.
Let’s go through it step by step.
Blue-Chip Savings Vault
The mechanism behind the Blue-Chip vault is critical to the health of the THORChain network. Let’s break it down together.
The “savings user” deposits an asset such as BTC.BTC, which is sent to the vault, is considered single-sided exposure as only BTC.BTC is deposited. The BTC.BTC is then swapped for RUNE. The RUNE is burned, and a derived asset is minted and sent to the vault; in this case, it would be THOR.BTC.
Akin to the process of minting TOR, there is a small swap fee (between RUNE and the derived asset) incurred by the saver and gets burned and sent to the treasury.
We covered the topic of derived assets in a previous article. The critical difference between derived assets and Synths (synthetic assets) comes down to the economic backing—of derived assets such as THOR.BTC and TOR are minted by burning RUNE only — no other native asset component is involved.
There is a direct relationship between the value of deposited savings capital and the amount of RUNE that is burned: the more capital deposited, the more RUNE that will be burned in the process of minting THOR.BTC.
Critically, this RUNE burning offsets the RUNE minting on the lending side — a symbiotic relationship.
The lending side needs the savings side to burn RUNE to offset the minted RUNE generated through loan issuance. At the same time, the savings side needs the lending side to attract loan collateral which can generate yield for the savers. To remain healthy, both sides need to perform their roles.
Yield
THORChain generates a variable yield driven by the loan collateral on the lending side. You’ll recall that the loan collateral in the liquidity pools generates protocol revenue through THORChain’s DEX model. This revenue will be distributed to the savers.
When the value of the savings deposits is more significant than the value of the loan collateral, the APY earned by the savers will be less than the APY in the liquidity pool. Naturally, some savers will withdraw their capital to chase the higher yield to become an LP. As the amount of savings deposits falls, the APY will rise, achieving an equilibrium.
THORChain developers forecast that users will be able to earn around 2–3% on their deposited bitcoin.
It’s important to understand that the Blue-Chip principle (e.g., bitcoin) does not earn yield ‘itself’. Instead, it is given fees and rewards generated from the LP collateral on the lending side.
Potential THORChain updates in light of the TerraUSD collapse
With all of the above in mind, a devastating series of events unfolded at the start of May, which saw TerraUSD (an algorithmic stable coin) and LUNA collapse in value. The story is complicated, and you can read a comprehensive summary here.
Since the catastrophe, THORChain developers have been discussing urgent actions that need to be taken to address any concerns.
Here are some key ones to be aware of:
- Derived assets (THOR.BTC & TOR) may not be exportable to other ecosystems for the first few years while THORFi becomes established.
Rationale: to tightly control the derived assets' supply and only let THORChain’s internal incentives influence them. Additionally, this will allow liquidity on THORChain to rise to a stable level. UST was aggressively exported to other ecosystems to the point of no control over its growth.
2. The Blue-Chip savings vault lock-in period may be extended.
Rationale: to prevent mercenary capital from corrupting the vault. Instead, a long lock-in duration will attract long-horizon capital and slow exits.
3. Burn the derived asset slippage fee (paid in RUNE).
Rationale: there are specific forces that produce inflationary pressure on the supply of RUNE, and the burning of the slippage fee will provide a counter-force to reduce this inflationary pressure.
Let’s look at a quick example to see this in action:
- User swaps 1 BTC.BTC to 1 THOR.BTC. Consequently, $40K of RUNE is burned, and the RUNE price stands at $5.00.
- Time passes, and the user decides to reverse the trade. He swaps 1 THOR.BTC back to 1 BTC.BTC. BTC’s price has increased to $45K while RUNE’s price has stayed at $5.00. This means $45K of RUNE will be minted.
- As you can see, the net effect of this trade is $5K of RUNE being minted. To enable an offsetting mechanism, the proposal to burn some of the slippage fee, which will burn RUNE, should provide an offsetting mechanism.
Be mindful that THORFi is a work in progress and subject to further changes. Not to worry, Lendscape will be keeping you up to date!
Conclusion
THORFi is a complicated system, but we are here to support our THORChads every step of the way. There is no shortcut to deep learning!
We at Lendscape are super excited to be launching our platform in the coming months. Stay tuned.
Other resources that you may find helpful:
- Chad Barraford, THORChain lead developer, on lending/savings — here
- GrassRoots Crypto, a THORChain educator on THORFi — here
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