PSE Trading: Is a No Clearing Protocol a Ponzi Scheme?

Author: PSE Trading Analyst @Daniel Flower

! [PSE Trading: Is No Clearing Protocol a Ponzi Scheme?] (https://img-cdn.gateio.im/webp-social/moments-7f230462a9-8f72f82ed1-dd1a6f-cd5cc0.webp)

Introduction

Since the development of blockchain, the DeFi sector has developed the most maturely, and lending is one of its cores. In a bull market, borrowing is often the engine that starts the market, and investors tend to pledge BTC, lend USDT, and buy BTC to push the market up while getting more excess returns, but as the cryptocurrency market boom fades, the decline in BTC prices often leads to serial liquidations, and the BTC price falls to the freezing point. In order to achieve the goal of "eternal bull market", the market has launched many "no liquidation" protocols, so that investors can enjoy excess returns at the same time, will not face the risk of "liquidation", this article will sort out several common "no liquidation" protocols in the market, first of all, the conclusion is that the so-called no liquidation is essentially the risk transfer, but the wool is out of the sheep at the same time that investors make profits, someone has to bear the risk.

1. There is no difference in the settlement agreement

1.1 Early "liquidation" with other collateral assets

Thorchain is a cross-chain protocol that will establish various asset pools such as BTC/RUNE (Rune is the platform currency) on each chain, and when users need to cross assets, they need to exchange the BTC of the Arb chain for Rune, and then the Rune for the ETH of the OP chain. During the borrowing and lending process, you need to exchange BTC for Rune > Rune burns to generate Thor BTC (synthetic asset) > Thor BTC to Thor TOR (official stablecoin) in Burn Mint to Rune > Rune and finally exchange for USDT. In this process, Rune will eventually deflation, because the burning generates USDT, and users need to pay each swap fee to LP, so there is no interest charged for lending, and unlike traditional lending protocols, the end user is "collateralized" USDT to lend USDT, so there is no need to care about the rise of BTC, and it will never be "liquidated", or it has been "liquidated" in advance.

! [Figure 1 Thorchain Lending Methods] (https://img-cdn.gateio.im/webp-social/moments-7f230462a9-260adda8a4-dd1a6f-cd5cc0.webp)

Figure 1 Thorchain borrowing methods

If the agreement has no "liquidation" and no interest, the lender can never pay back, but there is also an extreme situation where when the bull market comes, the lender will want to repay the money and get back more BTC because of the increase in the price of BTC. The process is as follows: USDT is exchanged for Rune> Rune burns Mint for Thor TOR, Thor TOR is exchanged for Thor BTC and then burns to generate Rune, and finally the Rune swap into BTC is returned to the customer. In this process, it will be found that Rune becomes the biggest variable, Mint Rune goes to get back the pledged BTC, and if the number of repayments is too large, an "unlimited" amount of Rune will be minted, which will eventually lead to a crash.

! [Figure 2 Thorchain Repayment Methods] (https://img-cdn.gateio.im/webp-social/moments-7f230462a9-82e9aeaef3-dd1a6f-cd5cc0.webp)

Figure 2 Thorchain repayment methods

Therefore, Thorchain has set the maximum number of mint, that is, the debt ceiling, which is currently capped at 500 M, and the native rune is 485 M, which is the number of rune with 15 M of long mint. Thorchain will set the value of the Lending Level to be multiplied by the amount of Rune that can be burned, and the value of USDT that can be loaned can be calculated based on the current price of Rune.

! [Fig. 3 Rune Total] (https://img-cdn.gateio.im/webp-social/moments-7f230462a9-7a5c778c06-dd1a6f-cd5cc0.webp)

Figure 3 Rune total

In addition, the price of Rune is also the key to the success of the protocol compared to the price of BTC, as can be seen in the following two figures, when the price of BTC and Rune rises by 20% at the same time, the user will repay 301 Rune more, compared to the Rune burned when the loan is burned, but when the price of Rune rises by 30%, the repayment will not be Mint out of Rune, the protocol is still in a state of deflation, on the contrary, if the price of BTC rises much more than Rune Once the number of Mint is about to reach the upper line, the protocol will increase the Collateral ratio to a maximum of 500%, forcing users not to lend more USDT, assuming that the upper line of 500 M Rune is reached, the protocol will also terminate all loan repayment behaviors until the BTC price falls back and no more Rune needs to be minted.

! [Figure 4 The impact of Rune price changes on the protocol] (https://img-cdn.gateio.im/webp-social/moments-7f230462a9-45feaba585-dd1a6f-cd5cc0.webp)

Figure 4 The impact of Rune price changes on the protocol

! [Figure 5 The impact of Rune price changes on the protocol] (https://img-cdn.gateio.im/webp-social/moments-7f230462a9-07041414f5-dd1a6f-cd5cc0.webp)

Figure 5 The impact of Rune price changes on the protocol

It is not difficult to see that only when the protocol has been borrowing, it is good for the protocol itself (Rune's deflation), but it can't withstand large-scale repayment (Rune's inflation), so Thorchain's model is destined to be small, and if it is to scale, it is the tragedy of Luna 2.0. Secondly, because the number of loans is also controlled through the collateral ratio, the CR of the platform is 200%-500%, which is much higher than the 120-150% of traditional lending platforms such as AAVE, and the utilization rate of funds is too low, which is not conducive to the borrowing demand of mature markets.

1.2 Transferring liquidation risk to Lender

Cruise.Fi is a mortgage lending platform, its collateral is stETH, by outsourcing the liquidation line to other Lenders to bear, as long as there are users "taking orders", theoretically there will be no liquidation, for loan users: the risk of liquidation is reduced, there is more space to carry orders, and for "taker" users can get more income (basic lending income + ETH additional rewards).

Borrowing process: When a user stakes stETH, USDx will be generated, and the user can take USDx to the Curve pool and eventually exchange it for USDC, and the interest generated by stETH will eventually be given to Lender. There are two ways to maintain the price of USDx

1: When the price of USDx is too high, a part of the income of stETH will be given to the Borrower to subsidize their high borrowing costs 2: When the price of USDx is too low, a part of the stETH will be converted into borrowing costs and subsidized to Lender.

! [PSE Trading: Is No Clearing Protocol a Ponzi Scheme?] (https://img-cdn.gateio.im/webp-social/moments-7f230462a9-2b403097c5-dd1a6f-cd5cc0.webp)

Figure 6 USDx price curve

So how does the project achieve non-liquidation? Let's assume that the staked ETH is $1,500 and the liquidation price is $1,000. When liquidation occurs, the platform will first lock the collateral (stETH), and then give the staking income of stETH to the Borrower, and reserve a part of the original position through the staking income of stETH, and the position that exceeds the income of stETH will be suspended, but the disadvantage of this is that after the ETH pledge rate goes up, it will affect the income of stETH, resulting in a smaller position that can be reserved.

For the positions that were originally to be liquidated, the platform will generate a Price Recovery Token, and when the ETH returns to above the liquidation line, Lender can exchange this part of the PRT 1:1 for ETH, which is an extra layer of excess return for ETH compared to traditional lending platforms, not just lending interest. Of course, if Lender does not think that ETH will rise above $1000, Lender can also sell PRT in the secondary market, the project is still in its early stages, a lot of data and the secondary market is not perfect, the author also makes a bold prediction, if Lender puts PRT on the secondary market for sale, then Borrower can also have a lower price to "take back" their positions at the same time (compared to margin call), but also get ETH future excess returns.

! [Figure 7 ETH redemption process] (https://img-cdn.gateio.im/webp-social/moments-7f230462a9-5cb69932a2-dd1a6f-cd5cc0.webp)

Figure 7 The process of redeeming ETH

But the project also has a drawback, the project can only develop in a bull market (even if a big pullback occurs, there will be a "faith" ETH holder to provide liquidity), if the bear market comes, the market sentiment will drop to the freezing point, liquidity will dry up, and it will pose a lot of threats to the platform, and there may not be many users who are willing to come to the platform as Lender, because the protocol itself is to transfer all the risks to Lender.

1.3 Interest covers the borrowing rate

The Federal Reserve's wave of interest rate hikes has also led to a number of RWA "no liquidation" protocols, the most noteworthy and largest is T Protocol, STBT is a U.S. bond wrapped token issued by MatrixDock U.S. institutions, and a U.S. Treasury yield 1:1 rivet, TBT is a STBT encapsulated version issued by T Protocol, which uses the rebase method to distribute U.S. bond income to platform users, and users only need to deposit USDC to mint TBT to enjoy U.S. bond income.

! [Figure 8 T Protocol's internal process] (https://img-cdn.gateio.im/webp-social/moments-7f230462a9-bcfbadef73-dd1a6f-cd5cc0.webp)

Figure 8 T Protocol's internal process

The biggest highlight is that the interest charged by the platform is always less than the yield of U.S. bonds, assuming that the yield of U.S. bonds is 5%, then the platform charges about 4.5% of the interest and distributes it to Lender, of which 0.5% is used as a handling fee, so that MatrixDock can mortgage U.S. bonds to encapsulate tokens for interest-free borrowing, but how to solve the problem of non-liquidation? At present, the LTV is 100%, when MatrixDock mortgages one million US dollars, it can lend one million US dollars of stablecoins, and when users want to get their stablecoins back, MatrixDock will liquidate their own US bonds and pay them in equal amounts, and large users need to wait for three working days to complete the payment.

However, there are also dangerous points, when MatrixDock gets the loan, if the user makes high-risk investments and other behaviors, there is a risk that the user will not be able to just redeem the U.S. bonds, and all the trust depends on the platform and the U.S. bond institutions, there are regulatory blind spots and opacity, so the process of T Protocol seeking cooperation with other U.S. bond institutions has become extremely slow, and the ceiling is limited. Second, with the easing of macro monetary policy in the future, the yield of U.S. bonds will begin to fall, and when the interest rate decreases, there is no need for users to deposit on the platform and turn to other lending platforms.

2.Summarize and think

The author argues that so far, most no-liquidation protocols are "pseudo-no-liquidation", which is actually to transfer the risk from the Borrower to other places, such as Thorchain to transfer the risk to the protocol itself and the person who holds the Rune token, Cruise.Fi to transfer the risk to Lender, and T Protocol to transfer the risk to opaque regulation. It is not difficult to see that there is a pain point in these types of agreements: it is difficult to achieve scale effect, because the borrowing itself is unfair to a certain party, and the short-term "high" returns brought by this unfairness are difficult to sustain and unstable for users. Eventually, users will use traditional lending platforms like AAVE, accepting liquidations while embracing fairness. The essence of liquidation is insolvency, any asset will fluctuate, there is no risk-free investment in the world, as long as there is volatility, there is a moment of insolvency, traditional finance has not been "designed" from the birth to the perfect risk-free investment, and the high volatility attribute of the cryptocurrency world will not have. The "no-liquidation" agreement may reappear in the public eye in a relatively "stable" way, but the wool is out of the sheep, and one of the parties will eventually accept the painful price.