Collateralized lending in DeFi has exploded over the years, with the use of LP tokens, as one of the most attractive services in the DeFi space. For example, Aave, the permissionless lending protocol, had over $3.8 billion locked in its smart contracts at the close of 2022.
Other platforms such as DeFi Swap, AQRU, Nexo, and Yearn Finance have also recorded some success in terms of the number of users and TVL. While this service presents an opportunity for the DeFi ecosystem, there are risks associated with DeFi lending.
Anthony Hayot, the co-founder of Secured, said at the concluded ETHCC Paris that Securd Labs is creating a protocol to solve the risks involved in LP (Liquidity Provider) token collateralized lending across the DeFi industry.
DeFi Lending involves users borrowing assets by providing collateral, typically cryptocurrency. Collateral ensures loan repayment; if terms aren’t met, collateral is sold to cover the debt.
This occurs through smart contracts, bypassing banks, and is a vital aspect of DeFi platforms, determining ratios, amounts, and interest rates.
These platforms operate in such a way that Liquidity Providers are needed to make available the funds that are lent out. In return, they earn interest for the liquidity they provide.
The downside of current Lending Protocols Using
He further explained that the current method, where borrowers deposit their digital assets into lending pools, and these assets become accessible for others to borrow, earning interest in return, is highly risky.
The disadvantages are these – firstly, borrowers face losses as their collateral is sold at a discount benefiting liquidators; secondly, lenders risk losses if sale proceeds can’t cover repayments, affecting depositors; and thirdly, ecosystem-wide losses occur if liquidators dump assets, causing price drops and cascading liquidations.
The Solution
To counteract this, Hayot proposed the principles that his team is using to build the Securd protocol. The two-fold strategy is: Minimizing the Probability of Liquidation and Minimizing Loss Upon Liquidation. The first strategy is focused on reducing the likelihood of liquidation.
He illustrated this by focusing on the correlation between the asset being borrowed and the collateral using Monte Carlo simulations. The result he showed the audience showed that the higher the correlation, the lower the probability of liquidation.
He argued that the optimal collateral choice would involve high correlation, reducing the chance of liquidations caused by market downturns.
On the second strategy, which is centered on minimizing losses in the event of liquidation, Anthony pointed out that the ease of converting collateral back into the asset being borrowed is crucial. He highlighted that LP tokens, which are easily convertible, should meet this criterion.
Applying Liquidity Backlending
Another concept he introduced during the presentation is “Liquidity Backlending,”. Here, the same asset is used for both borrowing and collateral. He noted that the critical distinction is that the collateral consists of LP tokens from decentralized exchanges, which offer higher stability and smoother conversion.
Similar to the previous explanation, he demonstrated how this works with a simulation and stated that this approach significantly decreases the probability of liquidation.
He summarized the entire process, saying that the Securd protocol, which will use these principles, aims to benefit both borrowers and lenders.
For lenders, the protocol promises enhanced capital protection due to the absence of liquidation events. For borrowers, LP token collateralization allows for capital efficiency, enabling them to leverage positions more effectively.
The audience was also told that the protocol would be launched as soon as possible.
