Building the Post-liquidation Era

Decentralized Finance just passed its second stress test with one of the wildest crash events in crypto-assets history.

The first stress test of DeFi was the year 2018 and a 94% decline in ETH valuation from all-time high to bottom.

This second one was even stronger, Crypto assets conceded 30 to 55% of their value in a single day.

March 12th is now officially the worst day for Ethereum as an asset, even beating the “DAO hack” event in 2016.

The day was full of liquidations and the DeFi giant MakerDAO went underwater 4.5M$ and is currently at a 5.6M$ negative balance.

For readers willing to catch up on the events now called “Black Thursday”, I made a simple thread on the situation and a more detailed forum post has been published by MakerDAO community.

During this Black Thursday, the failed process of liquidation ended up with all collateral of CDP owners being seized.

Even in the nominal market situation, the liquidation penalties across DeFi Dapps are pretty hefty. Ranging from 5 to 15%, getting liquidated adds salt to the wound of a market downturn.

In traditional finance and in some trading focused Dapps, traders employ “Stop-loss” orders to cut their positions at key levels and limit their risks.

In DeFi it’s pretty complicated to do so — for most users, it’s hard to find the necessary funds to pay back part of their debt and/or add collateral.

What’s more, if you’re already close to your liquidation price, manually taking some collateral from your deposit is a pretty risky endeavor!

To avoid forced liquidations, DeFi has some tools that leverage Ethereum’s capability to perform many actions in a single transaction.

Both DeFi Saver and InstaDapp have now long provided users with the features to leverage (by taking on more DAI debt to obtain more ETH) and deleverage (through CDP unwinding, paying back DAI debt with ETH within) in a single transaction. These have indeed quickly become highly popular tools for management of MakerDAO CDPs and Vaults.

However, DeFi Saver recently pushed the limits by introducing flash loans into the mix, allowing for these features to be much more effective, allowing users to leverage or deleverage much higher amounts than before. Where users were previously limited by the 150% ratio, flash loans allow an instant covering of the debt as the first step and much more wiggle room for any further adjustments.

Moreover, users can now also use DeFi Saver to utilize liquidity from Aave Protocol’s lending pools to instantly pay back their CDP debt and take out all collateral, using the required part to pay back flash loan and walking away with remaining ETH. Basically, you can now self-liquidated and avoid the 13%+ liquidation penalty, with a simple 1 transaction process described here

The choice is yours on whether you want to simply go down to a safer liquidation ratio or close your position completely, basically applying a stop-loss. Though the feature can also be used to collect profits, if you used the CDP for leverage in an upward moving market.

Either way, the outcome for the end-user is much more desirable. Yes, DeFi Saver is not free (0.25% fee) and nor are flash loans from Aave (0,09% fee), but replacing a 13%+ liquidation penalty with a 0.34% saving fee is a deal many would find attractive.

This is reinforced by the Black Thursday events, where many of the users liquidated by MakerDAO did not have a 13% liquidation fee but simply all of their collateral taken from them due to the auction failure.

Self-liquidations occur by definition before the need for a protocol level liquidation.

DeFi saver did more than 1180 repay actions to protect users from a liquidation that in many cases would have meant a complete loss of borrowers’ deposits.

We can safely say that DeFi Saver, greatly helped by Aave Flash Loans, helped avoid a great chunk of additional underwater debt for MakerDAO, potentially up to another $4m.

On Aave protocol side, all of this Flash Loans volume was more than noticed with nearly 16000 ETH of flashloans volume in 24h, the protocol was hard at work to save CDP owners.

Every Flash Loan has a flash fee of 0,09%. The ETH depositors collected 11,67 ETH of flash fees leading to more yield provided by the Flash Loans activity than borrowers’ interest paid.

The DAI depositors collected 2,19 ETH worth of DAI on top of their yield.

With the DeFiSaver app, Aave users were in the sweet position to make money by preventing others from losing their deposit.

While the ecosystem continues to lick its wounds from the “Black Thursday” event, we all learn from what happened. Every event makes our ecosystem stronger and every weakness is a bug bounty. New tools and actors emerge to prevent history from repeating itself.

New actors are also emerging and filling the void: already announced launching a stop-loss service. The Flash Boys from Stake Capital are hard at work to compete in the liquidation business and are seriously considering the release of Self-liquidations services.

The services will not be limited to MakerDAO CDPs, but will also cover most decentralized finance protocols in the next few weeks.

More competition will mean better services and fewer fees for the end-users.

If Stop-Loss services expand as they’re expected to after the events, MakerDAO might need to adapt their tokenomics as the liquidations were a stable source of income for burning MKR.

What is not so bright in the short-term is actually better in the long run. A part of the Black Thursday event has already been mitigated thanks to already available services, and we believe new tools and the users leveraging them will contribute to the resilience of Decentralized Finance.


What do you think?


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