How Equilibrium Embeds Bailouts and Mitigates Risks to Stability in DeFi
The current downturned state of the cryptomarket has the entire industry on its toes. Some investors have pulled out after disappointing losses and critics seized the moment to highlight crypto’s flaws — especially after the dramatic collapse of Terra (LUNA).
However, crypto isn’t going anywhere and those with foresight doubled down on their support. Projects of a “pump and dump” nature or investors looking for a quick buck may have fled out of skepticism, though in doing so made way for projects seeking to build the future of the space .
Industry insiders and experienced financiers often point to bear markets and times of uncertainty as moments to educate on the market, assets, and utility thereof. In times of uncertainty, we at Equilibrium want to highlight the pillars of stability inherently available in our ecosystem and strategies to mitigate risks.
Bailsman: managing debt and risk
Equilibrium offers users a built-in bailout mechanism. This allows users to manage both debt and risk within the DeFi protocol more effectively. For this to work, we introduced the role of “bailsman”.
Who are bailsmen? Bailsmen are liquidity providers who pre-pledge liquidity in the dedicated bailout pool prior to a market decline or black swan event but with anticipation thereof. They are securing loans in case of borrowers defaults being critical to smooth operations in both the Equilibrium and Genshiro protocols.
Funds allocated by bailsmen within the system ensure a level of security within the protocol in case of an unfavorable market event. How does the bailout pool work exactly and how do bailsmen get compensated for taking risks of liquidations?
The functionality of bailouts
Foremost, bailsmen must deposit their funds into their liquidity portfolio which then makes the funds available in the bailout pool for borrowers. See the chart below:
As said, bailsmen commit to securing loans by joining the bailout pool. If a borrower gets a margin call here is what happens:
- Their collateral is transferred to the bailout pool
- Bailsmen take over their debt obligations
Bailsmen are free to repay this loan anytime, however, it must occur before they decide to withdraw their deposits from the bailout pool.
When users borrow funds from the system they start paying an interest rate to bailsmen. Interest fluctuates depending on two things:
- Risk profiles of their positions
- Leverage they take (collateralization of position)
- Conditions of the bailout pool
This means the more risk and leverage, the higher the interest and vice versa. As such, bailsmen help ensure a functioning debt and risk mitigation system in Equilibrium. This keeps the entire protocol function and full of utility for development.
In case of risk spikes, bailsmen earn up to 25% APR — a fair compensation for their efforts to maintain system stability.
Mitigating DeFi risks
In recent months, the DeFi space saw major upsets from some of its most trusted or well-known protocols. For example, the Terra protocol and stablecoin UST took a dramatic plummet and de-pegged from the dollar, which then caused the collapse of LUNA.
Following LUNA’s collapse, Celsius halting all transactions on the protocol and 3AC faced a $400 million dollar liquidation and then defaulted on a $670 million dollar loan. These incidents don’t paint a stable or welcoming picture towards the DeFi space.
However, what Equilibrium offers is different. Through our community powered bailout system, we are all in a symbiotic relationship together. Borrowers build out the ecosystem, while bailsmen help ensure stability of that ecosystem while getting interest from borrowers.
Therefore, the importance of the bailsman role in mitigating risk for the community with the goal of avoiding massive liquidations and other catastrophic events. Our liquidity providers bear the risk of liquidation.
Since this is the case, they need an effective liquidity management tool to get rid of their liabilities and liquidated assets.
Liquidation rules
In our protocols we go through a multistage liquidation process. These liquidation benchmarks help stagger any potential risks which could follow liquidation.
- = 105% LTV — minimum LTV possible on Equilibrium
- ≤ 102,5% LTV — 24 hours grace period and liquidation then. To avoid liquidation you need to increase the collateral value back to 105% or higher.
- < 100,5% LTV — absolute liquidation
*LTV = Loan-To-Value
As a borrower, the minimum LTV can be as low as 105%. However, if it drops in value, liquidation becomes a possibility.
This means: the user facing liquidation will lose collateral and has the ability to get it back by providing the loan in return. These parameters will most likely change to a more conservative setting to avoid unnecessary risks associated with low liquidity levels at this stage.
Liquidity pledges help mitigate risk
As liquidity providers, bailsmen are the gatekeepers to monetary fluidity within our ecosystem. Therefore, the available amount of a particular asset available for borrowers hinges on the availability of that asset in the basilman pool.
In the liquidity pool, the only available assets are those deposited by LPs and of those assets borrowers are limited to 40% of the supply of the given, non-synthetic asset.
Our system was designed so that these pledges by bailsmen give the ecosystem the security it needs to not overload itself. Bailsmen mitigate overall risk in advance, by taking it on themselves.
Additional strategies
We aggregate all bailsmen in the ecosystem into one liquidity, where they receive interest as a reward for leveraging risks for the community.
The interest received by the bailsmen come from that which borrowers pay based on a combination of their portfolio risk and margin level. Rates for interest adjust accordingly:
Interest rate ~ Leverage * (Portfolio volatility * scale factor)
Risk scaling: The more liquidations bailsmen absorb,the safer the system becomes. Additionally, it lowers the scale of the interest for the borrower. However, less liquidity results in the opposite.
Borrower interest can scale up to 4x.
Bailsmen rewards
We reward our liquidity providers for their service! LPs receive staking rewards which are withdrawalable so long as all liabilities are paid.
Bailsmen to the rescue
In these times of industry instability, Equilibrium offers solutions. We want our community to work in synastry. Security is one of our top priorities; both technically for a safe ecosystem to work on, and in the case of asset security.
With this in mind, it becomes clear that the unique function of Equilibrium bailsmen are key to the success of a stable and secure market. They take on the risks so borrowers don’t have to and reap rewards for their service to our community.
Through this system users can be assured of an ecosystem they can trust and will never be left hanging.
Stay up to date
Our community is at the heart of everything we do at Equilibrium. We are constantly improving our offering and products to give you an exceptional experience using our all-in-one DeFi platform. Ensure you subscribe to our newsletter and social media channels to be up to date with everything we are doing to serve you better.
About Equilibrium
Equilibrium is a one-stop DeFi platform on Polkadot that allows for high leverage in trading and borrowing digital assets. It combines a full-fledged money market with an orderbook-based DEX. EQ is the native utility token that is used for communal governance of Equilibrium. xDOT is a liquid and tradeable wrapped DOT that unlocks liquidity of DOT locked in parachain auctions and delivers multiple crowdloan bonuses on Polkadot.
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