In order to keep decentralized finance (DeFi) borrow/lend protocols solvent, liquidations are executed on unhealthy accounts. Lending in DeFi is overcollateralized due to the volatility of assets in such a young market, and since the market is so young, DeFi hasn’t figured out the best strategy for ensuring debts can be paid if something goes wrong without the need for over-collateralization.
Traditional finance (TradFi) usually accepts collateral in the form of real estate or other valuables that can be used to cover a loan amount if the borrower is unable to pay back their loan. In TradFi, banks and other lenders get to keep the collateral for themselves after a loan goes unpaid, but Hubble’s take on DeFi is transforming the paradigm of collecting collateral into a liquidation process that benefits the many over the few.
How DeFi Lending Works on Overcollateralization
DeFi borrowers are usually asked to provide collateral at a ratio of 150%-200% of the amount they want to borrow. For example, if a user deposits $100 worth of a dynamic asset like SOL into a protocol with a 150% collateral ratio, they can borrow up to $50 worth of another asset, like a stablecoin, against this deposit.
This metric can also be described as loan-to-value (LTV). If a protocol allows users to borrow at an LTV of 70%, then a $100 deposit can be borrowed against for a maximum of $70 value.
Most of the time, users will deposit assets that they don’t want to sell or trade. If a DeFi user believes the token they possess will increase in value, then selling that token would count as a loss of unrealized gains once that token’s price begins to rise.
No one wants to see a token moon right after they’ve sold it, and at the same time, no one wants to see the untapped liquidity held in that token go unused. This is where DeFi lending supercharges the community’s ability to HODL tokens and seek further gains with the value that can be unlocked from those tokens.
Why Liquidations are an Important Part of DeFi Lending
DeFi is a financial sector that seeks to favor the community around it and make nearly every aspect of participating in this revolutionary financial system beneficial for all involved. Consequently, DeFi offers users several ways they can earn revenues from participating in the protocols that operate peer-to-peer financial services.
Liquidating overleveraged loans is one of the ways users can seek gains and keep the DeFi ecosystem healthy. When a loan becomes unhealthy, or when the value a user has deposited begins to dip closer to the value the user has borrowed, DeFi protocols allow other users to pay off the difference in the loan and liquidate the account, keeping a portion of the collateral assets deposited.
In theory, this should benefit anyone who wants to participate in keeping a DeFi lending/borrowing protocol financially solvent, but in fact, most of these liquidations are executed by bots that serve a small fraction of the DeFi community.
A protocol can initiate liquidations itself, as is the case with Hubble, but what happens to the liquidated collateral when this happens?
If the protocol keeps this collateral, then the idea of open participation in DeFi goes out the window. Some protocols’ developers sleep better at night by using this captured value to buy back tokens and lift their token price, benefitting speculators on the hunt for price action. This value created for the token price lasts only as long as token holders are not selling their tokens, and whenever a token rises in price, people will naturally sell it in order to capture that value, and the widespread deployment of trading bots makes this scenario a near certainty.
How Hubble Directs Liquidation Value Back Into the Community
Hubble takes a different direction that directly benefits those most involved with the success of the protocol, users who deploy liquidation bots and supply USDH to the stability pool that facilitates the repayment of bad loans.
Hubble allows users to close accounts when that account's collateral value falls below 110% of the value of the loan (or rises above 90.9% LTV), and closing these accounts can earn users 0.5% of the liquidated assets. The remaining value is directly spread between users who support the health of the Hubble community by deposing the USDH used to repay the remaining balance on over-collateralized loans.
Borrowing and lending have become essential services for the DeFi community. Users simply cannot keep flipping positions from one mooning token to the next without harming the entire ecosystem as a whole, and by depositing valuable dynamically priced tokens from worthwhile projects into borrowing contracts, the DeFi community can secure the value locked in these tokens while at the same time deriving liquidity from them in order to further push DeFi and the crypto space forward.
DeFi borrowing and lending cannot be conducted at a loss, which is why liquidations are necessary to keep the space healthy and thriving. However, not all liquidation mechanisms are created equal, and in the pursuit of capital efficiency and maximizing users’ gains, Hubble has chosen a path that best rewards those who are in DeFi and support Hubble’s mission for the long haul.
DeFi is a new frontier in the financial world that provides, for maybe the first time, a trustless system for wealth creation within an open community. The way Hubble approaches this landmark innovation in finance keeps this open community in mind.
Hubble has set up its liquidations distribution system to be one of the most equitable and fair methods available in the DeFi space. The pursuit of a democratic DeFi that benefits the all those that participate is a huge part of Hubble’s mission on Solana, and through these pursuits Hubble hopes to lay the foundations for the future of a robust DeFi ecosystem on one of the world’s fastest and most scalable blockchains
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