Taihe Observation|Analysis of the Dilemma and Prospect of Liquid Pledge

Original title: "Analysis of the Liquidity Release of Pledged Assets"

Original source: Ti Capital 

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Preface

Nowadays, whether it is a lending platform, asset issuance or derivatives Platforms all need a cold start, and a cold start means that it needs to attract users, introduce investment and obtain liquidity just like banks absorb deposits. The current common cold start methods such as liquidity mining are the process of attracting users who hold coins to help enter the market to pledge and mine to obtain tokens. From Proof of Work (PoW) to the current Proof of Stake (PoS) consensus agreement, from participants requiring expensive mining machines and a large amount of electricity to the current low-threshold pledge that is mining, all of them are attractive to investors. As shown in the figure below, the total locked-up volume (TVL) of DeFi has grown from one billion US dollars in the first half of 2020 to the current tens of billions of dollars, which perfectly demonstrates the explosive growth of pledged assets and is expected to continue.

Data source: DeFi Pulse

This article explains the following key points:

·What is liquidity

·The problem of PoS is the opportunity of liquidity staking

·Liquidity Solutions

·Mainstream release of liquidity products

·Necessary factors for the success of liquidity staking projects

·Prospects and challenges of liquidity staking

1. What is liquidity

Liquidity refers to the ability of assets to be quickly realized at a fair price. It is the cornerstone of any financial field. Liquidity allows investors to have sufficient counterparties and The potential loss caused by the completion of the transaction and the loss of liquidity, such as the difficulty of realizing real estate at a fair price in the short term, or the difficulty of investors matching the counterparty to clear their positions in a timely manner, are all caused by lack of liquidity. The problem of asset liquidity is a common problem faced by the global capital market from ancient times to the present. In history, many large financial institutions such as Long-Term Capital Corporation have a large number of bonds with low liquidity and poor credit ratings in their assets. Chain panic selling in China is more inclined to hold assets with high liquidity and strong short-term liquidity, which means that investment portfolios held by long-term capital have potentially huge room for depreciation and liquidity problems. The ensuing default of the Russian government bonds led to the loss of long-term capital’s credit spread strategy, and the rapid depreciation of the Brazilian real caused the loss of long-term capital’s hedging volatility strategy. In addition, it was difficult to realize the fair value of its assets quickly, so that the cash flow was not enough to call for margin. In the end, it was rescued by the Federal Reserve Bank of New York at the cost of 90% of the shares. The case of long-term capital also confirmed the consequences of insufficient liquidity.

In the cryptocurrency market, tens of thousands of exchanges from large to small provide unsatisfactory liquidity. However, in 2017, there was a price difference of up to 3,500 US dollars in bitcoins on different exchanges. The lack of market circulation efficiency created investment opportunities for experienced arbitrageurs. Buying low and selling high between different exchanges also gave some novice players cause unnecessary losses. Another example is that each loan of Compound will reduce the size of the fund pool. Once the cash withdrawal operation and loan operation exceed the liquidity limit, it will fail. There is enough funds in the pool to pay the withdrawal person. When depositors are anxious about market stability, they will try to quickly withdraw cash from the platform, but repeated withdrawal failures will cause serious market distrust of the protocol system, which will worsen and cause panic selling.

2. The problem of PoS is the opportunity of liquidity staking

As lock-up has become the most concerned indicator of many DeFi projects, a large part of it can be attributed to the pledge to obtain income, voting rights and become a liquidity provider or even a network maintenance participant. Why do you need voting rights? Because there is no institution like a bank in the decentralized world to make a final decision on your assets. And voting rights represent the consensus in the decentralized world. There are two ways to allocate bookkeeping rights, which are more laborious than the PoW mechanism. A lot, not only the computing power of the mining machine is required, but the workload of decoding calculations also increases exponentially, causing a lot of resources to be wasted. PoS determines the bookkeeping rights based on the amount of coins held and the time of holding coins, which solves the problem of wasting a lot of resources. , which means that PoS gives an opportunity for ordinary people to participate in community governance.

In the PoS consensus protocol, digital assets are mortgaged to determine the verifier, and the pledged assets will serve as an incentive mechanism to regulate the behavior of the verifier. If a validator verifies a valid transaction, they will be rewarded with transaction fees, so they can only get incentives if they act honestly in the system. After the verifier completes the actual verification work, they can get the native token reward in the network, but if they do some malicious behavior, the rights and interests will be cut. However, the current PoS seems to be contrary to his original intention. The original intention of PoS is for the common governance of the community. The more pledged tokens, the higher its security, and today’s token holders are more inclined to “exchange tickets for money” Coin speculation has become their primary goal, which has also created the pain point of PoS today-the pledge freezes the liquidity of currency holders. The PoS staking mechanism allows users to obtain a certain weight of voting rights for network upgrade governance based on their pledged cryptocurrencies. As shown in the figure below, the pledge rate in the current mainstream PoS public chains exceeds 50%. In the encrypted world with huge market fluctuations, the time cost of staking is too high. Before releasing the pledge, users will bear many risks such as: loss of liquidity, huge price fluctuations, and they cannot make corresponding actions in time; The projects have different requirements for the redemption period, and the tokens can only be received after waiting for the corresponding redemption period. Currently, the redemption period of TRX is 3 days, while that of ATOM and XTZ is 21 days. Among them, the potential risks for investors are actually caused by the insufficient liquidity of Staking pledge rights.

Data source: stakingrewards as of 2020.10.18

3. Liquidity Solutions< /h3>

In view of the prevalence of the pledge economy, pledge behavior makes investors lose asset liquidity and lose liquidity It means the loss of value, and the waiting period of the lock-up period makes investors lose control of assets in the short term, and liquidity staking emerges as the times require. Liquidity staking is also known as derivative staking, which allows users to retain their liquidity while obtaining staking income. The conversion of pledged assets into derivatives not only gives liquidity to pledged assets, but also allows investors to manage their risks Exposure and thus the possibility of hedging risk. Just imagine that pledged assets can be used for transactions, investment projects, or even pledged again. Tokens of different chains are constantly running between investors and even between chains, and economic activities occur. This will add to the DeFi industry and even the entire blockchain economy. more value.

 

3.1 Comparison of liquidity pledge and traditional financial market

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Some people think that liquid pledges are somewhat similar to ABS. ABS (Asset-Backed Security) asset-backed securities refer to asset-backed securities Assets with poor liquidity or non-performing assets are packaged in a standardized way, layered, and then sold to investors. Due to its absolute advantages in improving the quality of bank assets and controlling loan risks, ABS has become a good financial tool for my country's supply-side reform and deleveraging of the real economy. As shown in the figure below, the scale of my country's ABS business has exceeded the 3 trillion mark.

Data source: Asset Management Association of China

 

It is also releasing liquidity, and it is also converting illiquid assets into tradable and convertible assets, but the two are fundamentally different. First, a major feature of the entire blockchain industry is that the code is open source and sufficiently transparent. Compared with the opacity of the traditional financial market, the code open source of the block chain, the complete disclosure of information is more symmetrical, so that the systemic risk can be avoided to a certain extent. In contrast, ABS investors have no way to obtain the information of the purchased ABS ingredients, only the packaging An overrated rating is not enough for ABS investors to know the creditworthiness of the lender behind it. Second, the blockchain world does not have a government agency like a central bank to assist when the entire economy is in distress. Therefore, security has become a major consideration for liquidity pledges. In contrast, ABS investors can hedge risks through derivatives such as credit spread swaps (CDS), thereby giving market confidence. Third, common DeFi lending platforms usually require an overcollateralization of 150% of the collateral. Overcollateralization means that low leverage means that systemic risks are avoided to a certain extent. In contrast to traditional financial markets, leveraged loans and leveraged investors may face a death spiral of accelerated asset decline. After horizontal comparison, we can tentatively conclude that one of the major risks faced by liquidity staking is security risk.

 

 

4. Mainstream release liquid products

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As more and more projects based on the PoS consensus are launched, it has become normal to generate income from staking. A higher staking rate also means higher network security. However, the trade-off between greater security and greater liquidity becomes a headache.

There are currently many projects dedicated to providing liquidity for pledged assets. The following paragraphs will explain the characteristics and comparisons of these projects.

4.1 Bifrost

Based on the fact that single-chain smart contracts are difficult to copy to multiple chains, the Bifrost team found that the combination of Polkadot relay chain and Substrate development framework can be very good after technical research. To solve this flawed problem, the Bifrost project was born. Bifrost is a cross-chain network that provides liquidity for pledged tokens. It is developed based on Substrate and built on the Polkadot network. As a DeFi project in the Polkadot ecosystem, through Bifrost users can exchange PoS currency into vToken through the Bifrost protocol at any time Get Staking income and liquidity. Compared with Stafi, Bifrost focuses more on lowering the user threshold and increasing staking income while providing staking liquidity.

This project has designed a mechanism that allows users to exchange PoS currency into Bifrost vToken through the Bifrost protocol at any time. vToken is a cross-chain asset issued by users based on Bifrost exchange. Hold vToken to obtain pledge income. vToken can be freely traded in different chains, mortgaged and borrowed, paid for Dapp, and can be sold at any time to redeem the assets of the original chain without waiting for the release time. Holding vToken can obtain pledge income, and based on the characteristics of vToken built on the parallel chain, it can also enjoy the income of cross-chain pledge. Users can obtain vToken through various channels such as exchange, DEX, wallet, Dapp, airdrop, etc. Holding vToken means participating in the staking of the original chain, obtaining income while retaining governance rights. The original chain assets converted into vTokens are locked in the transfer bridge of Bifrost, and the weight of the votes obtained by the Stake proxy node is used for staking of the original chain nodes. Users can participate in the governance of the original chain through BNC voting.

4.2 Stafi

Stafi is based on Substrate's NPoS consensus, and NPoS can ensure that the pledge amount is evenly distributed among validators. The solution given by the Stafi protocol is that investors will get an equivalent bond rToken while pledging, and the bond rToken can be traded. Proceeds are passed along to the bond buyer. The bond being bought and sold does not have the action of releasing the pledge and re-pledging, so the security of the network is not affected. rToken will be protected by two types of nodes, one is Stafi Validator (SV), SV is used to provide protection for the entire agreement, and the other is Special Stafi Validator (SSV), SSV will provide protection for all pledge contracts. One problem with NPoS is that it cannot prevent sybil attacks, and unknown or stolen tokens can also become validator nodes or participate in governance.

Regarding the Stafi economic model, a commission is charged for staking to incentivize Stafi token holders. Stafi needs to operate a large number of nodes to minimize the risk of collusion, which also means that Stafi needs to extract a lot of value from liquidity staking to ensure its network security. Based on the assumption that PoS will never update the chain, the function of Stafi can be replaced by smart contracts to a certain extent. In short, the less PoS provides native pledge derivatives, the better the prospect of Stafi will be.

Data source: stafi

4.3   Kira

Kira is based on the framework of the Cosmos SDK. When users pledge assets, they will be generated 1:1 Derivative token sToken, this derivative token realizes the liquidity of pledged assets without trust and access permission. sToken can not only be transferred, traded, but also leveraged to pledge, and at the same time, it will also generate rewards brought by the pledge. MBPoS prevents Sybil attacks and security issues through governance-driven nodes and does not rely on cloud infrastructure. Kira will charge network fees, and its core logic is that the more PoS supports staking derivatives or the more competitors like Stafi enter the market, the better Kira will be.

As more staking derivatives enter the ecosystem, Kira will be able to provide liquidity to more networks and assets. Kira provides 100% liquidity for pledged assets, not only does not charge commissions, but also distributes additional income in the form of blocks and fees. One of the more prominent features of Kira is that it releases liquidity without sacrificing security, and provides a way for assets to be transferred across chains and cost-free transactions. Kira will experience a positive cycle as shown in the figure below. As more and more pledged assets are provided with liquidity, the income of network fees will be higher, and the income brought by network fees will further motivate more Assets are pledged. In general, the more PoS networks that offer native derivatives staking, the better Kira's potential and applicability will be.

Data source: Kira

5. Necessary factors for the success of liquidity staking projects

·A solid economic model

·Whether it supports smooth switching between chains

·Will cross-chains destroy the original Structure

·Governance level

With the gradual increase of liquidity staking projects, survival of the fittest will become obvious. From the perspective of the majority of currency holders, the release of frozen token liquidity will be supported, and the ensuing economic model setting has also become a top priority. A virtuous circle economic model will not only give the project reliable potential development space, but also attract users and strengthen the security of the network. Whether the switching between different public chains can be smooth and whether the cross-chain will destroy the original structure. At present, the locked amount of DeFi is mainly concentrated on Ethereum, so cross-chain becomes very important. In addition, regarding the issue of network governance voting rights, after the pledged assets release liquidity, if the corresponding token rights are owned by multiple people, voting network governance will become relatively difficult.

6. Prospects and challenges of liquidity staking

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Will the released liquidity accelerate the economic cycle

Is there a reasonable mechanism to balance the emergence of run tide

A complete economic cycle includes four stages: prosperity, recession, depression and recovery. Liquidity is a double-edged sword. Insufficient liquidity will lead to liquidity drying up. Similarly, even though the emergence of virtual currency solves the problem of inflation through technical means and decentralization, coupled with the fact that derivatives pledges naturally come with double leverage, will the liquidity released by derivatives pledges accelerate the formation of bubbles and accelerate the economy? The cycle repeats the mistakes of 312. Secondly, due to the convenience brought by the Internet information age to people's life, information is more symmetrical, and the speed of information transmission is accelerated, which makes the correlation of emergencies suddenly increase when the market goes down. A reasonable balance run mechanism can alleviate the chain reaction such as market panic to a certain extent.

Based on the limited overall market volume, the project needs users and sufficient liquidity to operate and form a network effect. For example, the circulation of derivative tokens exchanged for pledged assets is Liquidity staking is an important part. If there is enough demand, it will form a positive cycle. Otherwise, the derivative tokens will be worthless, which will make the liquidity staking lose its value. Therefore, liquid staking products are destined to continue in an oligopoly manner, and those projects that do not have an absolute competitive advantage are bound to be eliminated.

Summary

People often The "next-generation blockchain technology" and "the next DeFi boom" mentioned on the one hand reflect the expectations of investors for the current market changes, and on the other hand, they also confirm the rapid development of the industry. The iteration of the blockchain industry is bound to go through a baptism. Today's pledge economy may only last for a few years, but the liquidity problem will still be an eternal topic in the financial industry, so liquidity releasers will eventually occupy the capital market A place, PoS should also regard liquidity staking as a great boost to ecological development rather than a crisis.

References:

1.Andrea__Chang.(2020.9.19).  Comparing Staking Rewards - Is Liquid Staking Better Than Proof of Stake  (PoS)?URL: hackernoon:  https://hackernoon.com/comparing-staking-rewards-is-liquid-staking-better-than-proof-of- stake-pos-ua3h3wv5

2.ChitraTarun.(2020.6.16).arxiv.org.URL:  deepai.org: https://arxiv.org/pdf/2006.11156v1.pdf

3. DeFiPulse.(2020.10.18).URL: DeFi  Pulse: https://defipulse.com/

GRZELAKMATEUSZ.(2020.9).KiraCore.URL:  github :  https://github.com/KiraCore/docs/blob/master/KIRA-Network-Whitepaper.pdf

4.Liam, & Middle.(2020.8). stafi  protocol. URL: stafi.io: https://docs.stafi.io/stafi-whitepaper/stafi-whitepaper

5.StakingFinance.(2020.10.18).URL:  Staking Finance: https:/ /www.stafi.io/

6. stakingrewards.(2020.10.18).URL:  stakingrewards: https://www.stakingrewards.com/

7. China Securities Investment Fund Industry Association Asset Securitization Business.(May 7, 2020).UR;: Asset Management Association of China: https://www.amac.org.cn/

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