Can Cover's CDS break the logjam in on-chain lending?

Before that, Rhythm introducedGoldfinch article"Discusses the drawbacks of" overcollateralization "mechanisms and details the negative effects that a low currency multiplier can have on crypto economies. Goldfinch arranges unsecured lending of on-chain assets through off-chain institutions and helps amplify the value of crypto assets. However, this mechanism excessively relies on the qualification audit of lending institutions and the improvement of credit investigation system. In essence, this system cannot completely avoid default risk, and the off-chain solvency will directly affect the safety of on-chain assets. Therefore, the rights and interests of on-chain creditors need another system as a guarantee.

CDS in the "big short.

Credit Default Swap (CDS), as the most effective financial derivative to hedge the risk of Default in the traditional financial market, is applicable to the debtor who holds the debt position and is exposed to the risk of Default in most cases.

The way a CDS works is that the buyer pays a premium to the provider, and the provider gives the buyer protection against default. When an event of default occurs, the purchaser is compensated for the total amount of the default coupon, while if no event of default occurs, the provider earns the full premium.

CDS workflow diagram

But CDS, like other derivatives, are not just a powerful hedge against risk. They also help financial gamblers compete with the market as a whole. In 2005, Michael Burry, a "big short" betting on the subprime bubble, took an early position and lobbied investment banks, including Goldman Sachs, to sell it "subprime CDS" that did not exist at the time. When the subprime bubble finally burst in 2008 and borrowers defaulted on their debts, Michael Burry effectively used CDS to win a near-perfect battle and make a 489% return for his hedge fund Scion Capital.

CDS in the DEFI world

As we all know, Alpha Homora, the leveraged liquidity mining protocol, was recently attacked and suffered huge losses. The attacker disguised the Alpha protocol (Cream whitelist address) to loan $37.5 million worth of assets from Cream's Iron Bank. If you want to grant credit from the Iron Bank of Cream, one of the following three conditions shall be met:

1. The assets in the Treasury of the loan agreement shall be higher than the total amount of the credit;

2. The loan agreement shall hold a Cover Protocol policy with the amount of insurance higher than the amount of credit granted;

3. The loan agreement shall hold a Nexus Mutual policy with the amount of insurance higher than the credit amount.

Fortunately, Alpha has $1.6 billion in assets in its coffers, and the losses have been handled well. However, not all contracts are backed by sufficient funds, and contract insurance is just a generic solution to hedge against the risk of a contract being attacked. The DEFI world needs an on-chain financial protocol to break the logjam of on-chain lending, and breaking the "over-collage" limit is the only way for the DEFI world to continue its rapid growth.

Cover Protocol will launch a CDS product to address on-chain credit issues. More lending agreements, backed by CDS, will either open up credit services or diversify lending patterns. In the future, mortgage rates will be gradually reduced, capital utilization will be higher and higher, and risky assets will be able to become collateral.

The probability of a CDS on the chain

Compared with traditional contract insurance, CDS will be more targeted at the default risk with stronger financial attributes rather than the contract risk with more technical attributes. In the future, when the user deposits the funds in the credit agreement, the user can buy the CDS of the agreement to guarantee the security of the funds. If the agreement has bad debts or the credit agreement has problems, the user can get full compensation when the loan can not be returned in time.

From the point of view of collateral assets, the agreement may support riskier (and more volatile) assets as collateral. Typically, when the price of the mortgage asset falls, the user has two choices: to cover the mortgage asset to maintain the mortgage rate, or to be liquidated at a discount. But when prices are volatile, the market does not leave users time to cover their positions. As in the recent pullback, Defi's lending platform liquidated assets worth more than $150 million. Users are forced to liquidate their mortgage assets at a discount, but if users buy CDS, they may be able to avoid the losses associated with the liquidation.

From the perspective of speculation, when it is found that the credit agreement or technical problems will lead to repayment, users can simultaneously purchase the contract insurance of the credit agreement CDS with the credit agreement. When the credit extension agreement is attacked or has problems, the user can pay the CDS of the credit extension agreement and the insurance of the credit extension agreement.

Cover Protocol's Ruler Protocol will be the first revenue Protocol for CDS. Users who have contributed funds to the Ruler protocol can now choose to buy CDS to hedge against default.

Welcome to join the official BlockBeats community:

Telegram Subscription Group: https://t.me/theblockbeats

Telegram Discussion Group: https://t.me/BlockBeats_App

Official Twitter Account: https://twitter.com/BlockBeatsAsia