The counter-balancing collateral mechanism: Impermanent Settlement
In a whopping $130b stablecoin market (DeFiLlama), you can name only few to be accountable for addressing as in a completly decentralized class. Decentralized finance ecosystem, with wide array of thousands of coded currencies, lacks the infrastructure to facilitate pegged yet non-consored crypto tokens to be used alternatively to fiat or other stable base-priced assets.
There are numerous dApps strugglingly experimenting to find market-place and looking for widespread adoption, whereas numerous have failed to achieve the by-product. Hence, the need for sufficient decentralized solutions in DeFi stablecoin sub-sector remain still.
Impermanent Settlement
What most of the lenders in DeFi prioritize while allowing financing with collateral deposits is overcollateralization. Essentially it means its traders’ duty to not let the collateral ratio hit indexed mark and avoid liquidation in order to secure the collateral for underlying borrowed asset. This puts trader’s collateral at severe risk in high-volatile market. Such in January, 2022 when nearly $300m worth of assets across 1,000 different positions were liquidated in a matter of days.
When the most common assets such as ETH is used to provide collateral against stablecoin or any value-assigned asset, a high-volatile market condition where the prices of assets face a brutal assault, liquidations are most likely to occur. This is very unfriendly for traders and overall health of the decentralized financing economy. Impermanent Settlement herein replaces the overcollateralization in issuing CDP (Collateralized Debt Positions) sanctioned assets.
Impermanent Settlement is first ever innovation in DeFi to introduce internal debt settling. As not requiring additional fund for issuance security, the CDP — as in whole — is managed by internal algorithmic methodology and dynamic variables in Impermanent Settlement.
In the consequence to utilizing non-liquidative collateral positions for issuing collateral-backed derivative, there needs a vehicle for debt recovery in order to reclaim and match collateral to its derivative market valuation. While in proposed design-engine, this is enabled by assigning the debt to primary asset market.
At the core of this mechanism, lays the counter-balancing algorithm (as the title suggest, of course). Impermanent Settlement idealizes self-sustaining decentralized framework for collateral management empowered by the heart of the mechanism — settlement contract.
The settlement contract, an immutable set of code deployed on blockchain network, functionalizes whole process to achieve counter-balance in a decentralized manner. The self-enforcing nature of settlement contract manages collateral efficiency ensuring the debt, arised by the price fluctuation in collateralized asset’s valuation, is resolved without needing adjunct fund from trader.
In simpler term, if the valuation of total asset-backing collateral falls below the issuance, settlement contract self-manages the additional collateral and secures trader’s CDP.
When the collateral valuation is short to its underlying issuance (c+n) it occurs the positive debt(n), which means there is insufficient collateral ratio. Debt is measured in either positive or negative variable. Negative debt does not affect the whole financial application in any circumstance, positive debt on the other hand needs to be resolved as its harmful for applicaton’s sustainability. The state of positive debt is stored as unrealized debt until the PDT is hit. Positive Debt Threshold (PDT) is off-setting variable that store positive debt until finalizing minting and deploying additional collateral.
The intent of the Impermanent Settlement is to remove burdened CDP-managing from trader’s overhead to self-managing smart contract. The purpose behind originating this mechanism is to bring sustainability and stability to DeFi collateral by absorbing debt internally.
Let’s understand the Impermanent Settlement through a simplified example. Suppose the total funds in collateral is in c amount and its derived issuance valuation is c+n (where n is debt). In this scenario, the settlement contract will markout additional collateral until it hits the debt threshold (PDT). In the subsequent, on triggering threshold, settlement contract opt to mint the additional collateral and sell-it-offs in primary liquidity pools on decentralized exchanges. The fund is transferred to collateral contract upon, thus the ratio is re-maintained by interchanging debt with primary asset’s market liquidity.
This mechanism’s ability depends on the market valuation and how liquid is primary asset market. In addition, it comes with the high risk of excessive fluctuations in primary asset’s rate.
This debt-settlement method open-ups an entire new market segment in DeFi for managing collateralized financing and debt settling. The impermanent settlement mechanism is potentialized to be the building block for, currently TwoX and its stablecoin infrasrtucture, late DeFi native applications and collateral-contracts.
Application
TwoX protocol is to issue the first crypto-collateralized stablecoin utilizing this method. By incorporating Impermanent Settlement and combining it with a high-degree of sustainable token economy and DeFi operative asset-collateral, TwoX is building a resilient stablecoin ecosystem. The protocol primarily allows to mint USD-pegged stablecoin TUD through burning native TWOX tokens.
