Revealing the true prospects of crypto-collateralized stable coin infrastructure.
What is Overcollateralization?
Overcollateralization refers to a risk management strategy used in decentralized finance (DeFi) and lending platforms. Very much adopted from Traditional Financing, where a customer takes a loan from a Lending Platform by providing some asset (collateral) as a security, where the later can seize the collateral to cover their losses if the borrower fails to repay the loan. The advanced version called Overcollateralization takes this to few steps ahead by demanding a higher value of collateral than the borrowed amount. In simple terms, Overcollateralization refers to a situation where more assets are required as collateral for a loan or financial transaction than the actual value of the loan itself.
In decentralized ecosystem, Overcollateralization helps to reduce the likelihood of default, as the borrower will lose more than the amount borrowed in case of non-repayment. Thus, primarily it acts as a risk mitigation measure to safeguard traders and platforms.
However, Overcollateralization in crypto lending raises some impactful risks to traders. Firstly, by Overcollateralization, the traders are forced to underutilize the complete potential of their Collaterals. Unlike Traditional Finance where the value of assets pledged are less volatile, in crypto lending, the collaterals are subjected to volatile market conditions. This means, even if borrower meets all the repayment conditions, a negative market crash can pull the value of pledged collaterals down, which on the other side can trigger the platform to liquidate the collaterals to recoup the loaned funds. Accepting this as the status quo, many blockchain players who want to imprint their footnotes in DeFi arena of crypto-backed assets and products, continue to build features which are more or less similar to the end users in its behaviors. Below is a representation of how frustrating the impacts of Overcollateralization can turn out to be!!
Overall, the dark sides of Overcollateralized assets are waving negative sentiments towards health of DeFi economy, leading to poor adoption of Crypto lending platforms. Only few innovations have tried to address the underlying issues of Overcollateralization, where the concept of Impermanent Settlement seems to be promising.
How Impermanent Settlement solves the dilemma?
The concept of Impermanent Settlement is pitching in as a key strategy to minimize the adverse impacts of Overcollateralization. Impermanent Settlement in it’s attempt in DeFi is a significant innovation which introduces the concept of internal debt settling which gets rid of the need to collect additional assets as issuance security while lending. It is a replacement to existing guard of Overcollateralization, as it issues CDP (Collateralized Debt Positions) sanctioned assets.
Removing the technical jargons, CDP can be called as a debt recovery strategy managed by internal counter-balancing algorithmic methodologies and dynamic variables. With the end state defined as utilizing non-liquidative collateral positions to issue derivates backed up by collaterals, still there exists the need to transmit debt recovery to a mechanism which can reclaim and match collateral to its derivative market value. Impermanent Settlement conceptualizes this transmission by assigning the debt to primary asset market through the core of this mechanism, called as Settlement Contract.
Above example illustrates a stage where the collateral valuation is short to its underlying issuance, where it is called as PD (Positive Debt). This means, there is insufficient collateral ratio, which in the traditional lending platforms would have triggered liquidation. Impermanent Settlement manages debts as positive or negative variable, where negative debts doesn’t pose any risk to trader’s financial position. As PD carries risk and could potentially disturb the harmony, the state of PD is stored as unrealized debt until Positive Debt Threshold (PDT) is hit.
As PD is transmitted to Settlement Contract, it counter balances the debt by minting and deploying additional collateral to balance the whole equation. What a perfect blend of Technology which caters the needs of today’s lending ecosystem!
The biggest advantage of Impermanent Settlement is that, it invokes a self-sustaining decentralized framework for collateral management which is more acceptable to borrowers, without compromising the security aspects demanded by lenders. As the Settlement Contract maintains a self-enforcing nature, it efficiently manages the Collaterals by assuring that risky debts coming out of market turbulence impacting Collateral valuations are automatically resolved without demanding the borrowers to inject additional funds or collaterals. By removing burdened CDP-managing from trader’s overhead to innovative self-managing smart contract, Impermanent Settlement promises a sustainable and stable DeFi ecosystem as the debts are absorbed internally.
To simplify the concept, let us look at a different example:
- Sean borrows 100 USDT from a lending platform.
- He deposits 0.5 ETH equaling to $1000 total value as collateral, with a required collateralization ratio of X%. The total collateral (0.5 ETH) now has derived issuance valuation of $1000 (current collateral value) + $100 (debt issued) = $1100. Also, the current collateralization ratio is 1000/100 =10x or 1000% (above required collateralization ratio of X%)
- In a volatile market, if the value of ETH drops, the collateralization ratio can potentially fall below X%. The more ETH falls, the borrower is in Positive Debt, which when hits the threshold can trigger Impermanent Settlement.
- Lets say, to restore the collateralization ratio of X%, an additional amount of 50 USDT worth of ETH is needed. Settlement Contracts will mint 50 USDT and sells it for ETH on a DeX.
- This ETH will be added back to Sean’s collateral to ensure that X% ratio is maintained always ($800 worth of ETH, $150 debt).
- This safeguards lenders from potential losses caused by volatile market conditions and borrowers from risk of liquidation of all Collateral.
How to access the benefits of Impermanent Settlement?
As discussed above, Impermanent Settlement opens up new market dimensions in DeFi for managing collateralized financing and debt settling in a trader friendly way. This is going to be the potential pillar behind the infrastructure which few DeFi players are trying to build, with TwoX being the key player who is building its stable coin architecture by adopting Impermanent Settlement.
TwoX protocol: A market changer?
TwoX is a decentralized finance protocol that functionalizes to mint crypto-backed stable coin TUD on Ethereum. TwoX Protocol, a block chain innovator in its zone, is aiming to issue the first crypto-collateralized stable coin backed up by Impermanent Settlement.
The upper edge of Impermanent Settlement along with high degree of sustainable token economy and DeFi operative asset-collaterals, are going to make the TwoX ecosystem stand unique and phenomenal.
Primarily, TWOX Protocol will allow minting of USD-pegged stable coin called TUD by burning native TWOX tokens.
Basically, the protocol will unwrap the utilities of unused non-functioning liquidity or assets by putting it to use. This will maximize liquidity credibility and usability and will also act as a permission-less hub for stable coin financing.
How TwoX Works?
TwoX protocol is expected to attract lenders who will supply assets in exchange of two counter assets — tTokens and $TWOX.
So, what are the basic functions a trader can execute in TwoX platform?
- Supply: The supply function is employed when lenders deposit cryptocurrency collateral assets. TwoX facilitates assets that exhibit high liquidity, proving advantageous for effectively managing finances within the DeFi ecosystem.
- Mint: To mint stable coins, traders must burn $TWOX tokens. For every $1 worth of $TWOX tokens burned, 1 TUD stable coin is minted and given to the deserving party. This ensures that each TUD in circulation is backed by supply deposits and collateral, achieved through the burning process.
- Redeem: TwoX employs a vault system that enables traders to redeem their TUD stablecoins. The RC-Vaults are formed by combining tTokens and TUD, with both assets needed in equal proportion to create the vault. To redeem the stablecoin, traders must burn the vault, effectively withdrawing the supply deposits from the protocol.
- Borrow: Borrowing will be enabled after Governance decision. It will be enabled by accessing protocol’s borrowing market or through contract-guaranteed borrowing or even as Flash loans.
Below diagram represents how TwoX protocol interacts with user base.
Role of each Token in TwoX Platforms:
TwoX protocol ecosystem has 4 primary tokens:
a) TUD: TUD is a cryptocurrency-backed algorithmic stable coin, softly pegged to the fiat USD, and unique in that it does not mandate users to lock their assets or make any deposits to mint $TUD. Instead, individuals holding $TWOX tokens have the privilege to generate $TUD stable coins at the prevailing market rate. The total market of TUD is always limited to not exceed the TVL of protocol.
b) $TWOX: $TWOX token is the native token of TwoX Protocol and can be unlocked by lenders. When lenders contribute to Supply pool, they are expected to receive equal amount of $TWOX as per the market price. Apart from using to mint TUD by undergoing burning, $TWOX can also be used to gain voting power.
c) tTokens: tTokens represent lenders’ stake into the protocol and hence act as liquid derivatives for lending assets. The lenders will receive tTokens at a 1:1 pegging ratio. tTokens are transferable and meets ERC-20 standards. Apart from being a token of liquid derivatives, this will also have extended utility in TwoX protocol’s lending-borrowing markets.
d) veTWOX: veTWOX are NFT tokens which represents voting power and is used for governing TwoX protocol. The holders will have their voice in taking part in governance decisions and are free to cast their votes related to improvements proposed by governing members. In order to be eligible to lock their voting rights, the holders have to time-lock their $TWOX tokens for at least 3 months. veTWOX holders also enjoy the benefits of earning incentives from protocol fees generated from minting and redeeming TUD.
How can I know more about TwoX Protocol?
TwoX is actively building DeFi capabilities by resolving many of the challenges put forward by downstream impacts of Overcollateralization. To be part of the community and follow the recent updates, visit the below paths.
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