bZx: the Most Efficient DeFi Protocol that Integrated Margin Trading and Lending
Disclosure: Hashed has established, maintained, and enforced strict internal policies and procedures designed to identify and effectively manage conflicts of interest related to its investment activities. Hashed abides by a “No Trade Policy” for the asset(BZRX and VBZRX) listed in this report for 3 days following its public release. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. Furthermore, references to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services.
Hashed met bZx team through the introduction by Kyber Network’s Loi Luu in 2019. After the initial meeting, we have actively engaged with Tom and Kyle who founded bZx. Although bZx protocol relatively had much less deposit amount compared to other major DeFi protocols, we saw its potential because the team knew how to crystallize the understanding of openness and composability of DeFi liquidity for better results. And, starting from 2020, the team has successfully gained the market’s attention which led to the rapid increase of the protocol’s TVL from $5M to $19M within just 50 days. However, a lethal attack that took place during the ETH Denver hackathon put a brake on bZx platform for quite a time.
When bZx struggled through the aftermath of the attack, Hashed supported the team along the process. Indeed, we could actually witness how this team solved the unprecedented DeFi incident. We believe the team showed integrity. Instead of losing hope, the team did everything in its power to fulfill its responsibility as a DeFi protocol. Now, the team is rebooting its protocol with stronger security and community support. And, Hashed is excited to officially announce our investment in bZx through the private round before the token release in this July.
Margin Trading Protocol that Boosts Borrowing Demand
As a decentralized lending platform, bZx is quite similar to Compound or Aave. However, the biggest difference between bZx and other platforms lies in how they create demand. In the crypto lending market, the lender becomes the liquidity provider and the borrower becomes the liquidity user. As long as the lender thinks that the interest rate is attractive, she has an incentive to participate in the protocol. Yet, the borrower is the one who has to pay the interest rate. So the borrower will only use the protocol when there is more value than her cost. The following are when the borrower would use the protocol for loan:
- Maintain 1x long position on the collateral while acquiring additional liquidity on other tokens(e.g. Depositing ETH to borrow DAI)
- Open a leveraged long position on the collateralized asset
- Open a leveraged short position on the borrowed asset
It seems apparent that MakerDAO and Compound are focused on #1 considering their user experience designs. However, we believe that #2 and #3 are the ones with the potential to dramatically drive liquidity. In other words, we believe that margin trading is the critical component, capable of effectively facilitating lending protocols. Acknowledging this, the 1inch team had launched 1x.ag, a margin trading platform utilizing Compound and FlashLoan. Aave had also announced that it will support margin trading with its release of version 2. There is a high possibility that the market will ultimately choose the most on-demand liquidity protocol. Since its launch in 2019, bZx organically integrated margin trade and lending features. This naturally drove demand for loans, allowing the protocol to provide a higher interest rate compared to its competitors. bZx accurately foresaw how the lending market will develop, and swiftly acted upon those insights. Such capabilities will allow bZx to maintain its competitive advantage in the DeFi industry.
A sustainable token distribution model capable of attracting real users
Yield Farming, initiated by COMP tokens of Compound, has created a sensation in the DeFi and Ethereum ecosystem with its powerful token distribution model that compensates early network contributors. This is good news for Hashed, which has invested in DeFi and encouraged entrepreneurs to adopt tokenization since 2017. Although the current Yield Farming model created lock-in effects for loyal users and value-adding use cases, it has led to several side effects. The model indiscreetly distributed governance tokens, pushed organic users away from the network, and opened opportunities for some users to game the system.
For example, Compound, which initiated the Yield Farming movement, compensated both the lenders and borrowers, encouraging Yield Farmers to conduct wash trading in the form of depositing assets and receiving loans based on the same asset. Because of the fixed daily compensation amount, borrowers were able to be rewarded more than the cost they paid to the network. As Compound determined its interest rate based on supply and demand, false demand was applied in such cases. This could ultimately lead to the interest rate becoming higher than the equilibrium interest rate, imposing losses to organic users. In fact, after COMP mining started, many token pools experienced supply and demand volatility and the associated interest rate volatility, forcing Compound governance to frequently modify its mining rewards and interest rate policies.
bZx team is well aware of both the utility and risk of Yield Farming, and is carefully designing its platform token, BZRX, which will be rewarded to protocol contributors. bZx provides 50% token payback when margin traders (i.e. liquidity users) pay to the network. This will prevent wash trading that happened on the Compound protocol and will attract users who are capable of creating value that exceeds the residual 50% of the cost. Since such an approach may not be effective in terms of bootstrapping liquidity in the early phase of the network, bZx is planning to distribute 2% of the total token supply in the first month. Such benefits will be able to draw in on-chain margin traders from other platforms such as dydx.
A groundbreaking idea: security mining and permission-less listing
An on-going trend of yield farming in DeFi facilitated many other DeFi projects to issue their native tokens. As a result, dozens of DeFi tokens are being traded in the market and there is an expected growth in demand for depositing, trading, and margin trading on these assets. On the other side, allowing depositing and trading of multiple assets can increase the systematic risk of the protocol. For example, Uniswap had clearly separated risks associated with independent liquidity pools and thus it supports permissionless listing. However, lending platforms that have not done so can be highly vulnerable if a single collateral displays significant risk. It can greatly increase risk of the system as a whole and some might have to file bankruptcy.
bZx team is conceptualizing ‘security mining’: Security mining is an approach that allows BZRX holders to stake their tokens to a ‘token pool’ which they have selected to support. Staked tokens are used as an emergency insurance fund. Then, assets are deposited proportionate to the insurance fund in the pool and can be used for margin trading and borrowing. As a reward of contributing to the insurance fund, stakers are eligible to receive a share of fees from the pool. If the pool loses its ability to make a payment for whatever reason, stakers will use their BZRX tokens as an insurance to pay off the debt of the system. It seems somewhat similar to Maker where Maker holds a Debt Auction of additionally minted MKR when excessive debt is incurred. Yet we can mark the biggest difference of bZx as its scalability and structure that can accrue market efficiency because BZRX holders have their discretion to choose which token pool to support.
Another edge of security mining is that ‘permissionless listing’ can be performed. When permissionless listing is supported, any tokens supported by BZRX holders can be listed without central authorization. For example, some prominent tokens such as COMP, YFI, and CRV can be listed via decentralized governance. Note that BZRX holders must stake their tokens as collaterals in order to partake in the decision making; they are incentivised to make responsible decisions because their deposits will be used as an insurance if the system is at risk. I was having a conversation with Kyle, co-founder of bZx, and let me be honest, concern was the first thing that came to my mind when Kyle told me that he was conceptualizing permissionless listing. The idea seemed to be going ahead too far. However, as we talk about the idea with more depth, I could not deny his idea is well suited to the direction where DeFi is heading, open finance. Also, I believe permissionless listing can act as a potential trigger to turn the table in the current market.
Test-Driven Development(TDD), Quality Assessment(QA), and Security
There is a saying in the VC industry, “Make an investment in a person who has an experience of being miserably failed.” bZx made a flashy debut in 2019 and brought their ideas into life for the first time in the industry. However, bZx suffered an attack that maliciously took advantage of security holes, and it had to put a break on its service for more than 6 months. During this period, bZx team started back from the basics to redesign its structure. It also hired several senior-level staff, introduced TDD and QA, and established a periodic third-party security auditing process. The new bZx protocol has been verified by Peckshield and CertiK which offer the highest level of security auditing. The protocol plans to perform additional security auditing at every update. Moreover, Delphi Digital will be auditing token economics of bZx protocol. bZx has already pooled strategic investment funds from Hashed to financially support these future security audits.
Those who failed and resiliently stood back up can accomplish growth much faster through their lessons learned. Just like we supported bZx, Hashed will also continue to support talented founders who stay resilient from failures and strive to win numerous challenges in the blockchain ecosystem.
