Linear Finance: Deep Dive Into The Debt Pool
Dear Linear Community,
As many of you know, a key element of Linear Finance is its debt pool. Understanding the concepts and mechanisms behind the debt pool can be challenging for new users joining the protocol, this is why we have decided to go over the key elements in more detail in this post.
Let’s start simple and work our way up. The Linear debt pool is made up of LINA staked as collateral in the pool, but will eventually accept other tokens as the team works to implement multi-collateral staking. To create (or in Linear terminology build/mint) ℓUSD, Linear users need to stake LINA worth five times the dollar amount of ℓUSD they want to mint. This number comes from the target P-ratio (pledge ratio), which is currently 500%. When someone stakes LINA and builds ℓUSD they are basically creating a debt to the protocol.
You may be asking yourself, why do we need a debt pool on Linear? The reason is simple, the debt pool acts as a counterparty to all Liquids traded on Linear Exchange. Anyone who has staked LINA and built debt becomes a counterparty of trades on the exchange. This comes in quite handy as it removes the need for a buyer or seller when trading, and essentially allows trading with low slippage and unlimited liquidity.
In order for users to unstake their LINA, they need to repay their ℓUSD debt, however, the value of the debt is not static or tied to a fixed interest rate. If you place a trade on Linear Exchange and then close that position at a profit, that money is not created out of thin air, but is borne by the collective debt pool created by all stakers on the platform. This might sound very confusing at first, but let us share some examples below to show how this works. Note that this only affects users who build ℓUSD debt by staking LINA, users who bought ℓUSD from an exchange, i.e. Pancakeswap are not affected by the debt pool and can trade freely regardless of changes in the Linear debt pool.
- Step 1: Alice and Bob each have $10,000 worth of LINA. They each minted $2,000 ℓUSD at the Target P-ratio of 500%. If Alice and Bob are the only users of the platform, this equates to a total debt pool of $4,000 and Alice and Bob are responsible for 50% each.
- Step 2: Alice believes ETH will appreciate in price and decides to get exposure by purchasing ℓETH on Linear Exchange, while Bob continues to hold ℓUSD.
- Step 3: Over the next week ETH price increases by 20%. Since Alice purchased ℓETH, her position went up by 20% to $2,400. This increases the system debt to $4,400.
- Step 4: Both Alice and Bob decide to repay the debt and exit the system. Alice’s position is now worth $2,200 while Bob’s position is worth $2,000. As the debt proportion remains the same, they each have to repay $2,200. Therefore, Alice makes a profit of $200 ($2,400-$2,200), while Bob incurs a loss of $200 ($2,000-$2,200).
- Step 1: Eric, Carl and Annie have $15,000, $10,000 and $25,000 worth of LINA respectively. They all minted ℓUSD at the Target P-ratio of 500%. This equates to a total debt pool of $10,000, with Eric, Carl and Annie responsible for 30%, 20% and 50% respectively.
- Step 2: Eric decides to hold ℓUSD, while Carl purchases ℓETH and Annie ℓMATIC.
- Step 3: ETH price increases by 50% while MATIC price decreases by 40%. Since Carl purchased ℓETH, his position went up by 50% to $3,000. On the other hand, Mary purchased ℓMATIC, and her position went down by 40% to $3,000. The total protocol debt is now $9,000.
- Step 4: All users want to repay debt and exit the system. Since the debt pool decreased to $9,000 while the debt proportion remained the same, Eric, Carl and Annie have to each repay $2,700 (30%), $1,800 (20%) and $4,500 (50%) respectively. That gives a net profit of $300 for Eric, $1,200 for Carl, and a net loss of $1,500 for Annie.
The above examples are a simplification of how the Linear debt pool works. In reality, there are many users who have built debt which may have several positions, both long and short or no open positions but the mechanics are the same.
Note that users’ P-ratio is affected as their collateral value and/or debt balance changes. Users are responsible for maintaining a healthy P-ratio, 500 or above, in order to claim weekly rewards.
We hope you found this article useful. Should you have any questions or require any further assistance, please reach out to our admins on Discord, and they will gladly help you.
Linear Finance Team
About Linear Finance
Linear Finance is a cross-chain compatible, decentralized delta-one asset protocol that allows users to get synthetic exposure to various assets, including cryptocurrency, commodities, and market indices. Users can utilize our cross-chain swap functionality to instantly swap assets across leading blockchain environments and DeFi protocols with unlimited liquidity and zero slippage.