A deep dive into how Non-liquidatable loans on Timeswap are unlocking unique use cases previously not possible in DeFi
Leverage as a source of yield
There’s demand for leverage when one doesn’t want to sell an asset and have temporary exposure to another asset at the same time and/or one wants to increase the size of a certain trade to 10x, 20x, or even 50x the initial size.
For example, Say Bob needs USDC for a short period of time. Bob prefers borrowing USDC by locking ETH instead of selling ETH for USDC. Here, Bob has leveraged ETH. Leverage is deeply inherent in finance, so everyone deals with leverage at some point or the other. DeFi is no different, and leverage in DeFi is a source of real yield!
Let’s go a bit deeper, shall we?
Leverage — a double-edged sword ️⚔️
Since leverage amplifies a position —it is a highly risky strategy; And with high risk, comes high returns but also sometimes the risk blows through the roof & ends up in what we call liquidation.
Liquidation is your enemy
Suppose you long ETH (buy ETH) with $100 & lever the position 10x i.e multiply initial investment 10x ~ $1,000. Now say the market favored your decision & pushed ETH higher ~ money that you would have made otherwise is now amplified 10x, thanks to leverage. But say ETH went lower — you would be at risk of losing your $100 because any loss would also be amplified 10x leading to losing the principal i.e liquidation.
Leverage is a double-edged sword — sweetener in good times, a killer in bad.
They’re around you
Like leverage, liquidations are also omnipresent in finance, i.e where there’s leverage, there’s also liquidations.
Let’s look at the overall liquidations across centralized exchanges (think Binance, OKX, etc). As per Coinglass — total liquidations in the past 24 hours stand at a whopping $167.85 Mn. To get a broader sense here’s the liquidations across all tokens on centralized exchanges since Oct ‘22
Remember….FTX?
Early November is when the FTX blowup began unraveling leading to market participants placing trades according to their view of how the market is going to behave, liquidations on 8th Nov (peak) were upwards of half a billion!
Think about it, $550 Mn got evaporated in a single day, a sheer loss of liquidity 🤯
DeFi is no exception
Liquidations are happening on lending/borrowing markets all the time, be it centralized or decentralized, here’s some data with respect to daily liquidations over the course of the past month in some DeFi protocols(Dec ‘22).
Zooming out, AAVE, with its liquidation model has liquidated assets north of $1.03 Bn (since inception), and Compound is racing towards that mark, check out this dune for a deeper insight!
Max pain…with existing DeFi protocols
Liquidations are merely the end-state, market participants scratch their heads and try….to not get liquidated 😓
In the process of managing your leverage in DeFi, a user is faced with numerous challenges.
Active position management
Lending/borrowing products across DeFi ecosystem require over collateralization for borrowing & users have to manage a minimum collateralization by themselves, at all times. If collateral price tanks, and user doesn’t top up with sufficient collateral, their position could be liquidated.
Health factor down only
Every borrowing position comes with health factor that can be calculated by dividing collateral by debt, as this number falls close to 1 i.e debt value ~ collateral, your collateral is at risk of being liquidated.
Bottomline: User experience in lending/borrowing by design involves active position management i.e users have to constantly monitor their positions and collateralization and cough up additional collateral if the value falls. Not the best user experience unless you are DeFi degen who’s 24x7 glued to your screen in your basement.
There has to be a better user experience for borrowers, one where user shouldn’t have to be glued to the screen 24/7 or worry about liquidations. Timeswap is introducing non-liquidatable loans to address this specific pain point.
What are Non-Liquidatable loans
Non-liquidatable loans are loans for a fixed maturity where there is no active liquidation of your position if the collateral value falls below value of debt, instead the borrower has to repay the debt before the specified maturity. In case, they chose not to repay the debt before maturity, the collateral they deposited is forfeited and distributed to the lenders.
With the launch of Timeswap V1 on Polygon in March 2022, we’ve brought Non-Liquidatable loans to life where borrowers have the flexibility to lever up as much as they want without worrying about downside of liquidation.
By design, a non-liquidatable loan resembles an option since the borrower has the option to repay/default on the debt whereas lender receives yield along with principal (if borrower repays) or collateral (if borrower defaults).
Leveraging ETH Merge while Time Traveling 👨🏻🚀
Let’s take ETH merge that happened in Sept ’22 to showcase an example of how users on Timeswap leveraged the power of non-liquidatable loans to maximise their returns.
The image below shows the collateral factor on Timeswap during this period. We can see that it was trending up leading to the Merge, implying borrowers were depositing collateral to leverage as much as possible given that they don’t have to worry about liquidations. Users were borrowing stables, possibly swapping to ETH & bridging to mainnet to be eligible for PoW airdrop, all without any active management of positions, health factors!
Min CDP i.e minimum collateral to be locked to take a loan on Timeswap during Sept was going through the roof. Put simply, leverage goes brrrr 🚀
We can also see from the APR chart below for the respective months how there was a spike in APR leading up to the merge as many users were leveraging up as mentioned above.
Fixed cost of leverage v/s variable cost
Perps as financial instruments are great, but their cost is a little harder to predict i.e funding rate. The degree of fluctuation involved in funding rates is quite high which might deter DeFi users to take leverage. To drive the point home: here’s the funding rate of APE coin -
As Timeswap is a fixed maturity product, borrowers have clarity over the cost of leverage (yield/APR to pay) & the comfort of no liquidations, best of both worlds 🤝
Oracle……less leverage
There’s a reason why current money markets in DeFi are unable to safely serve lending/borrowing for long-tail assets….Oracles!
Oracles are used by money markets for price-feeds, however for long tail assets with low liquidity, they can be easily manipulated as evident from multiple oracle manipulation hacks suffered by various DeFi protocols.
On Timeswap, you can create lend/borrow market for any ERC-20 tokens without the risk of oracle manipulations! For a good bedtime story here’s a thread on some oracle attacks that happened in the past couple of years & how a good chunk of liquidity got drained away ~
Make everything market-driven 🧠
Goes without saying that free markets make things more efficient. The only means to leverage on AAVE, Euler, etc is via the collateral factor which is a fixed percentage i.e collateral/debt in a fixed %.
On existing lending products, the collateral factor for a particular asset is not determined by the market i.e by lenders & borrowers, instead the protocol’s DAO decides via governance the individual parameters for each market. This is leads operational inefficiencies associated with coin voted governance.
On Timeswap collateral factor is determined in real-time as per demand (borrow) & supply (lend) which results in more efficient leverage as it leads to better price discover of collateral factor during volatile times and during quiet times
Wrapping up
Over the last 9 months our model of non-liquidatable loans have worked as expected and many of our users have unlocked unique use cases that are only possible with non-liquidatable loans. And with Timeswap V2 we’re increasing our capital efficiency by 5x+! We’re excited to bring this new primitive to the DeFi economy and can’t wait to see all the interesting ways in which our users will deploy them.
Non-liquidatable loans are a new primitive in DeFi which unlocks unique use cases previously not possible in DeFi. It allows new user behaviour previously unseen in DeFi leading to interesting new revenue generating opportunities i.e yield for lenders
