Lend's role in keeping SILK at peg
Lend serves are the primary mechanism for creating SILK and maintaining the stability of SILK's peg.
- When a loan is taken out, the price of SILK is determined by the peg of SILK, not the current market price. This means that if the market price is above the peg, then it is profitable to take out a loan and immediately sell the SILK. This increases the supply of SILK and brings the price back down to the peg.
- When a loan is repaid, the price of SILK is determined by the peg of SILK, not the current market price. This means that if the market price is below the peg, then it is profitable to purchase the cheap SILK and repay your loan at a discount. This decreases the supply of SILK and brings the price back up to the peg.
In addition to the above primary stability mechanisms, Lend provides the following secondary stability mechanisms:
- Any user may purchase SILK on the market and Redeem it for a collateral of their choice. Redemptions repay a pro rata share of the Vault's debt and return a pro rata share of the Vault's collateral to the redeemer.
- For Redemptions, the price of SILK is determined by the peg of SILK, not the current market price. This means that if the market price is below the peg, then it is profitable to purchase the cheap SILK and Redeem it, then sell the collateral for profit. This allows even users who do not have outstanding loans to participate in and be rewarded for the arbitrage of stabilizing SILK.
- In order to discourage excessive Redemption activity, there is a variable Redemption Fee. There is a minimum Redemption Fee of 1%. This cannot be changed. The Redemption Fee increases as Redemption volume increases, ensuring that supply absorption during extreme changes in market demand is not too sudden, giving borrowers time to repay their loans voluntarily. The Redemption Fee decays over time. The decay rate can be adjusted by the protocol. The details of this calculation are outlined in the Risks and Fees section of the Lend documentation.
- As compensation to the borrowers who are subject to Redemptions, half of the redemption fee is awarded to the borrowers pro rata, meaning that Redemptions will always be profitable for borrowers.
- As SILK is backed by volatile collateral, it is possible for the price of collateral backing SILK to fall below the value of the outstanding SILK loan, meaning that SILK becomes undercollateralized. For example, if a user takes out a loan of $500 of SILK with $1000 of BTC, and the value of that BTC eventually dropped to $400 while the price of SILK remained $500, then there would be $100 of Bad Debt -- $100 of SILK exists in circulation without any backing.
- To prevent this, each Vault has a Max LTV. When a position's LTV is above the maximum for the Vault, it is marked for liquidation. This allows the user's debt to be repaid by the Stability Pool, removing SILK from circulation before the price of the collateral backing that SILK drops too much.
- The Stability Pool is a pool of SILK that anyone can deposit into. The SILK is used to repay liquidated debt, and the purchased collateral is distributed pro rata to the Stability Pool depositors.
- Liquidations are orchestrated by off-chain bots. Anyone can query a Vault to see a list of Vault IDs that are marked for liquidation. You cannot see any more information about these Vaults, such as how much debt they have or how much collateral they have. This is for the sake of preserving the privacy of borrowers. Once you have a Vault ID, anyone can trigger a Liquidation by calling the liquidate function on the Vault contract to liquidate an at-risk Vault. There is no UI for this, it must be done with an off-chain service or bot.
- The most senior creditors for liquidated debt is the Stability Pool depositors -- when a liquidation is executed, Lend will prioritize ensuring Stability Pool depositors at least break even. Excess Profit comes from the Liquidation Discount configured in the Vault.
- Excess Profit is split between the Stability Pool depositors, the protocol, and the user that called the Liquidate function. This distribution of profits ensures there are incentives for users to deposit into the Stability Pool, as well as incentives for users to operate off-chain services that liquidate risky loans.
- This distribution of Excess Profit is configurable by the protocol.
- Liquidations for positions above a certain value will only liquidate 50% of the position -- half of the debt will be repaid, and that value of collateral will be awarded to liquidators. This is to minimize unnecessary losses to users who are liquidated, as most liquidations will happen right around the Max LTV
- Liquidations below this threshold will completely liquidate a position -- this is to prevent a small position from infinitely remaining on the system and adding unnecessary strain to the liquidation system.
- This threshold is configurable by the protocol.
- The Stability Pool is a place for users to deposit SILK which will be used for liquidating risky loans.
- When a position is being liquidated, SILK is taken from each depositor's pro rata share and used to repay the loan.
- Depositors will earn pro rata rewards in the form of liquidated collateral which they can claim and then sell for profit.
- Depositors can withdraw SILK at any time
- As loans are liquidated, the amount of SILK depositors have in the pool will decrease. The value of claimable collateral is always expected to exceed the value of SILK taken from depositors.
- In the event that there is not enough SILK in the Stability Pool to liquidate a position, the position will be Redistributed instead of liquidated.
- A Redistribution is a last-resort to minimize system insolvency by distributing potentially Bad Debt to other borrowers, giving more time for the market to refill the Stability Pool.
- Redistributions also prevent extremely large loan positions from being unliquidatable if the Stability Pool does not have enough SILK to liquidate a position in normal market conditions.
- Redistributions follow the same rules as liquidations -- above the liquidation threshold, half of the position will be Redistributed, and below the threshold the entire position will be Redistributed.
- A Redistribution will first use all of the SILK in the Stability Pool to liquidate as normal. Whatever debt remains will be distributed to all other borrowers in the same Vault pro rata. By definition, a position that is marked for liquidation is among the highest risk positions in the system, and a Redistribution event will spread that risk to the other, less risky positions in the system.
- Redistributions may cascade, causing other positions that are very near the Max LTV to become marked for liquidation. These other positions may also be liquidated through Redistributions if the Stability Pool does not have enough SILK to liquidate them.
- Since Redistributions are a last resort stability mechanism to prevent the accumulation of Bad Debt, the Liquidation Discount is not applied to a position that is Redistributed.