Original Author: Nian Qing, Chain Catcher
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BAYC floor price and average price change chart in the past three months, data source:NFTgo
In just three days, 28 BAYC and 28 MAYC were liquidated, and dozens of Boring Ape NFT health factors were less than or equal to 1.1, trembling on the verge of liquidation. Even BendDAO co-founder @CodeInCoffee's Boring Ape NFT is on the verge of liquidation.
The "liquidation crisis" caused quite a panic, with depositors quickly withdrawing their assets from liquidity pools and even triggering a run. In just a few days, the balance in the BendDAO ETH lending pool went from more than 16,000 ETH to almost exhausted. This also triggered a series of chain effects. BendDAO mortgaged nearly 3% of the entire Boring Ape collection. The Boring Ape floor series BAYC and MAYC had to face downward pressure, and the floor price fell again.
The market is beginning to worry whether this will further trigger the "death spiral" effect in the NFT lending field. How did this "liquidity crisis" come about? Specific events can be referred to"From the 300-fold increase on the line to the chain liquidation of blue-chip NFTs, what has BendDAO experienced? "。
Although the liquidity crisis of BendDAO has been passed temporarily. But what we have to ask is, will everything be fine with the NFT lending pool model after escaping this small storm? Are there potential risks in the liquidation mechanisms of other NFT lending pools, and can they stand the test of extreme market environments?
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1. Peer to Peer VS Peer to Pool
First of all, we must clarify a concept, that is, NFT lending currently includes the Peer to Peer model and the Peer to Pool model. BendDAO, which caused the liquidity crisis this time, belongs to the fund pool model. As soon as the incident happened, many peer-to-peer lending projects like NFT-Fi began to "advertise" that their P2P model is better than the fund pool model.
In the P2P mode, NFT holders need to negotiate a price acceptable to both parties with the fund lender, and then the lending platform facilitates the transaction. For example, the process is similar to that of placing an order on Xianyu. The holder mortgages the NFT on the lending platform, fills in the amount, term, and interest to be paid, and the lender can browse the information of each NFT loan on the platform, and then Submit the loan amount and interest you are willing to provide. Representatives of such projects are NFTfi and Arcade.
Lenders are not at risk of being liquidated as long as they make their repayments on time. But if the loan is not repaid when it is due, the mortgaged NFT will be transferred from the smart contract to the lender of the funds. Because the transaction is limited to both the borrower and the lender, even if there is a default, the risk will not be further expanded.
In the fund pool mode, holders can lend money immediately after over-mortgaging NFT assets to a fund pool. The whole process is just like using the Aave or Compound platform. NFT pricing is determined by the average floor price in recent times. The amount of interest paid by NFT owners depends on the amount of borrowed funds and the remaining funds in the pool. If the NFT owner fails to repay or the NFT price falls below the liquidation line, the NFT will be put up for public auction and the funds will be returned to the lender. The market track of the NFT lending agreement using the peer-to-pool mechanism is even more crowded than the peer-to-peer one. BendDAO, DropsDAO, JPEG'd, XCarnival, Pine, Pilgrim, etc. all belong to this model.
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2. How to set up the liquidation mechanism of the NFT fund pool model?
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1、BendDAO
What was the liquidation mechanism of BendDAO before this crisis?
BendDAO uses the most direct indicator "health factor" to evaluate the current lending situation. The health factor is a digital representation of the security of the mortgaged NFT relative to the loaned ETH and its basic value. The higher the value, the higher the funding status. The safer it is, it can resist liquidation risks. Its calculation formula is:
Health factor = (floor price * liquidation threshold) / debt with interest
In addition, another key value is the mortgage rate LTV (loan amount or debt value/collateral market value). BendDAO’s mortgage rate is up to 40%. Currently, BAYC and CRYPTOPUNKS have the highest mortgage rate, close to 40%. Users can set their own loan requirements. The lower the loan price is, the higher the health factor will be.
Suppose you mortgage a BAYC with a pricing (usually the floor price) of 150ETH, and you lend 60ETH, calculated according to BendDAO’s previous liquidation threshold of 90% (the same as LTV, debt value / collateral value), if the floor price falls to 66.67 ETH , you can trigger the 48-hour liquidation protection and the auction of NFT collateral, because the health coefficient of your NFT loan is less than 1.
For example, the BAYC floor price fell below 65 ETH this time, which triggered the liquidation of some mortgaged NFTs. The health factor depends on the liquidation threshold of the collateral and the amount of the loan,The lower the loan amount (debt with interest), the higher the floor price, the lower the liquidation threshold, and the higher the health factor.
BendDAO NFT calculation data comes from OpenSea and LooksRare, and the collateral value is denominated in ETH instead of USDT. The 48-hour liquidation protection was initially set up mainly for the protection of mortgagers. Borrowers (users with mortgage NFT) will be able to redeem their mortgages by repaying the loan within 48 hours.
In addition, in order to protect mortgagers, the conditions of the auction are relatively strict: the bid must 1. exceed 95% of the floor price; 2. exceed the total accumulated debt; 3. exceed the previous bid plus 1% of the debt.
BendDAO co-founder @CodeInCoffee admitted in the community proposal: "When setting the initial parameters, we underestimated the illiquidity of NFT in the bear market".
After BendDAO passed the proposal, the liquidation mechanism was revised as follows: the liquidation threshold was gradually adjusted from 90% to 70% to reduce bad debts; the auction cycle was adjusted from 48 hours to 4 hours to prevent excessive fluctuations in NFT prices and stimulate asset flows Sexuality; adjust the ETH benchmark interest rate to 20%, cancel the 95% reserve price and first bid limit, and adjust the storage interest rate to 20%, to encourage ETH depositors to provide liquidity.
In fact, in the early mechanism design of BendDAO, the extreme situation where the reserve price dropped but no liquidator participated in the auction was considered. However, the team believed that the short-term fluctuation of the NFT reserve price was normal. won't crash. Therefore, the platform only has a temporary floating loss and no actual loss. Either the borrower will repay the debt at some point in the future, or after the market price recovers, some liquidator appears to participate in the auction of the debt.
However, the biggest problem that BendDAO will encounter is that the liquidation price is less than the debt price, so it cannot be liquidated, and when the liquidation price is greater than the debt price, no one is willing to buy back the NFT. Therefore, the NFT category can only include blue-chip projects in the end.
Why did BendDAO turn on the yellow light first this time?
NFT-Fi researcher Walon Lin believes that the key to the liquidity crisis of BendDAO is not the setting of LTV and liquidation thresholds, but the requirement that the liquidator’s bid must exceed 95% of the floor price and be greater than the total amount of debt in the later stage, which lacks incentives for liquidators , which also caused the failed auction of the liquidated NFT. In addition, BendDAO is a direct liquidation model, instead of setting up a priority liquidation mechanism for the DAO treasury like JPEG'd, that is, the DAO treasury will first buy the liquidated NFT and then dispose of it.
But the premise of this model is that DAO has full confidence in the market prospects of the NFT series, and believes that these assets can be digested by the market to ensure the stability of the funds in the treasury. Therefore, this model requires strong risk control capabilities, and also requires the NFT consensus to be strong enough.
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2、JPEG'd
JPEG'd also belongs to the NFT lending platform of the fund pool, but it adopts MakerDAO's CDP (mortgage loan stable currency) model in the lending mechanism. Protocol users pledge NFT to enter the agreement, and lend the stable currency PUSd generated by the NFT mortgage. 32% of the reserve price of PUSd can be borrowed. JPEG'd offers mortgagers a 2% loan rate with a 10-20% APY on deposit.
At present, the NFT fund pools mortgaged on the JPEG'd platform mainly include CryptoPunks (69), BAYC (9), MAYC (12), and Doodles (5).
JPEG'd also evaluates the current borrowing situation through the "Health Index". The higher the value, the safer the financial status. Its calculation formula is:
Health Index = (1-(LTV/ Liquidation Index)) X100
However, the liquidation mechanism of the platform is triggered by the liquidation index. The previous liquidation index (debt value/collateral value ratio) set by JPEG'd was 33%. If the product ratio is equal to or exceeds 33%, it will be liquidated.However, after the liquidity crisis in BendDAO, JPEG'd adjusted the liquidation ratio to 40%, that is, if the LTV is greater than 40%, it will be liquidated.
The health index is presented as a percentage, so that users can more intuitively feel whether their orders are at risk of being liquidated, so as to repay the loan in time. It is not the same as BendDAO's health factor and liquidation direct link function.
As shown in the figure above, suppose the base price of your CryptoPunks is 66.52ETH, and the maximum amount you can lend is 25.94ETH. When the floor price of CryptoPunks falls below 64.94ETH (25.94ETH / 40%), your NFT will enter liquidation Conservation and auction process, the auction lasts 24 hours. If a new bid is placed less than 5 minutes before the end of the countdown, the auction will be extended by 10 minutes. This process repeats until there are no more bidders.
Compared with BendDAO's liquidation mechanism, the mechanism set by JPEG'd can be said to be extremely strict, which forces mortgagers to have to lend a smaller amount to ensure their order remains healthy. But the benefits are also obvious. As long as the floor price drops slightly, mortgagers will be forced to redeem NFT or enter liquidation, which relatively reduces the risk of bad debts. But from the perspective of the mortgagee, it means that there is less buffer space, and the risk of being liquidated increases, so the mortgage loan cycle is forced to be shortened. Of course, this also means that collateral flows faster on JPEG'd platforms.
In addition, as mentioned earlier, unlike BendDAO, after the liquidation begins, the JPEG'd treasury will buy back the NFT at the price of the loan amount, and finally DAO will dispose of the treasury NFT. To a certain extent, the NFT market is not good Panic and liquidity crisis are avoided under the circumstances.
Considering the risks faced by mortgagers, JPEG'd designed a new insurance module, which is not available in other similar protocols. The cost of purchasing insurance is 5% of the initial debt. If the staker is liquidated, they can repurchase their NFT from the DAO after repaying the debt and 25% of the liquidation fee within 48 hours of liquidation. The 25% liquidation fee is based on the user's outstanding debt, which is the principal plus any accrued interest.
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3、Drops DAO
Drops DAO officially launched its mainnet in May this year. Currently, the largest lending pool on the Drops platform is the Yuga Labs lending pool. Users who hold BAYC, MAYC and PUNKS NFT can conduct liquidity mining. Unlike the previous three agreements, the LTV of Drops is generally higher, and the official said that a loan of up to 60% of the NFT base price can be borrowed. But behind the high LTV is the special pricing mechanism of Drops.
Drops uses oracles, time weighting, and extreme value removal at the same time when pricing, and uses fragmentation for pricing. Specifically: based on the floor price, conduct a preliminary inspection of the transaction: 25 block confirmations, 1 NFT sold, and the same Token ID has not been sold again within 24 hours; remove extreme values: calculate 100 transactions After the floor price of the data, remove the transactions below 5% and above 950% of the quantile value; remove the extreme value of the possibility: remove the transaction price of N standard deviations; feed the price once every 4 hours, etc.
This stricter pricing method that takes liquidity into account ensures the basic quality of the NFT mortgaged on the Drops platform, so it can give a higher valuation while controlling the risk exposure, but for non-blue-chip The NFT series is not friendly.
In addition, Drops encourages staking multiple NFT assets at the same time.
For example, according to the maximum LTV set by Drops is 60%, the minimum mortgage rate (100% divided by LTV percentage) can be calculated as 166.6%.
Suppose, you borrow 50 ETH when the value of BAYC is 100 ETH, the minimum mortgage rate is 166.6%, 50 ETH * 166.6% = 83.3 ETH, as long as the BAYC price is not lower than 83.3 ETH and no more funds are borrowed, the loan will remain solvency. Once the borrowing limit is exceeded, the borrower's loan can be liquidated by anyone.
When only 1 NFT is provided as collateral, LTV greater than or equal to 90% is subject to liquidation. For example, the NFT value provided is 100 ETH, and the user lends 50 ETH. The NFT value needs to be greater than 55.5 ETH to not be liquidated.
When 2 or more NFTs are provided as collateral, the first liquidation threshold is 60%, and the second and above liquidation threshold is 90%.
For example: Suppose the user provides 2 BAYC, each worth 100 ETH (a total of 200 ETH), the LTV is 60%, the loan limit is 120 ETH, and the user borrows 100 ETH. Suppose the price of BAYC drops to 80 ETH, the total value of the collateral is now 160 ETH, the new loan limit is 96 ETH, the loan is under-collateralized, and the first NFT of the mortgagor is liquidated at the price of 80ETH*90%=72ETH, which is quite If one of the NFTs is used to repay the debt, the mortgager's debt is reduced from 100 ETH to 28 ETH, and the user can keep 1 of the 2 NFTs. Borrowers no longer exceed their borrowing limit and have a mortgage rate of 285% (NFT value 80ETH / debt amount 28ETH). If a user has more than 2 NFTs, the number of liquidated NFTs will depend on how many NFTs are needed to push the debt below the borrowing limit.
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4、Pine
Compared with the previous agreements, Pine is still in a relatively early Beta stage. In May this year, it completed a US$1.5 million financing led by Sino Global Capital and Amber Group. Pine has currently created 31 NFT fund pools with a total locked value of $855,765.
The setting of Pine's liquidation mechanism is relatively simple. If the LTV is greater than 40%, it will be liquidated. Pine's LTV will vary based on the collections and terms set by the lender. For safety reasons, Pine's LTV ratio is set in the 30-50% range. If the borrower fails to settle the loan obligation, i.e. repayment of the loan and accrued interest, by the loan maturity date, there will be manual liquidation.
According to its white paper, mortgagers will receive a notice of the deadline for repayment 24 hours in advance. After the loan expires, the borrower has a 12-hour grace period to repurchase its liquidated assets from the lender or liquidator. During the repurchase period, the liquidator will not sell the assets before the end of the period. In addition, borrowers have a 3-day reconciliation period, during which time the Pine team will try to help the borrower negotiate a buyback with the liquidator. There is no guarantee that a transaction can be arranged (for example, if a liquidator sells an asset on OpenSea, it may not be possible to repurchase it).
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3. What problems exist in the current P2Pool model?
Researcher Walon Lin believes that, in the final analysis, the biggest difficulty of NFT-Fi at present is the problem of liquidity. If this problem is not resolved, the leverage ratio of the capital pool agreement will be very low.
The infrastructure of the P to Pool fund pool model has not really been built. For example, the current pricing model and oracle machine have not really achieved good incentives. For example, if the floor price is used for pricing, it is not friendly to rare NFT holders. If the oracle machine is used for pricing, the NFT of the floor price cannot be liquidated in time. Second, this track has not seen more AMM mechanisms or liquidation-like platforms like Sudoswap. In the future, it may be possible to solve the liquidation crisis by using the NFT project party as the liquidator.
How to set and price the LTV of each fund pool agreement is essentially a trade-off problem, which needs to be considered and weighed at the same time. The interests of the mortgager and the liquidity provider, but these problems cannot be resolved for the time being. Before the infrastructure is fully established, P2P will be a better choice.
In addition, according to the current operating logic, the funding pool model still has a flaw in that it cannot achieve Permissionless, and only blue-chip projects are allowed to enter, so the audience is relatively limited. However, the original intention of NFT-Fi is to "improve the liquidity of NFT", and the entry of non-blue-chip NFT into the fund pool is the real large-scale adoption.
Finally, I would like to ask everyone to think about a question: among deep bears, can we count on NFT-Fi to improve the liquidity of NFT? At present, the answer is not so optimistic. NFT-Fi essentially adds a lever to NFT, which is equivalent to icing on the cake. In an environment where the market is sluggish, these agreements with the original intention of "improving NFT liquidity" are facing severe tests. How do you feel about this?
