A DeFi Drought Crisis

Just when we thought it was safe to breathe a sigh of relief from all the crypto liquidity contagion, another one started to appear last week with BendDAO, an NFT borrowing, and lending platform. Due to structural faults in the way the protocol had been created there came a point when it was perched on the brink of insolvency.

What we’ve witnessed over the past few months has been a clash between the overconfidence of some project founders and the realities of the emerging crypto market. It’s an unusual dynamic where some people say the market is still so young and filled with potential, and others speak as if everything is predictable.

The reality of the situation is between the extremes of overconfidence and abject fear. Blockchain technology occupies the bleeding edge of development which is why the returns are exponential when things go right and devastating when they go wrong.

At Paribus we believe in learning from others’ mistakes, anticipating the potential downsides of situations, and moving forward with cautious optimism. One example is in our choice of bridge partners, Multichain. We were going to proceed with another provider until we realized their approach could lead to future difficulties, so we quickly pivoted and adopted a solution we felt would be a better fit.

This ability to adapt and pivot quickly is crucial for the development of our technology and lacking this was one of the fundamental flaws in BendDAO’s approach that almost led to their downfall. Being a DAO means that to change course they have to get the agreement of the majority of their voting community. Paribus on the other hand can adapt quickly, in a matter of minutes if the conditions dictate a fast-paced reaction.

BendDAO’s problems occurred when rumors started to spread that they may not be able to cover their losses as the NFT markets suffered a drop in value. Lenders flocked to the platform to withdraw their funds from liquidity pools and BendDAO’s reserves rapidly dropped from 10,000 ETH to just 5 ETH, potentially causing a catastrophic collapse of the protocol.

Their format allowed NFT holders to borrow up to 40% of the value of their assets which they felt would give sufficient headroom for any market fluctuations. Provided that the liquidation process was fast enough and the margins were set with enough spread this would have worked fine.

Unfortunately, BendDAO wanted to help NFT holders prevent themselves from being liquidated by introducing a 2-day window. During this period people would be able to place bids on the NFT at a minimum value of 95% of its floor price. The combination of these factors along with the time delay in changing the protocol would prove to be calamitous for the platform.

The team hadn’t realized that in sharp market cycles the floor price can drop significantly over the course of 48 hours. This meant that very few people would be willing to commit to buying an NFT at 95% of its current floor price, gambling that it remained stable for the 2-day wait period. They were also unwilling to lock their funds for up to 48 hours while they watched the market tumble.

This meant that BendDAO faced multiple liquidations across their NFT loans and a liquidity crisis where no one was lining up to buy them. They have since tabled amendments to their protocol, and time will tell if these are sufficient to prevent a recurrence of the problem.

It goes to show that our approach to NFT lending is a more secure and logical path to take. For instance, we have already developed relationships with NFT investors who would be able to step in and buy liquidated NFTs in an emergency.

Most importantly though, we are rigorously testing our NFT algorithm throughout the present market cycle and ensuring the spread is sufficient to liquidate NFT loans with minimal risk to the platform. We also trigger liquidations automatically and immediately, placing the onus of responsibility on the NFT holder to prevent their loan from liquidating.

While BendDAO’s intentions to try and protect NFT holders from liquidation as much as possible are well placed, the harsh reality of the markets is that there is no room for sentiment. To do so places not just liquidity providers at risk, but also the protocol itself, which is why we’d never operate Paribus in that way.

We also feel that adaptability and speed of development are crucial in such a fast-paced market. This is why we’re working hard to develop a robust platform that can be scaled across multiple chains. Once it’s fully iterated and battle-tested we can then introduce the DAO format to guide a more stable and inclusive course in the future. To introduce a DAO too early can expose the platform to unnecessary risks, which is why we continue to take a steady, long-term view to our development process.

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