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How does earning mechanism work on Equilibrium and Genshiro?
Equilibrium’s bailout mechanism is an effective new approach for managing debt and risk within a DeFi protocol. Our system design introduces the role of a “bailsman.” Bailsmen are users who pledge liquidity in advance of a market decline or black swan event, and they play a pivotal role in keeping Equilibrium and Genshiro running smoothly. There’s no need to quickly gather liquidity when the bad debt mounts up because our bailsmen have supplied this liquidity in the form of other crypto assets. It’s immediately available when we need it.
Let’s briefly cover how this system works in practice and how you can benefit from it.
The entire setup may be depicted as in the following schematic.
Right after you deposit liquidity to your liquidity portfolio, you become a liquidity provider (bailsman or LP) in Genshiro. That means that from this particular moment you start to carry out three different activities:
- 1.Securing loans in the system.
- 2.Pledging liquidity for borrowers.
- 3.Receiving APY rewards for doing the two things above.
Liquidity providers take on the liquidation risk of traders and borrowers on our platform. When the borrower gets liquidated, the liquidity provider will receive a portion of his debt and a portion of his collateral. The debt goes straight to the LP’s liabilities while collateral goes straight to the LP’s liquidity portfolio.
Note: if a LP has an asset in his liquidity portfolio, which was borrowed by the liquidated borrower (his debt), this asset will be subtracted from his liquidity portfolio automatically. LPs have to pay back all the liquidated debt to keep the system solvent.
Let’s furthermore say the bailsman liquidity pool has two bailsmen and BTC and ETH in liquidity:
If the user borrows 1 BTC at ~ 50,000.00 USD, ignoring all the fees and price changes, his portfolio will look like this:
There won’t be any changes (any asset movement) to the bailsman pool, but there is now a 1 BTC debt in the system. So the overall system looks like this:
Total borrower collateral = 100,000 USD Total borrower debt = 1 BTC Total Bailsman collateral = 3 BTC, 20 ETH Total Bailsman debt = 0
- Total borrower collateral = 100,000 USD
- Total borrower debt = 1 BTC
- Total Bailsman collateral = 3 BTC, 20 ETH
- Total Bailsman debt = 0
Let's furthermore assume BTC price is rising and it rose to $100,000 USD, the level where borrowers get liquidated (borrower collateral of $100K = borrower debt $100K), ignoring all the penalties and critical margin levels for the sake of simplicity, when the borrower liquidates, his assets are transferred to the bailsman pool. So resulting bailsmen balances will look like this:
Notice how bailsman 1, who got ETH collateral, now has 0.25 BTC debt, while bailsman 2, who had BTC has his balance reduced by 0.75 BTC (since he got 75% of the entire liquidated collateral and debt). Now the total system aggregates will look like this:
- Total borrower collateral = 0 USD
- Total borrower debt = 0 BTC
- Total Bailsman collateral = 2.25 BTC, 20 ETH, 100,000 USD
- Total Bailsman debt = 0.25 BTC
Bottom line: Bailsmen bear the risk of liquidation and need an effective liquidity management tool to get rid of their liabilities and liquidated assets.
It’s simple. Liabilities depend on your liquidity size. You can count your maximum amount of liabilities by using the formula:
Total debt in the system * Your total liquidity portfolio / Total bailsman liquidity = Max liabilities I could receive as a bailsman.
The same works for collateral. The maximum amount of collateral which a LP can receive can be calculated with the following formula:
(Total liquidated collateral in the system + Penalty) * Your total liquidity portfolio / Total bailsman liquidity = Max collateral I could receive as a bailsman.
To sum it up, when borrowers liquidate, LPs get their collateral to their liquidity portfolios and their debt to their liabilities.
First, you need to know what Liquidation, Collateral and LTV means:
- 1.Collateral simply refers to something of value that you put up as a guarantee when borrowing assets on a platform. If you are unable to repay your borrowed assets, your collateral will be used to repay your debt. For example, if you take out a bank loan to buy a house, the house may serve as collateral. On Equilibrium/Genshiro, you can’t provide your house as a collateral, but can instead provide several crypto assets as collateral in order to take out a loan in return.
- 2.Liquidation - It’s basically a stop-loss for our LPs. In traditional finance, liquidation refers to when a company or group needs to sell some of its assets to cover a debt. DeFi liquidations are similar, but users need to provide crypto assets as collateral to back the debt. If the debt value starts getting close to the collateral's value, the smart contract will automatically sell your collateral to cover the debt.
- 3.LTV, or Loan-To-Value, is the ratio of your loan to the value of your сollateral. When you borrow a loan, we calculate your LTV based on the following formula:
LTV = (Market Value of Collateral) ÷ (Loan Amount)
We have a multi-stage liquidation process:
- = 120% LTV - minimum LTV possible on Genshiro
- ≤ 110% LTV - 24 hours warning, then liquidation
- < 105% LTV - absolute liquidation
As a borrower, your minimum LTV can be as low as 105%. However, if it drops in value, you can face liquidation. Liquidation means that you will lose your collateral and the ability to get it back by providing your loan in return. These parameters will most likely change to a more conservative setting to avoid unnecessary risks associated with low liquidity levels at this stage.
LPs (Bailsmen) are the one who provides liquidity to the system. Loan liquidity is provided by Bailsmen (If bailsmen bring BTC, only then borrowers will be able to borrow BTC). The limit on amount of a particular asset, borrowers can take is governed by the amount of liquidity in that asset in the bailsman pool: if there are total 10 BTC in the bailsman pool, borrowers will be able to take out 4 BTC at max. (40% of the supply in any particular non-synthetic asset).
Some further important mechanics/specifics:
- 1.Bailsmen are aggregated into one liquidity pool.
- 2.Bailsmen receive interest for taking on risk. Each borrower pays interest based on his portfolio risk (volatility) and margin level (leverage or LTV). Interest rates adjust inversely proportional to collateralization levels and proportional to level of collateral token volatility: Interest rate ~ Leverage * (Portfolio volatility * scale factor)
- 3.Risk scaling (scale factor in the formula above): the more liquidations bailsmen are ready to absorb (the safer the system is) the lower will be the scaling of borrower's interest, the less liquidity there is with bailsmen, the higher the interest borrowers pay will be, maximum possible scaling of borrowers interest is 4x.
- 4.As a bailsman (LP) you still receive your staking rewards, even if you have liabilities. However, if you want to withdraw your liquidity, you will need to pay off your liabilities.
- 5.If borrowers take out loans from the bailsman pool, the withdrawals of liquidity in the borrowed asset will be naturally limited. Currently users can borrow up to 40% of the entire liquidity in any particular asset.