Can DeFi lending work without liquidation?

There are many blockchain lending protocols, but they all have one thing in common: liquidation. 😱

A liquidation happens when you borrow money on a protocol like Aave, and the value of your collateral goes down. If prices go down far enough, your collateral gets sold to pay off your debt. Even if the price recovers, your collateral is gone, and your position goes to zero — or close to it.

Don’t lose your collateral to DeFi liquidation
Don’t lose your collateral to DeFi liquidation

Liquidations are in place to remove risk from the lender, and keep that risk on the borrower. But are they really the only way to make a lending protocol?

At, we think liquidations have their place, but they shouldn’t be the only option for borrowing and lending in DeFi.

That’s why we’re building the first yield bearing stablecoin backed by non-liquidating loans.

The problem with DeFi Liquidation

For borrowers, liquidations mean you lose you entire position when the price drops far enough. This can happen due to a market downturn or just a flash crash.

Consider this: the largest ever liquidation on Liquity was in June 2022. When the ETH price dropped to $927, a borrower with over 70,000 ETH was liquidated. The ETH price recovered in two days but that was too late for the borrower, who lost all their collateral.

Had the liquidation not taken place, their collateral would be worth over $100 million today.

Largest liquidation on Liquity. Price recovered above $1000 within two days.
Largest liquidation on Liquity. Price recovered above $1000 within two days.

Right now, borrowers have several options to deal with liquidation risk, but they all have drawbacks.

Option #1Conservative Borrowing 🤓

Only borrow small amounts compared to your collateral. Risk is reduced, but so is access to capital.

Option #2: Risk it 🙏

Borrow larger amounts of capital and hope the price doesn’t fall.

Option #3: Hedge a bit with automation 🤖

Use automation tools like HAL to maintain a capital buffer well above the liquidation price. But you’ll still lose collateral every time the price dips down.

DeFi deserves better alternatives than just liquidation.
DeFi deserves better alternatives than just liquidation.

Liquidation has downsides for lenders as well. While liquidations remove risk from lenders, it also reduces lenders’ returns. Aave is like as a risk-free place to park your stablecoins, and as a result,the returns resemble a risk-free rate: they hover just below treasury rates, in the 3–4% range.

Aave’s last 12 months yield is lower than US Treasuries.
Aave’s last 12 months yield is lower than US Treasuries.

The goal of is to build a new type of lending to solve both parties’ pain points. Through’s new non-liquidating stablecoin loan, we can simultaneously both reduce some of the borrower side risk while also increasing rewards for lenders.

Non-liquidation lending using stablecoins

The biggest difference between and other Defi lending protocols is that borrowers can’t be liquidated.

This brings up a bunch of questions, such as:

  • “What happens when the ETH price drops?”

  • “What’s the worst-case-scenario outcome for lenders?”

Let’s walk through a simple example to answer all of these:

Alice is a borrower, and she has 100 ETH.

Right now the price is 1500 USD/ETH, so her collateral is worth $150,000.

She wants to take out a loan, and she decides is the best place to do this.

Alice visits the app, which executes a few steps, all in a single transaction.

The end result is that she locks her 100 ETH, and with $100,000 in debt.

A few things happen behind the scenes with the protocol. Let’s take a look:

  1. First, it transfers 100 ETH from Alice to the protocol, and stakes it as stETH.

  2. It then mints an intermediary stablecoin, called USDx. This stablecoin represents a unit of debt attached to Alice’s borrowing position.

  3. The protocol then swaps USDx for USDC in a Curve pool. It executes this swap so that, after accounting for slippage, Alice gets $100,000 USDC.

At the end of the transaction, Alice now has 100,000 in both USDC and debt, and her collateral is worth 150,000 USD, putting her at 67% LTV.

If Alice wants to pay down her debt, she would use to execute the reverse transaction:

  1. Swap USDC for USDx

  2. Use the USDx to pay her debt and unlock collateral.

Of course, the protocol handles all the intermediate steps.

Rewarding lenders with variable yields

In order to understand how maintains its peg, it’s important to understand how our protocol compensates lenders.

In the example above where Alice borrowed 100 ETH, this happened when ETH was staked into stETH. The yield from that stETH is paid to lenders, and it represents the cost of borrowing.

However,’s yield paid to lenders is variable. Sometimes the staking yield may be too high (unfair to borrowers), or it may be too low (unfair to lenders). Depending on market conditions, one of two things will happen: borrowers actually retain some of the yield from the staked ETH, or part of the borrowers’ collateral is harvested as an additional cost of borrowing.

Either way, the mechanism is the same: the protocol continuously targets a $1 price for the stablecoin, adjusting the variable yield rate continuously over time. adjusts the yield rate to target a $1 peg for USDx stablecoin adjusts the yield rate to target a $1 peg for USDx stablecoin

Handling Bad Debt with “Price Recovery Tokens”

If doesn’t liquidate collateral, what does the protocol do when debt exceeds the collateral value? This is the key difference between and other lending protocols.

First, the protocol locks the collateral, and lenders continue to receive staking yield payments. This establishes a floor value for lenders.

Second, the protocol suspends the harvesting of collateral beyond the staking yield. This prevents the position from becoming more unhealthy due to a decrease in collateral amount.

Finally, instead of any harvesting of the collateral, the protocol mints derivative tokens against the underwater borrower’s position. These are called “Price Recovery Tokens” (PRT), and they are redeemable for collateral if, and only if, the price recovers and the borrower’s position becomes healthy again.

Let’s look at an example to better understand PRT in practice:

Suppose ETH price starts at 1500 USD and begins to drop. A borrower position with 100 ETH becomes unhealthy at ETH = 1000 USD.

In a typical lending protocol, the borrower would be liquidated at that point, closing their entire position. But on, that doesn’t happen. Instead, the protocol mints PRT at a variable rate over time. The PRT are given to the lender. The lender can redeem PRT for ETH, but only if the price goes back above $1000.

PRT is redeemed for ETH, but only if the ETH price is above a strike, like $1000.
PRT is redeemed for ETH, but only if the ETH price is above a strike, like $1000.

Let’s say it took a year for the price to recover back to ETH = $1000. In that time, the protocol minted 20 PRT for the lender. Those 20 PRT can now be redeemed for 20 ETH.

Both lender and borrower are in a better position: the borrower only lost 20% of his position, and the lender got to share in the upside of the recovery. 😎

There is a worst-case outcome, of course. If the price never recovers, the PRT holder is left holding the bag. However, PRT can be traded, so if a lender doesn’t want ETH long exposure, they can sell them on the open market. We anticipate PRT will be a popular option for speculators wanting to go long. PRT offers a new way to get leveraged upside exposure on the underlying asset.

The next step in DeFi credit is a providing a new approach to lending that doesn’t rely on liquidation. Liquidation is the most conservative form of lending. If a position falls into an unhealthy state for a minute inside just 1 block, the entire collateral can be liquidated. We believe DeFi is evolving to a state that deserves more lending options than only the most conservative.

Join us, and help us propel DeFi forward by signing up for early. We’ll be rewarding our early supporters with points before we go live on Mainnet. So be sure to sign up and share with your friends for a chance to earn points to be used inside the ecosystem.

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