Web3 Liquidation Protection with Reactive Network

Summary

• DeFi lending is on the rise. As more users onboard into Web3 and learn about the efficiencies offered via DeFi lending, both lenders and borrowers are sure to increase
• One of the most common methods of DeFi lending involved the lockage of assets from the borrower. The borrower must over collateralize the loan amount before the lender is willing to lend funds
• In times of volatility, the borrower may not be able to move fast enough to protect their assets before they are effectively margin-called and their collateral gets liquidated. Reactive Network offers automated protections against this

DeFi Lending

DeFi lending is on the rise. As more users onboard into Web3 and learn of the benefits of obtaining decentralized loans (versus the alternative of going to a bank), it is highly likely that these lending/borrowing mechanisms will continue to rise in both number of users and volumes.

One of the most common ways of lending/borrowing funds today is through the collateralization of assets. Would-be borrowers often must lock up 150% worth of assets before borrowing a corresponding loan amount (valued at 100%). That is, to borrow $100 worth of DAI, borrowers must lock up $150 worth of ETH before the DAI can be released for their use.

The Problem

Like all assets (real world and digital), values associated with those assets shift in value over time. In some cases, the asset values can shift dramatically, based on macroeconomic factors and other external market events. Even the most careful borrower may face volatility which they may not be able to plan properly for.

When collateralized assets suddenly depreciate significantly in value, the borrower becomes at risk of losing all of their collateralized assets if they do not react in time. That is to say, many lending protocols define a threshold which cannot be breached before such liquidations occur. Liquidations can be stopped if the asset value does not breach this threshold, and/or if the borrower moves in time to transfer more collateral to maintain their margin.

The Solution

No matter how diligent or careful the borrower may be, they would unlikely be able to monitor their position 24/7/365. In the end, some form of automation is required to ensure that their assets continue to be protected while the loan is outstanding.

Reactive Network can provide such automations. It works by listening for events on the blockchain, and reacting accordingly once a particular event has been emitted by a smart contract of interest.

Lending/borrowing contracts can be configured such that before liquidation levels are reached, the smart contract can send out a notification that collateralized asset values have declined in value by a certain percentage.

Reactive Smart Contracts (a key component of Reactive Network), can be configured in advance to provide emergency funding to the lending/borrowing contract. Such funds can be set to reinstate the contract to the initial threshold levels — and adverting a crisis of liquidation.

Additionally, an interesting alternative use-case also emerges assuming that the asset value recovers. That is, assuming that the depreciated asset eventually returns back to its initial levels, the lending/borrowing contract can also be configured to broadcast that the contract is over “over-collateralized”. Borrowers may want to take back some of their asset and deploy it in other ways.

Conclusion

While incredibly powerful, DeFi lending does come with certain risks. What we describe here is one of the more common ones, which involves the total loss of collateralized assets in a lending/borrowing contract.

Leveraging Reactoive Network, borrowers will be better protected against such losses. The timely notification of asset depreciation coupled with the instant reaction of RSCs to top up the collateralization ratio will help provide further assurance that the borrower is adequately protected through the life of the loan.