The Fundamentals Of Equilibrium
DeFi is a meaningful solution for making your crypto assets work for you. Dozens of Ethereum DeFi primitives are designed to do exactly that. So the question becomes: which platform should you choose?
You would want a platform capable of all the same things as Ethereum DeFi primitives. But if that platform should also add true cross-chain functionality and eliminate risk at the same time, it becomes unignorable.
These killer features are par for the course for Equilibrium. We are the first interoperable cross-chain money market on Polkadot to combine pooled lending with the ability to generate and trade synthetic assets.
We’re going to break what this means and how it all works in an explanatory series of articles. We’ll cover the advantages of our platform, how our EQ token works, and why our bailout mechanism is better than the usual auction for liquidating debt.
First up is this big picture explanation of how our platform works, and why it’s an improvement over other solutions.
Bringing DeFi’s bright, interoperable future to life
Those paying attention to crypto already know that DeFi, or decentralized finance, is the space’s big-deal breakout niche. DeFi is about using crypto methodologies and blockchain technology to reduce the number of intermediaries in a financial transaction and shifting control of user funds back toward the user again.
It’s an exciting premise, and we believe it’s the future of finance.
That’s why it should come as no surprise that the DeFi market has so far captured over $14 billion of disparate cryptocurrencies like Bitcoin, EOS, and more. (ETH accounts for some 80% of the DeFi market despite representing just 12% of the overall crypto market.) These siloed assets are tied to dedicated blockchains that mostly lack the ability to communicate with or transact with each other.
This is no problem if you hold the particular asset that a DeFi project calls for, but it recasts that impressive $14 billion lump sum as several smaller piles of incompatible crypto that don’t know how to work together.
It begs the immediate question: what if they did work together? That’s why the word “interoperability” comes up rather often in DeFi conversations. Interoperability refers to adaptive crypto infrastructure that makes it possible to send a token from one blockchain to a wallet address on a completely different blockchain. An interoperable fintech platform can transact across otherwise incompatible blockchains.
Interoperability unifies the fragmented DeFi market into a cohesive $14 billion economic force. It lets people transact in the currencies that they want without concern for what currencies the other party receives. They can furthermore lock collateral on one blockchain network in order to get a loan on another.
These are the problems that Equilibrium solves. Powered by Polkdadot, Equilibrium uses a Substrate-based engine and cross-chain bridges to drive interoperability for DeFi liquidity pools. It unites these pools into a decentralized lending platform complete with advanced price discovery and bailout mechanics. Whatever transaction you need to conduct across whichever blockchains, Equilibrium’s technology can make it happen.
EQ: Equilibrium’s core asset
The figurative star of the Equilibrium show is the EQ token, which works as bailout liquidity and collateral for loans. As collateral, EQ allows for raising liquidity in assets of the user’s choice, including Equilibrium’s native USD-pegged stablecoin. As bailout liquidity, holders can earn a decent return on it.
EQ tokens can also be used as a platform currency for paying fees, or as the means to gain access to Equilibrium’s decentralized governance system. This token is also a native asset for Equilibrium’s Parachain, which implies other use cases like voting for block producers and paying transaction fees.
These functionalities (not to mention the opportunities for liquidity farming) make EQ rather comparable to Synthetix’s SNX, one of the most popular DeFi tokens out there. EQ is cross-chain compatible and will first be ported to Ethereum — we may potentially launch a Uniswap pool there.
User roles in Equilibrium
Equilibrium users adopt roles within the ecosystem in order to make the platform function. Most of these roles have names from conventional finance: traders, lenders, and borrowers. But we also introduce a completely new role in the DeFi space called the bailsman.
Here’s what you need to know about each of them.
This user role is unique to Equilibrium. Bailsmen carry the risk of the system by using their own assets to secure loans, and they earn passive income for their role in doing so. Bailsmen assets are unified in one liquidity pool where they share the overall system risks and losses. This is especially relevant to institutional liquidity providers, who got used to taking risks managing diversified portfolios of crypto assets and want to earn additional yield beyond interest for lending.
Lenders stake their crypto assets from various blockchains connected to Polkadot and earn passive income via pooled lending. They can lend out a fraction of their holdings to other users who would like to borrow it for selling short or for fulfilling obligations with a third party. Lenders do not bear any risk of liquidation. Instead this risk goes to the bailsmen, and lenders always get their loaned asset back. Depending on the liquidity conditions of the bailsmen pool, they may also get or the value of their loaned assets back in stablecoins.
Borrowers can borrow major crypto assets and generate synthetics or decentralized stablecoins, all with an automatically determined APR. When they default on their debt, that collateral gets redistributed amongst the bailsmen on a pro-rata basis according to their relative liquidity in the pool. Borrowers can supply various crypto assets as collateral via cross-chain wrapping, and each one pays a floating rate fee based on their collateralization ratio, particular portfolio, and associated volatility risk.
Margin trading is the main feature of the platform. Traders can open leveraged positions up to 100x and execute cross-blockchain trades as they see fit.
Equilibrium has set aside 12 million EQ tokens (10% of the overall supply) in order to encourage crypto users to bring assets into our DeFi money market. The liquidity farming pool will distribute EQ tokens to borrowers and bailsmen alike, based on their relative liquidity size. The aim is to evenly distribute the entire allotment of 12 million EQ tokens over a period of three years.
Users can lock their tokens into smart contracts that work as “bridges” to other blockchains. These smart contracts can then use staked assets to generate additional rewards from inflation-based economies, which is common in proof-of-stake systems.
Users can lend out a fraction of their holdings to others who want to borrow it. The primary difficulties to overcome here are the depletion of the lendable asset and the lender’s inability to leave at their will when this happens. They must either wait for a sufficient number of borrowers to bring the asset back to the pool, or for new lenders to add collateral to the pool for lending. They can otherwise instantly unwind their position against the reserves.
Equilibrium’s lending functionality grants users the choice of becoming bailsmen by setting a corresponding flag when providing cross-chain liquidity.
Borrowers will pay a floating rate fee based on their collateralization ratio, particular portfolio, and associated volatility risk. Crypto assets carry a volatility risk, so when borrowers use them as collateral, it requires additional collateral and a fee.
We expect borrowers to supply various crypto assets as collateral via cross-chain wrapping, and we’ll consider their overall collateral portfolios rather than treating each collateral token separately. This is a common shortfall in DeFi behemoths like MakerDAO and Compound.
Synthetic assets and decentralized stablecoins
In practical terms, a synthetic asset is a collection of cryptocurrencies that can maintain the same value as another asset. Decentralized stablecoins (commonly pegged to major fiat currencies like USD) are price-steady cryptocurrencies that enter circulation when a user collateralizes their digital assets. Equilibrium lets users play in both of these arenas.
Outside of borrowing from pools of actual crypto assets, users may also avail themselves of so-called “virtual pools” of native USD-pegged stablecoins and assets that track prices of other assets and commodities. These products also make use of the core system components as on-chain risk management, programmatic interest, and bailout mechanics.
Bailouts are an additional opportunity for liquidity providers to earn additional income for their participation in the Equilibrium ecosystem. On other platforms, they can only earn by lending assets.
Hungry for more?
Our next article will break down the advantages Equilibrium offers over more established players in the space. From there we’ll go into how our EQ token works and why our bailout mechanism is better than the usual auction for liquidating debt. We’ll be getting into the details of the EQ token, Equilibrium’s governance system, and its risk model. Check out the outline of our series:
- The Fundamentals Of Equilibrium
- Advantages of Equilibrium
- How Equilibrium’s Stablecoin Works
- Key Functionality of The EQ Token
- Bailouts: The New Normal For Managing Debt In DeFi
- Equilibrium’s Risk Model
- Equilibrium’s DEX
- Liquidity Farming