DeFi Communities Take Extreme Measures As Cryptocurrency Liquidation Risks Rise

The record-breaking cryptocurrency rout has put a slew of decentralized finance apps and their communities in a race to protect themselves against a cascade of liquidations – sometimes employing unprecedented measures.

On Sunday, tokenholders of Solend, a lending app on the Solana blockchain, voted to temporarily take over the account of a large user who was facing the threat of a large liquidation, an extreme move for DeFi that appears to be a first. A day earlier, MakerDAO, an app that supports stablecoin DAI and is run by a crypto community that formed one of the first decentralized autonomous organizations, suspended depositing and minting of the token on crypto lending platform DeFi Aave.

DeFi applications – in which users can trade, borrow and lend to each other without intermediaries like banks – suffer because they tend to be interconnected, and problems with one can have cascading effects on the others. Users often pledge tokens as collateral to borrow a coin in one app, to deposit for higher returns in another. When crypto prices drop, as has happened recently, it can trigger margin calls on collateral, and users who don’t fix this by adding more collateral are liquidated in a software-triggered process. and executed by robots designed for this purpose.

Read more: Crypto traders are turning on each other in a crashing market

When a user is ready to be liquidated, these bots – run by programmers and third-party traders – jockey to liquidate positions so they can earn a bonus for doing so, a common practice in DeFi. As many bots compete with each other to liquidate a position, this can clog a blockchain with transactions. Meanwhile, a dumping of a slew of coins by liquidators may also put further pressure on token prices, causing another cascade of liquidations. By intervening, DeFi communities are trying to avoid all of this.

“Many DeFi protocols are reducing counterparty exposure during this volatile time,” said Paul Veradittakit, partner at Pantera Capital.

DeFi app communities are also stepping up to make sure their apps aren’t damaged by things like bad debts: if a liquidator can’t sell illiquid tokens, or if token prices crash over time. as they are sold, applications may end up being liable for refunds.

In the case of Solend, holders voted overwhelmingly in favor of a proposal to temporarily take over a heavy user’s account after the app unsuccessfully contacted the user, bringing the threat of a mass liquidation closer. If a wave of bots began competing to trigger the liquidation, the proposal stated that “it could cause chaos, putting a strain on the Solana network.”

By taking over the account, the Solend team could attempt to liquidate the position in a way that the price of the liquidated tokens would be less affected, through an over-the-counter sale with a specific buyer rather than on a DeFi exchange . But the move is highly unconventional, breaking DeFi standards and making some on Crypto Twitter cringe. And, a single crypto address accounted for the lion’s share of tokens that voted for the proposal, apparently undermining for some the idea of ​​“community” espoused by DeFi.

The move comes a day after MakerDAO, an app that supports stablecoin DAI, suspended depositing and minting of the token on Aave’s crypto lending platform due to Aave’s exposure to a derivative. troubled Ether called stETH, which became illiquid. The suspension prevents traders from borrowing DAI against stETH. On Aave’s governance forum itself, users are hotly debating how to reduce the risk of stEth, which according to DeFi risk tracker Gauntlet “may pose additional risk to the protocol.”

The DeFi app pain was sparked after centralized crypto lenders Celsius Network and Babel froze deposits, and the rumored collapse of the Three Arrows Capital fund, which drove crypto prices down double digits over the past of the last seven days. Celsius has worked with many DeFi applications to achieve high returns. About 30% of all stEth blocked on Aave, for example, comes from Celsius, according to researcher Novum Insights. Three Arrows Capital, meanwhile, was an investor in Lido, which issued stETh, and is debating a change in how it is governed.

As reported by DeFi Llama, the total value locked in DeFi, the amount of crypto used on apps, plunged to $70.6 billion from $205.7 billion on May 5, just before the implosion of the Terra blockchain triggers the biggest crypto crisis of the year so far.

This story was published from a news feed with no text edits. Only the title has been changed.

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