Overcollaterization: The Risk Aversion Protocol that Acts as Solvency Protection on Equilibrium
Obtaining business loans has been a source of concern in the financial sector for many years. It has become increasingly difficult for firms and people to obtain loans without having to overcome significant restrictions. Financial players impose strict constraints on loan access to ensure the security of assets. This is because there is a danger of the borrower not repaying the debt when lenders give mortgages, credit cards, or other sorts of loans. Similarly, if a company extends credit to a customer, the customer may default on their payments. As a result, borrowers must offer rated collateral assets to secure the loan.
Securitization of debt contracts has been away for financial organizations to reduce risk on their balance sheets in the financial markets. Furthermore, because investors have access to a larger pool of assets, it provides for better portfolio diversification. Securitization plays a vital function in increasing efficiency in this regard.
Similarly, just as in conventional financial markets, firms utilize over-collateralization, multi-collateralization, collateral fluidity, asset-backing, and many other strategies for capital security in digital asset lending and transactions. Equilibrium pioneered the technology that allows digital assets to be collateralized, transforming highly volatile cryptocurency into a stable store of value. This technology also gives crypto finance access to security measures that were previously exclusively available on the traditional market.
The user’s journey usually begins with locking value in a smart contract, regardless of the decentralized finance project. Defi now has a total value of $12.75 billion on several blockchains. Although this is a tenfold rise from mid-summer 2020, the Defi market potential remains untapped.
Among other challenges, an inadequate auction approach for eliminating bad debt is an issue with main Defi protocols. When the market begins to drop, selling collateral at a discount might be disastrous. It may turn out that, regardless of the discount, market participants are unwilling to buy a fast depreciating asset. It’s vital to remember that an undercollateralized loan’s risk remains on the system as long as the collateral isn’t liquidated. Risk-averse customers who hold collateral in the same pool may suffer losses, and the system may be shut down as a result. When the blockchain network becomes overburdened, the situation is worsened by rising transaction fees. Hence, you must pay expensive costs to transact rapidly.
Equilibrium suggests combining pooled crypto lending with a liquidity cushion for bailouts to create a more sustainable structure and connect the fragmented Defi industry. Users will be able to access Defi instruments that they previously utilized via different protocols all in one place at the same time. Equilibrium has developed technology to collateralize digital assets, allowing extremely volatile cryptocurrencies to be converted into a stable store of value.
What Is Equilibrium?
Equilibrium is a framework for creating digital asset-backed stablecoins supported by a user’s crypto holdings and tied to the US dollar. These stablecoins (known as EOSDT) are a price-stable cryptocurrency that participants can put into circulation via a collateralization procedure that utilizes their liquid digital assets.
The framework is overseen by a set of smart contracts developed on top of the EOSIO technology stack. These contracts, among other things, ensure that EOSDT is always over-collateralized and that its parity with the US dollar is maintained: 1 EOSDT = 1 USD
People can deposit and withdraw collateral, generate stablecoins, pay them back, modify their positions, or close them using the Equilibrium framework. EOSDT has several applications in addition to the collateralization function. A few examples include hedging against market volatility, offering fiat-like quotes for currency pairs on decentralized exchanges, and even conducting online payments with bitcoin merchants.
In Equilibrium’s system, there are four user roles: lender, bailsman, borrower, and trader.
- Pooled lending allows lenders to stake crypto assets and generate passive revenue.
- Bailsmen can their assets by securing loans in the system to earn extra premiums.
- Borrowers can use crypto to create synthetic assets or decentralized stablecoins, all with an APR that is calculated automatically.
- Traders can make cross-chain trades. There is no requirement to match counterparties because users only deal with blockchain networks of their choice (unlike in peer-to-peer systems).
Equilibrium desires to provide the groundwork for asset-backed stablecoins on several blockchains with smart contract compatibility. EOS is the first chain adopted since it has a promising infrastructure with cross-chain solutions and support for numerous forms of collateral for the EOSDT stable coin.
Overcollateralization on Equilibrium
Due to lessons learned from unsecured lending in the aftermath of the financial crisis, over-collateralization has become an industry-accepted risk management strategy. Equilibrium maintains a one hundred and seventy percent (170%) collateral backing, ensuring that the system always has adequate collateral to cover all outstanding positions. The project has a strong liquidity support level to provide adequate deposit holding for the highly volatile and unpredictable crypto market, as well as a high level of over-collateralization.
How does it work?
Anyone having a digital asset that is compatible with the Equilibrium framework can utilize a self-service gateway with a clear user interface to generate EOSDT stable coins. Although Equilibrium takes EOS collateral at launch, the broad idea is to provide support for a wide range of digital assets.
The deposited collateral is held in this state, and the user determines how much EOSDT to generate. These stablecoins are secured by collateral deposited in the position, which can be reclaimed by paying back the equal amount of EOSDT plus any fees incurred. The position holder can withdraw recovered collateral. Active positions are always overcollateralized, which means that the collateral value exceeds the value of the stable coins generated. The framework aims to keep the collateral-to-loan ratio at a minimum at all times.
Other Values of Equilibrium
● Stability: The soft price peg of the Equilibrium framework to the US dollar is the foundation of its stability, ensuring that one unit of EOSDT is always equal to one dollar.
● Reduced fees: The project charges two sorts of fees: an admin cost for paying down a position (which will be set at 1% when the framework starts) and an Equilibrium fee for taking market action against a stable coin holding (which will be set to 0 percent).
● Real-Time Monitoring: The Equilibrium framework requires real-time information regarding the market price of the collateral so that the system can determine when margin calls for an undercollateralized state.
● Risks are minimal: Equilibrium focuses on the market’s highest risk standards and has a comprehensive set of measures in place to mitigate the risks associated with the Equilibrium framework’s development, deployment, and operation.
Equilibrium enables the diversification of stable assets for crypto investors by giving them access to various protocols, assets, and platforms. Assisting a securitized procedure for the transaction of digital assets across chains through over-collateralization, while minimizing the risk and financial burdens. Equilibrium framework has also put in place in-depth technical descriptions of a range of blockchains that allow smart contracts, as well as how-to instructions, developer tutorials, and recommendations for EOS and other blockchains developers.
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