Borrowers must over-collateralise their position by a loan to value (LTV) ratio specified by governance. Balanced launched with a 25% LTV requirement. For example, if a borrower deposits $100 worth of ICX, Balanced will give them the right to mint up to 25 bnUSD.
If a borrower exceeds the LTV requirement, the borrower no longer has the right to withdraw collateral from the network. The borrower will not have access to their collateral until they drop below the required LTV.
While exceeding the LTV requirement locks collateral, exceeding the liquidation ratio will result in permanent loss of the borrower’s collateral and the closing of their debt position. The liquidation ratio was 66.67% when Balanced launched, and is subject to change via governance. It’s currently set at 85% LTV, or a collateralisation ratio of 118%.
ICX has a built-in reward rate for staking and voting on the ICON Network. Because of this feature, participants would be reluctant to use their ICX as collateral and miss out on these rewards. To solve this problem, ICX collateral will first be deposited into a staking and voting smart contract (staking pool).
When someone deposits collateral into the Balanced collateral pool, the ICX first gets converted into sICX (staked ICX), then sICX is deposited as collateral. sICX is a public utility smart contract for the ICON Network and is used in various protocols.
The amount of sICX received is a function of the amount of ICX in the staking pool and the total sICX outstanding. The amount of sICX received for deposits into the staking pool will be based on this formula:
Exchange rate of sICX = ICX in staking pool / total sICX outstanding
Figure 1: $400 of ICX being converted into sICX
The ICX in the staking pool will be staked and delegated. I-Score will be claimed, ICX will be re-staked, and re-delegated every time someone deposits ICX into the staking pool. Balance Token holders will have the ability to direct delegations of the staking pool to specific nodes (P-Reps) on the ICON Network.
1 sICX will always have the claim to its pro-rata share of the ICX in the staking pool. For example, if somebody holds 10% of all sICX, and there is 500,000 ICX in the staking pool, this person can convert their sICX into 50,000 ICX. When converting sICX into ICX, the ICX will not be received until the unstaking period is complete or new ICX deposits are added to the staking pool. The unstaking period varies on the ICON Network, and can range anywhere from 5 days to 20 days. Given the lengthy unstaking period, Balanced will also provide a decentralised exchange (DEX) to provide immediate liquidity for swapping between sICX and ICX for a nominal fee.
The Stability Fund is a simple but powerful mechanism to create clear arbitrage opportunities for traders. These arbitrage opportunities incentivise traders to stabilise the value of 1 bnUSD. Balanced approves specific stable assets and offers a fixed exchange rate for bnUSD (and vice versa).
This process enables Borrowers to receive the benefits of leverage without relying on outside lenders. bnUSD can be minted and traded by borrowers of volatile collateral, all while knowing bnUSD will remain stable because of the arbitrage opportunities offered by the Stability Fund.
The Stability Fund can absorb most price fluctuations of bnUSD, however, the rebalancing mechanism is in place if the Stability Fund can't support enough redemptions.
Borrower positions are used to ensure the buying power of bnUSD against collateral types within a certain range from the outside market price. This range is adjustable via governance action, but at time of writing the range is set to +/-10%. The outside market price for this purpose comes from BAND oracles.
Rebalancing has two effects on borrower positions:
1. It will sell collateral for a premium when collateral is too expensive on the DEX relative to other markets, then use the bnUSD proceeds from the sale to repay the borrower's debt at a favourable rate.
2. It will mint additional bnUSD free-of-charge on behalf of the borrower when collateral is too cheap on the DEX relative to other markets, then use that bnUSD to buy more collateral at a discount.
In both situations, borrowers neither gain nor lose any value.
- If $5 of their collateral is sold, then more than 5 bnUSD of their debt will be repaid.
- If $5 of collateral is purchased for them, then less than 5 bnUSD of debt will be added to their position.
- In all situations, borrowers will be making a beneficial trade compared to outside markets.
Every time a rebalance occurs, a group of 50 borrowers is rebalanced on a pro-rata basis, according to their relative debt within the group. Only 0.05% of the group's combined debt can be adjusted in each transaction.
Price of ICX/USDT on Binance = $2
Price of ICX/bnUSD on the Balanced DEX = $4
In this situation, bnUSD is only worth $0.50. Or put another way, its purchasing power is half that of USDT.
To remedy this situation, borrowers will have their collateral sold at this high price of 4 bnUSD until the price of ICX/bnUSD on the Balanced DEX is closer to the price of ICX/USDT on Binance. The bnUSD proceeds from the sale of their collateral will be used to repay their debt.
If a borrower drops below the liquidation ratio of 118% (above 85% LTV), the borrower will permanently lose access to their remaining collateral. Their unpaid debt will be tracked and referred to as bad debt. The collateral will be held by Balanced to field redemptions of bnUSD and pay off the bad debt. This provides a clear incentive for borrowers to begin paying off their debt or depositing more collateral if the price of their collateral begins to fall.
Liquidated collateral will be set aside into a forced liquidation pool and will be used to honour redemptions of bnUSD if bad debt exists.
Activating a liquidation must be handled by users because Balanced is structured as a DAO. If Balanced proprietary software activated liquidations, Balanced would be a single point of failure for the network. Therefore, Balanced offers a monetary incentive to those alerting the network that an individual borrower is eligible for liquidation.
Additionally, those that redeem the liquidated collateral by retiring bnUSD will receive the collateral at a fixed discount. Keep in mind that liquidated collateral will be approximately 118% of the bad debt. Here are the details for the gamified liquidation:
- The reward for triggering a forced liquidation will be 0.67% of the collateral
- The bonus for retiring bnUSD against the forced liquidation pool will be up to 10% of the bnUSD retired
Bob has $235 of collateral, but 200 bnUSD of debt. Bob’s collateral ratio is currently 117.5%, which is below the forced liquidation ratio of 118%.
Alice notices Bob is below the forced liquidation ratio, and sends a transaction to Balanced to trigger a forced liquidation. In exchange for this work, Alice will receive $2 of Bob’s collateral (0.67% of Bob’s bad debt) before it goes into the forced liquidation pool.
The forced liquidation pool now has $233 of collateral, and Balanced now has 200 bnUSD of bad debt. Meanwhile, Charley has been holding bnUSD waiting to earn rewards for paying off the bad debt of others. Charley uses 200 bnUSD to retire the 200 bnUSD of bad debt, and in exchange, receives $220 worth of collateral, an extra 10% (200 x 1.10).
While the economic design of Balanced is equipped to handle extreme fluctuations in the value of volatile collateral assets, Balanced must still be prepared for the worst case scenario. In order to handle edge cases, such as extreme price drops in short periods of time, Balanced employs an emergency reserve fund and a concept known as dead markets.
In extreme circumstances where the value of bad debt of a particular pegged asset is greater than the value of the forced liquidation pool, an emergency reserve fund will be made available for outside traders to be compensated for paying off bad debt. A percentage of Balance Tokens mined on a daily basis are sent to the emergency reserve fund, along with leftover collateral from liquidations.
If the net bad debt, defined as bad debt minus the value of the forced liquidation pool, is greater than half the total supply of bnUSD, bnUSD will be marked as a dead market. Dead markets can be revived when the aforementioned situation is no longer true.
When marked as a dead market, the bad debt of bnUSD will be paid off over time by the emergency reserve fund, and no new originations of bnUSD can occur.