Cygnus is a decentralized stablecoin and leveraged yield farming protocol for LPs to increase their farming yields. By using their LP Token as collateral, LPs can borrow up to 8x their LP Token value without ever having to leave the farm they are already in.
In this part 2 we show how Cygnus works for both lenders and borrowers and the mechanics behind our under-collateralized model.
Under-Collateralized Loans for LPs
Unlike other lending platforms, with Cygnus LPs can take out a loan more than 5x their LP Token value to farm more without ever leaving their farm. By increasing their position in the liquidity pool, LPs earn a higher percentage of trading fees and yields.
Other lending platforms usually require borrowers to deposit and lock collateral to take out a loan that is less than the collateral itself. This way, the lender is always assured to get their loan back. If the collateral drops in value or the loan value starts increasing relative to the collateral, anyone on the network can liquidate the loan (meaning pay back the loan) for a part of it and keep some profit.
By depositing collateral and taking out a loan in these platforms, the borrower gets full custody of the funds in their Metamask (or whichever wallet they use) and are free to use the loan however they choose to (use in other protocols, withdraw, etc.).
This model works well, but we outlined some of the problems in Part 1. As DeFi continues to grow, relying on an over-collateralized lending model means an ever increasing amount of capital-inefficient collateral which is at best earning minimum interest and at worst decreasing in value.
Cygnus Model
To provide under-collateralized loans safely, LPs can deposit their LP Tokens as collateral and use Cygnus to automate their yield compounding and loan repayment. The loan, unlike in the previous model, never leaves the protocol. It is only to be used strictly by smart contracts and the user never gets the funds in their wallet. If they wish to exit their position, they can only do so by de-leveraging (repaying) the loan or waiting for Cygnus to pay back the loan automatically.
To be able to do this Cygnus consists of 3 core mechanisms:
- Individualized Lending Pools
- LP Token Pricing Oracle
- Liquidators
1. Individualized Lending Pools
To provide under-collateralized loans safely, Cygnus consists of individualized lending pools which are connected to a specific farm in a DEX.
Funds in each pool are isolated from the rest and each have different Supply APR (for lenders) and Borrow APRs (for LPs) based on our interest rate model and the utilization rate of each pool. The main benefit of individual lending pools is that risk is mitigated for lenders in case another lending pool becomes corrupted or attacked by malicious actors. The funds in all other pools are always safu.
Total Value Locked (TVL): Total $ amount locked in the pool
Volume: Volume in the last 24 hours
Lend APR: The return for lenders
Borrow APR: Interest rate for the loan
Utilization Rate: cash borrowed / total cash in the pool
Farm APR: The farm APR without leverage and below the returns for borrowers
2. LP Token Collateral
Cygnus loans are backed by LP Tokens. This means the user never even has to leave the farm they are in, they can access more liquidity simply by using Cygnus.
Since LP Tokens are just a receipt of what users are owed from a liquidity pool, we can calculate how much they own from the pool, and therefore, how much the LP Token is worth. By using a simple Time-Weighted Average Price oracle (TWAP) Cygnus can calculate the price of LP Tokens. To find out more, read UniswapV2’s implementation documents.
Since oracles have been a common attack vector in DeFi due to so many things dependent on them, Uniswap provides a solution which is resistant to price manipulation and has been proven to work as long as the time window (cost of the attack) between each price update is long enough to offset the profit of the attacker. Delphi Digital report on “Attack Cost and Profit from Manipulating Constant Product Market Maker TWAP Oracles in DeFi Protocols” provides a clear understanding on the cost and profitability of attacks on TWAP Oracles.
3. Liquidators
With these previous 2 mechanisms Cygnus is able to:
1) Create individualized lending pools for lenders who wish to “invest” in only certain tokens they trust.
2) Put a price on LP Tokens.
With these, Cygnus is able to provide under-collateralized loans to farmers who wish to borrow without disrupting their investments (never leaving the farm). If the LP Tokens increase in value, now farmers are able to pay back the debt quicker or even borrow more, as their position is now much higher relative to their debt previously. If the LP Token decreases in value, lenders are guaranteed their loans back, as anyone on the network can liquidate debts for a profit.
Liquidators act in a permissionless fashion and anyone can liquidate any loan that goes underwater. As such, it is important for borrowers to always keep track of their Debt Ratio (Collateral / loan + collateral). Users can do so on the “My Positions” section or the main overview page of our dApp for a quick look:
Once this Debt Ratio crosses a certain point, their loans are up for liquidation. Liquidation means that anyone can repay the loan to the lender and take a cut from the collateral posted, while the rest of the collateral goes back to borrower. Cygnus uses a 4% liquidation incentive to keep the system healthy and provide security to lenders. This means that borrowers can lose 4% of their LP Token and get back the other 96% in case of liquidation, but the returns by leveraging can be much higher using our model.
Conclusion
In our previous Part 1 of our 3 part series we explained what Cygnus is trying to solve. In this Part 2 we outline how Cygnus works using individualized lending pools, price oracles for LP Token pricing and liquidation incentives to keep the Cygnus ecosystem healthy.
In the next part, we will outline our Interest Rate model. In DeFi interest rates are mostly set by a utilization rate, where as utilization increases so does the interest rate paid by borrowers. In traditional finance, the interest rates are mostly based on risk assessments, but we can see how that model in an anonymous and decentralized ecosystem would be hard to put to work. Instead, Cygnus uses a model based on utilization rate and the Farm APR the DEX offers, using the natural log of each farm to determine interest rates (the higher the farm APR the DEX offers, the higher the interest rate).
We will release part 3 soon, so please follow us on Twitter to be up to the latest Cygnus news 😎!
🐦 Twitter: https://twitter.com/cygnusdao
