DeFi backfires on market panic

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There have been some disturbing trends in crypto lately, but one in particular caught my attention last week. Solend, the Solana-based lending platform, passed a government vote to take over a private wallet.

The private wallet (now called “whale”) deposited 5.7 million SOL, currently worth $200 million, on the lending platform. Against this position, the whale borrowed $108 million worth of stablecoins. The 5.7 million SOL tokens represented more than 95% of the total deposits on the platform.

The problem arose when Solana’s price fell alongside the broader market, significantly reducing the value of the whale’s collateral and bringing into play a potential liquidation scenario. In this case, the market would be flooded and could crater the value of the Solana token.

“In the worst case, Solend could end up with a bad debt,” Solend said. “It could cause chaos, straining the Solana network.”

Consequences of liquidation

Plotting this amount of SOL against trading volume highlights the impact this would have on the market, with the bots triggering effects on DEXs likely further exacerbating the downward pressure caused if this wallet floods the market.

 

The liquidation price of the loan is $22.27, which would require a 35% drop from current prices to trigger. Although this is a substantial drop, Solana has fallen 80% this year alone and a 35% drop from here is far from inconceivable – and she came very close then that Solana dropped last week to $25.

 


Protocol attempted to reach out to the whale and ask it to top up the loan, but there was radio silence as the wallet was inactive for almost two weeks. Thus, a vote passed and the protocol voted to temporarily take over the portfolio of the whale and reduce risk to the protocol.

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After taking over the wallet, the plan was to liquidate the whale via OTC trades, rather than risk cascading contagion by liquidating on-chain via the automatic mechanisms.

Since then, the whale has transferred $25 million to Mango Markets, limiting the destruction that would be caused to Solend if the liquidation were triggered.

However, while this reduces the Solend Protocol’s vulnerability, the threat of liquidation remains, which means Solana is very nervous.

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But let’s stop thinking about it for a second.

Previous

I understand the protocol didn’t end up taking control of the wallet because the wallet independently pulled out, but the vote passed and that was the plan. It should also be noted that following intense backlash on Twitter, another vote was passed on Solend to reverse the previous vote.

But this is the exact opposite of what cryptocurrency is supposed to be: decentralized, censorship-resistant, and trustless.

And with the previous set, where is the line drawn? Which accounts could potentially be taken over? Can large accounts band together to take over small accounts and siphon off their funds? Can protocol owners claim assets from wallets if they believe they are acting in a way inconsistent with their vision?

The reality is that anything is possible because it’s centralized, and a dangerous precedent has been set. Ironically, this is essentially the main reason for the invention of cryptocurrency in the first place – to combat the dangers of centralization. If Bitcoin founder Satoshi Nakamoto is anywhere, he must recoil in horror.

Whale

It’s unclear who the whale is, but they were harshly let down by protocol. They deposited this money on the pretext that they could take out a loan and do whatever they wanted. Now the owners and protocol have stepped in to confiscate this privilege to protect the price of their token. Money talks, huh?

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It turns out that the protocol is not a trustless peer-to-peer protocol. Instead, it is a centralized borrowing platform that forces investors to trust owners and other users. The goal posts were not moved, but instead were completely dismantled.

It is not decentralized finance. Instead, it is still very centralized finance.

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