Cryptocurrency: Solend explained by ByBit - "The platform’s main goal is to decentralize lending."
ByBit Analysis 27.11.2022 19:43
Since its launch, Solend has been garnering the market’s attention. An algorithmic, decentralized protocol for lending and borrowing built on Solana, Solend opened gateways for Solana users to increase the methods they can employ to profit from the market. With prominent investors such as Dragonfly Capital, Polychain Capital, Balaji Srinivasan and many others, Solend gained remarkable traction, achieving $100 million in deposits just over a month after launch, achieved even prior to liquidity mining opportunities.
In late June 2022, Solend once again grabbed the front page of several financial news sites. However, this time the reasons weren’t as favorable. Concerns regarding the liquidation of a whale account on Solend left Solana users panic-stricken about a potential major crash, sparking intense discussions. Recent developments around FTX, the troubled centralized exchange, have also had an impact on Solend.
In this article, we’ll explore what Solend is, how a major crash almost occurred, and the impact it’s suffered from FTX’s downfall.
What Is Solend?
Solend is a decentralized finance (DeFi) lending platform built on the Solana network. It allows users to borrow or lend assets, using an algorithmic method to determine interest rates and collateral amounts.
The Solend protocol was first launched in August of 2021. At that time, Solana’s popularity was increasing due to its speedy transactions and low fees. The addition of a lending protocol to the Solana ecosystem attracted a lot of market interest. Users can now earn higher returns than before.
How Does Solend Work?
Solend starts with a fairly basic premise: Users can deposit assets to their Solend accounts to earn interest. They can also use these deposits as collateral to take out loans. The platform’s main goal is to decentralize lending.
Borrowers don’t need to take out a formal long-term loan, or justify their need for it. Instead, the platform enables them to take short-term loans with simpler deposits and no lengthy underwriting process. Smart contracts automatically assign lending limits and collect interest.
In order to use Solend, users need to have a Solana wallet. The SOL crypto asset is the backbone of this Solana-based lending protocol. Users can move to different denominations if they want, but SOL is the native currency for the platform. Solend has various "pools" of available crypto assets that operate with different currencies. For example, the Stable Pool lets users lend or borrow cryptos like USDC and USDT, while the Main Pool lets users work with all 20 of the crypto assets the platform currently supports.
Once users have their Solana wallet connected to the lending platform and they’ve added SOL to their account, they can begin borrowing or lending various types of crypto. The Supply option lets users look at how much interest they can earn, while the Borrow option tells users how much they can borrow with their current crypto stake.
Each loan that users take has a liquidation threshold. If crypto values alter in a way that causes the loan to cross the liquidation threshold, users’ assets can be liquidated. The funds then go to the lenders as collateral for the loan.
Key Features of Solend
There are many other similar DeFi lending platforms, such as Compound and Aave, but Solend’s Solana-based lending protocol has some special features that set it apart.
Low Transaction Fees
Many users find Solend helpful for investing because it has low transaction fees. You can quickly borrow and sell crypto without getting hit with excessive transaction fees. Most of the platform's fees are just protocol fees you pay with each loan. These fees contribute to an insurance fund for the platform.
Typically, the fee is set at around 10 bips, though it can vary slightly depending on which vault you use. There are also fees you pay for any Solana network transactions. The first time you interact with the network, you pay a 0.01 SOL fee. Then, for every subsequent transaction, you pay a low fee of around 0.000005 SOL. These fees are much cheaper than transaction fees on most other sites.
Increased Scalability and Connectivity
Unlike many other lending platforms, Solend prioritizes scalability. It doesn't require users to stick with one type of crypto, or conduct only low-level transactions. Users can leverage a wide range of crypto assets, with more being added to the platform regularly. You can choose from a variety of cryptocurrencies, such as native coins, stablecoins and meme coins, so there’s certainly a lot of versatility.
Good User Experience
Despite Solend’s many features, its network isn't confusing to use. One of its most impressive aspects is its streamlined dashboard. Well-organized and visually pleasing, it’s intuitive to use. Most people can get started without requiring extensive tutorials, or confusing statistics that can cause investors to make errors.
A lot of Solend's success may be linked to its referral program, which the network launched so that current users can encourage others to sign up through a referral link. The original user receives a small financial bonus when a new user participates. Right now, the financial incentive is set to 20% of each loan's origination fee.
Risks of Using Solend
Though the platform has some great perks, using it also comes with some potential problems. Before investing in any Solend strategies, there are a few risks you need to be aware of.
Solend’s liquidations are powered by the price feeds of Pyth Network and Switchboard. These oracles may report incorrect prices, causing wrongful liquidations to occur.
Smart Contract Risk
Given that Solend is an algorithmic, decentralized protocol, the crux of its operating system lies in smart contracts that facilitate the borrowing and lending of crypto assets. However, like any other type of software, these contracts can be a point of vulnerability. They could, for instance, potentially be exploited to steal or permanently freeze funds.
Note that such risk is inherent to all smart contracts. Despite the fact that this risk cannot be fully eliminated, there are some methods and steps taken to mitigate it:
Solend’s smart contract has undergone a code audit by Kudelski Group, an independent security firm.
Bug Bounty Program
Solend has incorporated a bug bounty program, which pays up to $1 million if a user identifies a critical vulnerability in the code. This incentivizes responsible disclosure instead of hacking.
Solend’s treasury of $20 million can be used as insurance for the Main Pool, should any exploits or hacks cause any of the protocol’s funds to be lost.
100% Utilization Risk
Solend's lending protocol only works when users are depositing crypto assets for others to borrow. If there are no crypto assets left in the pool — which would be the case should 100% of the crypto asset be lent out — any future withdrawal or borrowing becomes impossible. This is called 100% utilization, and it can occasionally be an issue.
This problem is resolved as long as users pay back their loans, or more users supply crypto assets to the pool.
Solend offers over-collateralized loans, meaning that each loan the platform offers must be backed by collateral that’s worth more than the loan itself. However, collateral value is constantly shifting.
If your collateral's value drops, asset LTVs may determine that your loan is below the threshold. At this point, you can either add more collateral or let your existing collateral be liquidated. However, liquidating your position incurs a penalty. If you aren't paying close attention to your loans and investments, there's a chance you could end up accidentally losing your loan — and having to pay the liquidation costs.
Bad Debt Risk
People who lend on Solend’s platform may potentially run into situations where their loans cannot be covered. This can happen during large-scale liquidations or periods of market turmoil. When a lot of assets are liquidated at once, their worth may not be enough to cover the user’s loans, resulting in a negative balance known as bad debt that can harm the lender.
To manage this risk, Solend uses isolated pools to isolate newer or riskier crypto assets. These pools are used to screen crypto assets that have less liquidity and higher volatility, which creates an exploitable opportunity and is deemed a risk for the main pool. In addition, deposit limits and collateralization ratios are also managed for this group of crypto assets.
Any bad debt created is filled via the insurance fund. However, this insurance fund is topped up by transaction fees, a source which isn’t limitless and can potentially run out.
Tough 2022 for Solend
In 2022 alone, Solend has faced multiple tough situations, partly due to the volatile market conditions and the fallout from big institutions failing, which has caused various crypto assets to suffer in price. Here are the three main issues that Solend has had to deal with.
Solend’s Oracle Exploit
On November 2, 2022, Solend was struck by an oracle exploit, resulting in $1.26 million in bad debt.
Three of its pools — Stable, Coin98 and Kamino USDH — were affected, since the exploit revolved around the Hubble stablecoin (USDH). As a result, these three pools have been disabled, and the exploiter’s address has been made known to exchanges.
FTX’s Downfall and Its Impact on Solend
The current downfall of FTX, the giant CEX, has thrown the market into turmoil. Given that the Solana ecosystem had close ties with Sam Bankman-Fried (SBF), the founder of FTX, the total value locked (TVL) of the DeFi ecosystem has taken a beating, partly attributed to the free-falling price of SOL.
There’s also been an impact on Solend, which had a TVL of over $280 million on November 2 and has since dropped all the way down to $28 million at the time of this writing (Nov. 23, 2022). This is a result of users withdrawing from the protocol, as well as the decreasing price of SOL.
In addition, Solend was faced with an issue pertaining to the liquidation of a whale account. An unidentified whale who had borrowed $44 million against $51 million worth of SOL had to be liquidated, due to the drop in value of SOL collateral. However, on-chain SOL liquidity had taken a huge beating when the price plummeted 43% in 48 hours, and Solend had difficulties liquidating the whale’s account.
In an attempt to attract depositors and incentivize borrowers to repay their loans, thereby improving liquidity, the team at Solend tried to resolve this situation by raising the interest rate on SOL to more than 2,500%. In addition, they also created a Binance account to process the SOL liquidations, since the SOL liquidity was deeper on Binance as compared to the Solana chain itself.
Despite the commendable efforts from the Solend team, which expedited the liquidation of the whale account, Solend now sits with a bad debt of $6.5 million. As Soju, Head of Business Development at Solend, wrote in Solend’s Discord channel, “It’s looking very bad now” as the situation had yet to be fully resolved.
The Near Crash of Solend
Prior to FTX’s downfall, Solend had encountered difficulties with regard to another whale liquidation in late June 2022. This particular incident took the DeFi space by storm, was intensely discussed by the Crypto Twitter community and appeared in news stories.
One of Solend's key vulnerabilities is that users join together to create a lending pool. This can lead to problems when a single borrower, called a whale, has an outsized presence within the Solana-based lending protocol. The June crash involved a whale borrower who had an outstanding loan of $108 million worth of USDC and USDT. The borrower's stablecoin loan was backed by $170 million worth of SOL in their Solana wallet.
The whale's loan was the largest single-user loan on Solend, taking up a huge portion of the lending pool. This was fine — as long as SOL prices were high. However, when SOL prices started tanking around June 15, this huge loan became a problem. SOL prices were dropping to $27, so the whale's loan was quickly approaching its liquidating threshold.
Solend’s Developers Try Notifying the Whale
When Solend's developers noticed this issue, their first plan was to notify the lender of the impending liquidation. At this point, another one of the platform's vulnerabilities became apparent: Solend is entirely anonymous, so there’s no way to contact a user — outside of sending a message to their account. Unfortunately for the developers, the whale wasn't checking the messages sent to their own account.
If SOL's price were to reach $22.30 without the whale taking any action, their collateral would have to be liquidated, resulting in over $21 million of SOL being dumped at one time. Users feared a serious amount of fallout for the market. Though SOL is a fairly robust blockchain, with a market cap of around $11 billion, such a huge sale would have caused its value to tank even further.
It was a race against time, with the group desperately trying to notify the lender before the liquidation was set in motion. After private methods of contact failed, they turned to the internet. The developers posted on Reddit and Twitter, begging the borrower to contact them. They even sent an on-chain transaction with a memo, asking the whale to talk to them about the issue. Of course, making the issue public caused further problems. Users were spooked and started to pull their funds, resulting in fewer tokens in the pool and more funds being frozen.
Eventually, Solend was able to use an intermediary to contact the whale and get them to add more collateral to their account. However, before this took place, the platform had been seeking other solutions. They ended up enacting their first decentralized autonomous organization (DAO) vote. This essentially required users to join together and vote on proposed solutions to the problem as described below.
Proposal 1: SLND1 — Mitigate Risk From Whales
Solend's first proposed measure was an "emergency powers" package. Named SLND1, it would have given Solend’s developers more control over users' accounts, allowing the platform to identify whales who represent more than 20% of the borrowing in any given pool. Solend would then have emergency power to take over these accounts in the event of any liquidation. The platform would be able to liquidate the account more slowly, so that lenders would get paid but SOL shares wouldn’t get dumped en masse. At the time, this proposal was met with a lot of favor. Solend got just enough voting participation to meet their 1% quorum requirement, and the emergency ballot passed by 97.5%.
However, users quickly found out that some unsavory dealings had been going on behind the scenes: Struggling to achieve enough user participation to reach a quorum, the platform found a user who owned over 1% of all the turnout tokens. This user’s outsized number of votes swayed the results of the election, while many members of the Solend community had been outspoken about how much they disliked the measure. They felt that it gave the platform too much control over individual users’ accounts, contesting the ethos of decentralization.
Proposal 2: SLND2 — Invalidate SLND1 & Increase Voting Time
Since there was so much public outcry over SLND1, the developers proposed a new measure, SLND2, which would essentially reverse everything that had been agreed to with SLND1. The new measure proposed both to cancel the idea of giving the Solend team more power over user accounts, and to increase the overall voting time.
This ballot ran into a similar problem as the first proposal. Once again, users were divided, and it mostly came down to the input of the same user, with their outsized voting power. This user initially said they would vote "No" on SLND2, because they didn't want to cave to public pressure. However, at the last minute, they decided to vote "Yes” and the proposal passed. The platform was no longer allowed to access user accounts in an emergency, while users were given more time on future votes.
Proposal 3: SLND3 — Introduce Account Borrowing Limit
After the first two controversial votes, Solend users were becoming fairly anxious. Fortunately, the platform was able to finally get in contact with the whale and work to resolve the ongoing situation. While this was happening, the team also began to work on a new proposal that would hopefully reduce the risks of another such occurrence.
SLND3’s ballot measure proposed to reduce borrowing limits for all users. The proposal suggested that, in the future, there should be a borrower ceiling of $50 million. This would hopefully prevent one borrower from being able to take up so many funds from a lending pool. The ballot passed on June 21, and the proposed limit went into effect. Though there was once again the issue of a single user deciding the vote, there was less public outcry because most people believed the new measure was a wise decision.
Overall Impact on SOL
It's hard to clearly define Solend's effect on SOL, since the two are so closely related. SOL was definitely on the downturn before the lending protocol disaster. In fact, the Solana network crash was the main reason that all of the whale's SOL collateral was almost liquidated in the first place.
During the days of constant, contradictory proposals, market uncertainty continued to drive SOL prices down. Many investors dumped their SOL out of fear that its value was about to drop further. However, even when the near crash was prevented, as a portion of the whale’s debt was moved to another protocol, the price of SOL didn’t immediately recover. It appeared that stabilizing Solend had prevented a bigger crash, but was unable to improve Solana’s ecosystem as a whole.
Is Solend a Good Investment?
The situation with Solend highlighted some key problems with the protocol. Many investors are now wary of lending to users, as the whale issue highlighted just how easily one bad call could destabilize any lending pool. It’s somewhat reassuring to see that the developers were able to handle things, and to keep users from losing money. However, if there’s a reoccurrence, the outcome may be very different. Despite the newer borrowing limits, there still isn't much regulation in place to prevent the same problem from happening again.
That said, there's no indication that borrowing on the platform or using it to leverage cryptos against each other is potentially disastrous. These sorts of activities don't necessarily run the same risk of drastic harm from a single large liquidation. However, the June 2022 crash did cause a limited lending pool. This could be a problem for investors whose plans involve acting quickly and constantly taking out various loans.
In addition to the practical issue of one whale borrower bringing things to a halt, the June crash also introduced some philosophical problems. Many investors had been drawn to the lending protocol because it claimed to be a DeFi program in which financial decisions weren't based on human error.
However, all of the SLND proposals ended up coming down to a single user whose votes were heavily influenced by both the developer team and the Twitter outrage. The ability of one voter to purchase so much power shows that Solend may end up being influenced by personal bias and real-world politics just as much as the traditional financial system it criticizes.
SLND’s price has dropped by roughly 97% since its peak in November 2021. Given the current volatile market conditions, and potential contagion effects that could arise from FTX’s fallout, users should be careful when deciding whether to invest in SLND.
The Bottom Line
Ultimately, Solend’s decentralized lending and borrowing protocol has some exciting features. However, the recent near-crash shows the potential dangers of DeFi lending platforms. Despite claims that Solend’s program is decentralized and algorithmic, it ended up relying entirely on user behavior. Since it's lacking in regulations, this opens up vulnerabilities that can cause real financial damage. Solend’s lending protocol is certainly intriguing to tinker around with, but we'd recommend caution when working with large amounts of funds.
Source: What Is Solend and How Did a Near Crash Almost Cripple It? | Bybit Learn