Michaël van de Poppe - 23 March 2022
Disclaimer: We are invested in Unbound Finance.
Unbound Finance, which went live this week, is a promising new project in the DeFi industry that aims to free up liquidity from LP tokens and use it to back derivative assets.
DeFi and LP tokens
Since DeFi started heating up during the summer of 2020, it has come a long way in this short period of time. Across all the chains, a total value of 238.6 bln is currently locked within smart contracts that are used in DeFi according to Defi Llama. At the top, this was around $276 bln.
Automated Market Maker (AMM) exchanges, such as Uniswap, are an important part of the DeFi industry. AMMs hold liquidity pools locked in smart contracts for traders to trade against. This could be a trading pair like ETH-USDC, for example. Anyone can add liquidity to these pools and receive a portion of the trading fees in return, among other possible rewards such as liquidity incentive programs. The top 5 exchanges hold $43 bln in their smart contracts.
When people provide liquidity to these AMMs, most often in the form of two different tokens, they receive Liquidity Provider tokens (LP tokens). These LP tokens have to be returned in order for them to claim the tokens that they put in the smart contract.
Right now, these LP tokens do not have much additional use, something which Unbound Finance is looking to change by allowing people to use these LP tokens to mint derivatives.
The first derivative asset of Unbound is the UND stablecoin, not to be confused with the UNB governance token. By using fee-generating LP tokens as collateral, it aims to bring a debt-free liquidity provision system for stablecoins.
The project is able to do this due to the exposure of two tokens, often involving at least a stablecoin. Because of this, the overall volatility of the value of the two tokens together is a lot less, limiting the risk of default. For an ETH-DAI pair with a Loan-to-Value of 50%, the Net Break-Even Price Percentage is at – 75%. To learn more about how this works exactly, read this article. Only large pools are used for this.
This is also the reason why Unbound has not implemented a liquidation mechanism for the collateral of its UND stablecoin. as the risk of becoming undercollateralized is so low and most likely temporary.
The protocol uses its SAFU Fund, an insurance fund, to keep collateral safe during black swan events. The fund grows every time a derivative is minted as users have to pay a fee to do this of which 40% goes to the fund.
In the meantime, UND can be used to earn additional rewards in UND incentivized pools. UND is expected to maintain its peg with the dollar through arbitrage. Currently, 5.9 mln UND has been minted in total.
In order to regain access to the staked LP tokens, the same amount of UND has to be used, which will then be burned. No interest is paid and there is no deadline for debt repayment.
The whole process looks as follows
The total market cap of all stablecoins in circulation is currently $158 bln according to coinmarketcap.com. The centralized stablecoins USDT, USDC, and BUSD, having $132 bln of this, a massive market share. Although these give people a sense of trust as they are backed by real dollars through known companies, decentralized stablecoins are becoming more popular as well. We expect to see the entire stablecoin market growing along with the overall crypto adoption with decentralized stablecoins stealing a larger market share.
UND can be sent to various chains. Users can also stake their LP tokens on one chain and mint the UND stablecoin on another chain. Unbound is built on Ethereum but is connected to a number of other chains including Binance Smart Chain, Polygon, Harmony, Avalanche, and Solana. AMM protocols that are supported include Uniswap, Curve, Pancakeswap, Sushiswap, and Balancer, the five largest AMMs.
While UND is the only derivative on the platform right now, other derivatives will be added in the future as well, including uETH. Volatile assets like these will have a liquidation mechanism as they are a lot riskier.
Margin trading, another industry that is becoming increasingly large in DeFi, is a feature which we can probably expect somewhere next year.
Unbound vAMM will introduce a Vault mechanism that will work autonomously, providing automatic liquidity algorithmically. This includes aggregator contracts and strategies for concentrated liquidity provision on Uniswap V3.
A great thing about Unbound finance is the wide range of backers that it has amassed from different top projects as stated on its website. These include founding members of Enjin, Harmony, Polygon, Kyber, Ziliqa, Fantom, among other important names. This shows the faith that other projects have in Unbound, but mostly helps the adoption of the platform and its stablecoin in particular across these projects.
Unbound Finance has found a way to unlock liquidity from the massive AMM exchanges and use it to create derivatives, including the creation of a stablecoin with this new type of collateral that has relatively low risk. With this, it will initially aim to take a significant market share of the stablecoin industry which is massive and currently still mostly centralized. Unbound Finance definitely has the potential to achieve this goal considering the extra incentives, the new use case for LP token and a large number of investors from other projects.
After that, more features will be added like margin trading, other derivatives and vaults to earn additional yield, making it a more complete DeFi project with a larger market to operate in.