A New Defrost V2 is Near
Coming Soon: New Defrost V2. Defrost evolving to a novel version — the “V2” — as a new-generation DeFi leveraging protocol, that efficiently allows users to participate in leveraged trading or earn leveraged yields in a trustless and user-friendly way.
The V2 was meant to rely upon two main products, namely decentralized leveraged tokens and decentralized leveraged instruments, all powered by supervaults, similar to the yield-compounding vaults in Defrost V1.
However, after weeks of development, They believe the decentralized leveraged tokens come with problems attached that they have not found convincing solutions to.
- First, a scheduled rebalancing mechanism must be programmed in the contracts. This requires triggering a series of transactions on major DEXs — like Trader Joe — to maintain the leverage level within a certain range. However, such auto-rebalancing transactions might be front-run and could be vulnerable to sandwich bots, a constant issue when deploying large trades. These may lead to financial losses to users, a risk we are not ready to take.
- Second, scheduled or temporary rebalancing may fail when facing an Avalanche network conjunction or during volatile times. This may bring additional risks to the whole leveraged token protocol, meaning the product would be at risk of liquidation.
- Third, the profits and losses associated with leveraged tokens can be tricky to accurately figure out for new traders, due to their very rebalancing mechanism. Automatically re-leveraging during a profitable session and de-leverage during a deficit one make the tokens’ financial behavior potentially “unexpected”.
Therefore, the team has decided to shift from the original leveraged token product to a margin/leverage trading model, while the decentralized leveraged instruments will remain a centerpiece of the V2.
A Decentralized Leverage/Margin Trading Platform
Margin trading, or “leverage trading,” means borrowing assets to long or short one’s underliers, using their own assets as collateral for borrowing.
Margin trading allows traders to use greater capital, increasing their positions without needing as much underlying capital. Essentially, margin trading amplifies trading results so that traders can realize bigger profits on successful trades. The catch that if the value of the collateral falls below a predetermine threshold, their position gets liquidate. (Unless they provide more collateral, of course.)
Lenders meanwhile earn interest for allowing traders to use their assets.
In centralized markets, the borrowed funds are usually provided by an intermediary, such as centralized exchanges or brokers. In DeFi, funds are often drawn from liquidity pools, whose contributors can earn an interest based on utilization.
Borrowing/lending and trades are all anonymous but transparent transactions, aligned with the rules pre-defined in smart contracts.
What can you do with the Defrost leveraged trading platform?
Users will be able to use the Defrost V2 in two ways — act as liquidity providers in lending pools or margin traders.
Earning in the lending pools with supervaults
Margin/leverage trading will also be power by supervaults, with the latter acting as lending pools. Idle assets not yet utilized to power margin trading in lending pools are deposited in interoperated DeFi platforms — aka projects that are cooperating with Defrost — to continuously accrue interest and mining rewards.
In other words, the ‘lending pools’ powering margin trades will function as smart pools. If there are no margin traders, the supervaults will put the idle assets in the vaults into other protocols, like AAVE, Benqi, etc, growing interest and compounding mining rewards.
When traders open their positions, an equivalent amount of assets will be withdraw from other yielding positions and lent to the margin contract. Normally, the rewards accrued in the margin contracts will be higher than those from other protocols, leading to higher rewards being passed into the supervaults.
Taking part in margin/leveraged trading
A margin/leveraged trader can decide to take a long/short leverage exposure level when opening a position. The leverage level can be adjust at any time and collateral can be added or withdraw freely, assuming the position maintains the require collateral ratio to avoid liquidation, bringing extra flexibility to users.
For example, one may open a 3.5x AVAX long position. This means that he/she will need to borrow stablecoins worth 250% times the value of the initial input and convert all of these assets to AVAX on a DEX. If AVAX’s price grows, he/she can close the position and claim the profits, choose to increase/decrease the leverage/exposure, or even withdraw some of the collateral.
(On a side note, though decentralized, the Defrost V2’s UX will be quite similar to margin trading on centralized exchanges, like Binance.)
Differences between leveraged tokens and margin trading
One of the most important differences between the two is that thanks to their rebalancing mechanism, leveraged tokens do not entail liquidation risks.
Margin trading positions can instead be liquidate if the market moves in an unfavorable direction, when the minimum collateral ratio is not maintain.
Liquidators may also get incentives for liquidating unhealthy margin positions.
Rebalancing is what keeps the leveraged tokens’ leverage at their targeted level. During every rebalancing cycle, each leveraged token reinvests profits if making any, and if losing money, sells off part of its position to lower the leverage and avoid liquidation.
Leveraged/margin trading has no rebalancing mechanism. Real-time leverage shifts from an initial state if the underlying asset’s price changes. If the position fails to maintain a healthy ratio within the minimum collateral requirement, it will get liquidate by a third party.
Leveraged tokens are seemingly easier. Just to make one example, a trader may take a constant 3x position on AVAX by simply holding the 3x AVAX bull token. Selling the token means closing the position.
Margin trading is a bit more complicated but more flexible. One needs to decide an exact leverage when opening a position, & constantly monitor the collateral ratio when the underlier’s price changes, in order not to get liquidate.
However, traders can be more flexible in tailoring the leverage exposure to their own needs.
Profit and Loss
Due to rebalancing, leverage tokens constantly maintain their leverage according to their “current” holding and borrowing state, potentially leading to some “unexpected” financial outcomes.
This is because when bull leveraged tokens have gains, they borrow and reinvest to increase their long positions. Whereas if bear leveraged tokens have gains, they borrow and sell more to increase their short positions.
Using Ethereum as an example, if ETH goes up one day and then up again the next, ETHBULL will do better than a standard margin position. It will have reinvested the profits from the first day back into ETH. However, if ETH goes up and then falls back down, ETHBULL may do worse, because the reinvestment during rebalancing increases its exposure, unlike in margin trading.
In sum, calculating PnL in margin trading is more straightforward and closer to traditional transactions, but vulnerable to liquidation risks when facing an unfavorable market.
About Defrost Finance
Defrost Finance the platform behind the next generation stablecoin and provides remunerative investment opportunities. A fully fair launch, decentralized project, its aim is to change the world of finance for good.