30.8.2024
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Bitcoin is sometimes referred to as magic internet money, the first entirely digital monetary asset that can be transmitted over the internet. Thanks to the new Zero protocol on Sovryn, we now have magic internet borrowing—with 0% interest.
Zero is an entirely new financial instrument—0% interest loans using bitcoin collateral without a centralized custodian, with the security of a merged-mined bitcoin sidechain (RSK). Using Zero, bitcoiners can access the value of their bitcoin without relinquishing ownership or giving custody to a third party.
A 0% interest loan sounds like magic—something too good to be true. How does the magic of a 0% interest loan on Zero work?
Zero allows you to be your own bank—not the modern kind—but the kind that once issued monetary certificates redeemable for gold. You provide full collateral in the form of RBTC and issue certificates (ZUSD stablecoins) to yourself that are redeemable for a specific value in the collateral assets. Specifically, you can redeem each ZUSD borrowed for one USD of bitcoin.
The digital, decentralized nature of the protocol makes the seemingly impossible possible. The ZUSD has no opportunity cost because it is minted as a claim on the RBTC collateral rather than diverted from another use. The loan has no carrying costs; it is recorded on the blockchain, awaiting the execution of a smart contract to unlock the assets. The loan risk is borne by borrowers. Since your assets are locked in a smart contract for the duration of the loan, you are your own counterparty.
The only cost to Sovryn is the investment of coding and deploying the Zero protocol. The cost of executing the contract code is paid by the user in gas (paid in RBTC!), and blockchain maintenance is incentivized by users paying fees and by merged-miners earning rewards.
A small upfront origination fee compensates Sovryn protocol stakers. Sovryn charges a minimum origination fee of 0.5% of the loan. The fee may rise to as high as 5% as part of the USD 1:1 peg mechanism. The higher fee discourages borrowing when the price of ZUSD falls below 1 USD, and reduced borrowing decreases the supply and causes the price of ZUSD to rise. Under ordinary circumstances the fee is expected to stay at 0.5%.
During normal operation, Zero requires a minimum RBTC collateral ratio of 110% of the loan. A safer collateral ratio is at least 150% (67% loan-to-value). These levels are far below the requirements of most centralized bitcoin-backed lending products.
The borrower must monitor the loan and maintain a collateral ratio of at least 110%. If the collateral ratio falls below this level, anyone may initiate a liquidation of the collateral. Zero maintains a stability pool of ZUSD that is used as the first line of defense to pay off liquidated loans that fall below the minimum collateral ratio. When this occurs, ZUSD from the pool is used to pay off the liquidated ZUSD loan. The RBTC collateral is then forfeited to the stability pool, even if it is worth more than the outstanding debt. Depositors to the stability pool share pro-rata in both paying off the ZUSD debt and acquiring the collateral, which should ordinarily result in a profit.
Zero has multiple mechanisms for maintaining a 1:1 peg to USD. Borrowers can at any time pay off some or all of their loan by returning their ZUSD, and they will cancel 1 USD of debt for each ZUSD. Repaying loans decreases the supply and can put upward pressure on the price of ZUSD. Each ZUSD is always worth 1 USD of RBTC to a borrower.
If this mechanism isn’t sufficient, anyone can trade in, or redeem, 1 ZUSD for 1 USD of RBTC from the collateral pool. That is, they can buy RBTC at a discounted price using ZUSD. The RBTC comes from the lowest-collateralized borrower. Some of that borrower’s collateral is liquidated, but the collateral ratio is raised by paying off some of the debt.
This redemption process is a net-zero transaction for the borrower, since the same value in ZUSD is swapped for the equivalent value of RBTC denominated in USD. The obvious disadvantage is that some of the borrower’s RBTC is converted to ZUSD. Borrowers can avoid redemption by maintaining a higher collateral ratio.
The 110% collateral requirement makes 1.10 USD a hard ceiling on the price of ZUSD. Arbitrageurs can buy RBTC using USD, take out a loan, sell ZUSD for USD, and forfeit the RBTC collateral. If they can sell ZUSD at more than a 110% premium, they immediately profit from arbitrage without having to recover their RBTC collateral.
Furthermore, if the ZUSD price rises above 1 USD, RBTC HODLers can arbitrage the price by taking out ZUSD loans and selling the funds at a premium to USD. This puts downward pressure on ZUSD. When the price drops in line with USD, they can unwind the position at a profit and unlock their RBTC by paying off the loan. While this provides no net long-term pressure on the price, the incentive to borrow and then sell ZUSD later can relieve short-term buying pressure and defend the peg. This encourages the smoothing out of buy/sell pressure over time.
Zero switches to recovery mode as a failsafe measure when the total collateral ratio — that is, the USD value of all the RBTC collateral divided by the total outstanding amount of ZUSD debt — falls below the critical collateral ratio, currently set at 150%. Recovery mode protects the overall collateralization of the protocol. In recovery mode, lines of credit below the total collateral ratio are liquidated starting with the lowest-collateralized line of credit until the protocol collateral level is above the critical collateral ratio again.
Borrowers can avoid recovery-mode liquidation by keeping their collateral ratio above 150%. As under normal operation, in recovery mode, borrowers can lose up to 110% of the loan's value in collateral. Because of the potential loss of collateral, borrowers are incentivized to keep the protocol generously collateralized so that recovery mode rarely, if ever, happens.
While we may be tempted to think Zero enables magic internet loans, it is no illusion. HODLers now have a new option to put their bitcoin value to work immediately while still HODLing.
Sovryn has established a waitlist where you can sign up to get access as Zero Beta is rolled out. For more about Zero, see Zero: Protocol for Zero-Interest Loans.
Visit Zero on Sovryn and conjure some value from your bitcoin.
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