The Solend Drama — Governance Is Hard, But Risk Control Is Basic
There is never a lack of drama during bear markets. Solend, the biggest lending protocol on Solana, passed a governance proposal on Jun 20 to take over a Whale’s collateral in order to avoid cascading liquidation. And, a new proposal was proposed and passed to invalidate the take-over proposal passed on the same day. Then on Jun 21, a third proposal is proposed and approved to change some lending parameters and impose a lending limit for the protocol. Well, these three interesting governance proposals mark the first 3 proposals ever proposed for the protocol after the protocol went live on mainnet in Aug 2021. What is Solend? What is happening to it? What is the implication of this drama?
Solend — Leading Lending Protocol on Solona
Lending protocol, DEX, and stablecoin are three pillars of a blockchain platform. Solend is the largest lending protocol on Solana, with a current TVL at $268 million which is the largest among all protocols on Solona. Solend is a lending and borrowing protocol just like AAVE and Compound, users can deposit tokens native to Solana and borrower stablecoins such as $USDC and $USDT.
Key Information of Solend
Product: Lending & Borrowing
Token: $SLND (governance token)
TVL: $268 million
Investors: top investors include Dragonfly Capital and Polychain Capital
Supply and Borrow Status (as of Jun 20th)
- Total Supply: $437 million, in which $SOL accounts for $193 million (44%) and $USDC accounts for $121 million (28%).
- Total Borrow: $186 million, in which $USDC accounts for $121 million (65%), $USDT accounts for $18 million (10%), and $SOL accounts for $40 million (21%).
From the above data, we can find the majority of supply (i.e. deposits) is $SOL, and the majority of borrowed assets are stablecoin.
So, we can conclude that the main lending business for Solend is to collateralize Solana’s native token $SOL, and lend out stablecoins including $USDC and $USDT.
On Jun 19, a proposal was raised by the project team on Solend’s governance site for voting. In short, the proposal intended to give Solend project team the right to take over a whale’s collateralized account and avoid the on-chain liquidation, and execute the liquidation themselves over the counter.
This whale collateralized a huge amount of $SOL and borrowed $USDC and $USDT, and it seems that they didn’t consider repaying the debt and leave the $SOL to be liquidated automatically considering the continual drop of the overall market and $SOL price.
This practice has nothing wrong. Just like a normal collateralized loan, say a property mortgage. Suppose you borrow $1 million against your property valued at $1.5 million, and the property market suddenly collapsed, and your property is only worth $0.5 million now. You would just leave the bank to foreclose your property rather than repay your full $1 million loans. The bank will have to assume the bad debt.
This is exactly the problem faced by Solend. It is possible that the liquidation bot cannot liquidate such a large amount of $SOL in the open market. The price of $SOL would further collapse due to the liquidation, and leave bad debt to the protocol. So, the team wants to directly take over the collateral and find an OTC buyer to liquidate the collateral through a private deal so that it does not impact the open market price.
How Big Is the Whale?
Directly taking over a collateral position is no doubt a very controversial proposal. But Solend team seems to have no other choices, otherwise, it would incur a large bad debt for the protocol, and all other depositors would suffer loss. This governance proposal has sparked intense discussion and criticism, but now let’s only focus on the whale’s position itself. As this shall be the root cause of the problem rather than the governance dilemma, which is the result.
The whale deposited 5.7 million $SOL ($179 million), which is 95% of the total $SOL deposited and 25% of all deposited. The whale then borrowed $108 million $USDC and $USDT, which is over 88% of $USDC borrowed amount and over 50% of all borrowed amount.
A lending protocol is just like a bank. Now imagine a bank’s 25% of total deposit comes from one single customer and 50% of the total loan extend to the same single customer. And mainly the loan is collateralized by one single asset. This customer and this single asset determine the life or death of the bank, this is just impossible to happen in traditional finance.
This large position shouldn’t exist in the first place, this shows the lack of risk control for Solend protocol.
The Governance, Oh No, There Is No Governanc
Under the current circumstance, I understand the team doesn’t have many options. Taking over the whale’s collateral and liquidating OTC could avoid bad debt and save other depositors. I would think the community would also agree to this emergency measure if there was really a community for token holders.
The proposal was passed, and 87% of the votes came from one single address… Probably, there was no community to begin with.
Then, due to the criticism from almost everyone in the industry, the team proposed to invalidate the proposal that just passed, and find another way around given the market has recovered a bit, which provided the team with more time to draft another plan. The new proposal to invalidate the last one was also passed. And no surprise, 68% of votes from that same address ended “sf6g4”.
The 3rd Governance Proposal
The team proposed a 3rd governance proposal to impose a per-account borrow limit of $50M. Any debt above this limit will be eligible for liquidation, regardless of collateral value. Some other liquidation factor changes are also proposed. The purpose of this proposal is to gradually liquidate the whale’s position through parameter adjustment instead of directly taking control of the position.
As of writing, the Solend team has made contact with the whale. The whale finally repaid a portion of the $USDC loan, the outstanding loan reduced from $108M to $72M, and removed some $SOL collateral from 5.7M to 4M. This mitigated the risk Solend protocol facing in some extent. And the Solend team is actively coordinating with the whale to work out a plan for further de-risking.
This whole issue is an example of the lack of risk management and stress testing. Hence, the lack of risk management leads to a messy development of governance issues. Personally, I think we should understand that decentralized governance is difficult, and this area is still in its infancy stage with not much prior experience or systematic procedure that can follow. However, risk management, such as concentration risk, is not a new topic, and has mature methods and rich practical experience in the financial industry. Better risk management could have helped avoid all the subsequent problem.