AMM is the root of all elegance and usefulness in DeFi, which is why Curve has placed LLAMMA at the center of its lending protocol. Blockworks Research analyst Dan Smith has broken down this new mechanism, analyzing its principles and its impact. Here are the key points of the Blockworks Research report.
Currently, almost all DeFi lending is overcollateralized, relying on “hard liquidations” to maintain solvency when collateral value drops. While this design protects the protocol from bad debts, it forces borrowers to bear losses since even if the value recovers, the collateral cannot be retrieved after liquidation. Curve is addressing this by reducing protocol process risks and improving borrower user experience. Introducing LLAMMA, a lending and liquidation AMM algorithm.
By replacing traditional lending pools with AMMs, Curve introduces “soft liquidations,” gradually liquidating collateral within a price range instead of suddenly at a specific price. To open a loan, borrowers deposit collateral into LLAMMA and receive debt in Curve’s stablecoin crvUSD. Collateral is distributed within a user-specific “band” to form a “liquidation range,” with band numbers controlling the distribution of collateral throughout the range. The price provided by the LLAMMA pool does not depend strictly on the balance of assets in the pool. Oracle prices will affect AMM prices.
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This design creates arbitrage opportunities to encourage third-party interaction with the pool, which operates the soft liquidation process. The use of an oracle is necessary, and the protocol currently utilizes a Chainlink-based solution. To maintain solvency during a drop in collateral prices, the LLAMMA pool needs to perform soft liquidations of crvUSD collateral. The LLAMMA price drops faster than the oracle price, so the Curve lending pool sells collateral at a price lower than the current market price.
Currently, arbitrageurs can purchase collateral from LLAMMA with crvUSD and sell it on the market, capturing the price difference between the market price and the LLAMMA price. While arbitrageurs play a critical role in maintaining the protocol’s health, each transaction erodes the borrower’s collateral. In other words, borrowers must pay a small cost for the potential ability to recover their collateral after a soft liquidation.
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