Could Duet Protocol be the catalyst to push DeFi to the 3.0 era?
Fundamentally, the purpose of the financial industry is to efficiently allocate resources across the economy. Simply put, the financial system facilitates the flow of money from entities that have an excess amount of it, to those who need it to produce an excess return.
Debt has been the most powerful tool for both borrowers and lenders. It is less risky than investing in equity for the lenders and less costly for the borrowers. You could generally categorize all the debts into two types, mortgage debt, and credit debt. If the borrowers do not repay their debt in time, they would lose the over-collateralized mortgage in the former case and lose their creditworthiness to further financial debt in the latter case.
Innovations of decentralized finance have largely centered around mortgage debt. Mortgage debt is quite a simple arrangement where the borrower puts up collateral and borrows assets against it.
Let us examine variations of mortgage debt and shed some light on what Defi 3.0 could look like.
Variations of Mortgage Debt
Let us first consider the responsibilities a bank assumes in a typical mortgage debt arrangement. Suppose Alice would like to borrow some money from the bank against her house as collateral. The bank essentially does 6 things:
- value the house and Alice’s financial situation,
- Offer a loan and sign a contract with Alice
- collateralize her house,
- monitor if Alice is unable to repay,
- liquidate her house in case of a default,
- lend her the money she needs
Alice’s house could be worth $1 million, and the bank is willing to lend her $700,000 cash.
Suppose instead of the bank lending the borrower money directly, the bank issues a certificate of $700,000 to Alice. The certificate is proof that Alice has put up enough collateral to borrow $700,000. Should Alice default, the bank is happy to liquidate the house for anybody who would lend money to the borrower to buy back the certificate in order to repay any outstanding debt. Alice can now take the certificate and borrow money from anyone interested.
This decentralizes the process of lending, whereas the mortgage debt used to be between a centralized institution (the bank) and Alice, now Alice can borrow money from anyone on the street in exchange for the certificate the bank has issued.
It could be the case that Alice would only need $300,000 now, and she would probably be better off if she was able to borrow from more than just one entity. So, instead of issuing a single certificate of $700,000, the bank offers Alice 700,000 certificates of 1 USD face value each. The debt arrangement becomes quite flexible and decentralized now.
Suppose the bank is now offering identical certificates to not just Alice, but also all its clients so long as they have provided an asset as collateral to the bank. Suddenly, a market could be formed between 1 USD certificate and 1 USD of fiat currency.
Buying a 1 USD certificate is essentially lending 1 USD to a random individual who has supplied over-collateralized assets. Repayment is guaranteed since the bank would liquidate the collateral if any borrower were not able to repay. The market between USD certificate and USD is a de facto decentralized lending market between any individuals or entities.
The certificate is essentially what we call a synthetic asset. It represents a tradable certificate of debt obligation that is backed by some over-collateralized asset (e.g. a house or some amount of crypto assets) that can be liquidated in case of a default. This certificate could be a monetary amount, like 1 US dollar (e.g., dUSD), or pegged to some fluctuating value, like the price of a Tesla stock (e.g., Synthetic Tesla).
The bank in the above example no longer needs to accept deposits. It serves as a trusted middleman who continuously monitors a default event and is responsible for the custody, valuation, and liquidation of the collateral in the case of a default.
Defi 2.0 as we know it
Whereas in traditional finance, we rely on financial licenses issued by governments to facilitate trust, in blockchain, in code we trust. The immutability of smart contracts makes them a better-trusted middleman than any single financial institution.
In Defi, projects like Compound essentially replicate what a traditional bank would do.
One could argue that Maker DAO, the organization behind stable coin DAI, can also be categorized as a lending protocol. Maker DAO collateralizes assets like ETH and issues a synthetic certificate that is worth 1 dollar called DAI. Borrowers and lenders trade DAI and USD-backed stable coins like USDT or USDC in a secondary market, which is essentially a decentralized lending market.
Abracadabra went a step further than Maker DAO by accepting yield-bearing tokens as collaterals. Yield-bearing tokens are tokens that represent ownership when a user provides liquidity to a DeFi protocol, like Uniswap. These yield-bearing tokens can be used to withdraw underlying assets that could be easily liquidated.
Synthetic asset protocols like Synthetics or Mirror also rely on a typical mortgage risk control mechanism. They custody, value and liquidate collaterals, monitor default events, and issue synthetic certificates. The certificates they issue not only include synthetic dollar, which is like DAI, but also synthetic stocks like synthetic Tesla or synthetic Gold.
Lending protocols, collateralized-debt position protocols (Maker DAO), synthetic asset protocols are three variations of traditional mortgage debt. They all rely on the capability of default event surveillance, custody, valuation, and liquidation of collaterals, which we could call Collateral as a Service (CaaS).
The three variations of mortgage debt can be easily integrated together. The next phase of Defi 3.0 could be the integration of services where the integration makes it as if a virtual bank is providing comprehensive financial services to its users.
When Alice supplies any asset to the bank, she can choose to allocate part of her savings into a financial product (yield aggregators/yield farm); receive a credit to borrow anytime (synthetic USD), exchange it for other assets (decentralized exchange), and so on.
Note: The author of this article is not a licensed financial advisor, and none of the following content should be treated as financial advice. Do your own research.
Duet protocol is a CaaS Defi project. It integrated decentralized lending, CDP stable coins, and synthetic assets and hope to expand its services by onboarding third-party use cases for its collaterals. Duet protocol focuses on two things, onboarding more and more collaterals and finding more and more use cases for the collaterals.
Currently, synthetic asset protocols either only accept single tokens (Synthetics, Mirror protocol) or accept receipt tokens but only issues synthetic dollars (Abracadabra). To onboard more collaterals, Duet accepts single tokens as well as receipt tokens and the right to withdraw as collaterals. Receipt tokens are tokens that represent a right to withdraw supplied liquidity and proceeds, a typical example would be LP tokens of Uniswap DEX. Right to withdraw refers to a situation where the right to withdraw assets is locked to a specific wallet address instead of issuing a new token, a typical example of this would be yield aggregators that do not issue receipt tokens to its users.
Even though users’ assets are supplied to third-party farms or yield aggregators through Duet protocol, due to the ability of Duet’s smart contract to withdraw and liquidate these assets in an event of default, Duet provides users with a line of credit, which they can use to borrow synthetic assets (dUSD is the only synthetic asset now, but more will be added).
Borrowing synthetic assets using lines of credit is just one use case of users' collaterals. Duet‘s Collateral as a Service （CaaS）would make it possible for users to utilize their credit elsewhere. For example, Users’ collaterals in the Duet vault could serve as a margin for opening a long or short position in a decentralized futures exchange or any other Defi protocols that requires collaterals before use. Think of Duet protocol as a fundamental layer, on top of which, financial applications that rely on CaaS can be deployed to further provide users with more comprehensive financial services.
Although CaaS is only on the roadmap of Duet protocol, it points to a future of integrated Defi protocols that offers clients comprehensive financial services that are previously only available at banks.
With the Duet protocol, users can enhance their returns by borrowing synthetic stablecoin in the short run. In the long run, Duet’s vision is for the Duet protocol to be the entry point of liquidity providing, the reserve capital system that supplies liquidity to almost all DeFi protocols whilst generating a world of synthetic assets whose values are 100% backed by its reserves.
Advantages of Duet protocol
There are several advantages of the Duet protocol that is worth noting
1. TVL could increase easily
Duet protocol accepts receipt tokens and rights to withdraw as collateral. This means Duet does not compete with existing Defi protocols for single tokens like BTC or ETH. Receipt tokens like Pancake swap LP tokens can be supplied to Duet protocol, users receive enhanced returns with Duet’s proprietary farming strategies and Bonded Duet token as an additional incentive.
By supplying LP tokens through the Duet protocol, users now have the ability to borrow synthetic dollar dUSD, which can be used as leverage to enhance existing strategies or be supplied to dUSD liquidity pairs to claim incentives.
It should be clear that supplying liquidity through the Duet protocol is more advantageous for all liquidity providers. The total valued locked (TVL) of the Duet protocol is set to increase quite substantially.
2. Bonded Duet defers selling pressures
As mentioned above, Duet protocol incentivizes liquidity providing through the protocol with Bonded Duets. Bonded Duets are bonds that will mature in a predetermined period of time. At maturity, they can be redeemed to Duet tokens. They can also be sold at secondary AMM markets at a discount before maturity.
The discount rate is determined by the market. Whereas some miners hope to cash in their proceeds by selling Bonded Duet early, others may wish to invest their Duet tokens for more Duet tokens by buying bonds.
When the selling pressure overwhelms the buying pressure, it discourages selling from miners and encourages buying from investors. The selling pressure is thus deferred to match buying power from the market.
This mechanism mitigates selling pressures from farm rewards.
Over the past several months, they had been a lot of partnerships between yield aggregators and lending protocols. This allows better fund utilization for the lending protocols and leveraged farming for the yield aggregators. An example of such an alliance could be Yearn and C.R.E.A.M.
These alliances require substantial business development efforts and integration efforts. Whereas Duet protocol provides leveraged farming capabilities to any yield aggregators if the users just provide liquidity to the yield aggregators through Duet protocol.
This is just one example of how CaaS is a powerful tool going forward into the integration phase of decentralized finance.
Expect more use cases like using Duet credits as a margin to open future positions and so on as the protocol grows.
Modular services that emerged in Defi 2.0 era make it possible for integrated Defi services that provide clients with comprehensive financial services that are previously only available at banks.
Specifically, decentralized lending and Collateral as a Service (CaaS), could be a cornerstone for such integration.
Duet protocol is one of the first protocols to accept receipt tokens and rights to withdraw as collaterals and allows users to borrow synthetic assets like dUSD and dTesla. Furthermore, CaaS could be the fundamental service layer for all Defi protocols to be built on.