Financial markets were in turmoil on Thursday, March 12, 2020 as governments around the world scrambled to prevent the spread of COVID-19. The US stock market (Dow Jones) dropped 10% — the 5th-largest drop in history — Bitcoin dropped 37%, and Ethereum dropped 42%, leaving investors and consumers in shock as uncertainty about the pandemic and its impact on the economy dominated headlines.
For decentralized finance projects, the drop was especially catastrophic. MakerDAO made headlines when their liquidation mechanism broke and they sold millions of dollars of ETH collateral for free. The community is exploring ways to fix the situation, which left countless borrowers without any compensation for their overly liquidated collateral.
Balanced isn’t live yet, but it’s important to back-test these scenarios to make sure our system is designed to withstand any challenges.
What would happen to Balanced participants?
On March 12, the price of ICX dropped over 44%, from $0.30 to $0.167. Before we analyze how Balanced would react, let’s go over the rules:
- The Mandatory Collateral Ratio is 400% ($4 of collateral for every $1 of debt)
- If you drop below the Mandatory Collateral Ratio, your collateral is locked until the ratio is back above 400%
On March 11, Bob had $1 million of ICX collateral in Balanced, which he used to borrow 250,000 ICON Dollars. He’s maxed out the 400% collateral ratio, so he can’t borrow any more.
After a 44% drop, Bob’s ICX collateral is only worth $560,000. With 250,000 ICON Dollars of debt, he’s now fallen below the Mandatory Collateral Ratio of 400%. His new ratio is 224%, and his collateral is locked. What can he do?
Bob has three options:
- Wait for the price of ICX to increase.
- Repay at least 110,000 ICON Dollars to increase his collateral ratio above 400%.
- Wait for traders to repay his debt when they sell ICON Dollars in exchange for ICX collateral.
What would happen to the price of ICON Dollars?
Based on this scenario, we can assume demand for ICON Dollars will increase as people try to pay back their debt and access their collateral. Higher demand leads to a higher price, which isn’t good for a stablecoin. To counteract an increase in demand, Balanced must increase supply.
If exchanges sold ICON Dollars for $1.10, Balance Token holders could vote to temporarily lower the Mandatory Collateral Ratio from 400% to 200%. They could then borrow more ICON Dollars and sell them on an exchange to meet demand. When demand is met, the price will fall back to $1, and borrowers will have more ICX to add to their collateral position.
How does this help ICON?
Financial markets — especially cryptocurrency markets — are driven by human emotion, and days like Black Thursday cause excessive panic. Balanced supports the price of ICX because no one can panic sell: ICX collateral is locked until the price recovers or people rebalance their collateral ratio.
After going through this scenario, it’s clear that Balanced can withstand events as bad as Black Thursday, and help ICON in the process. We look forward to seeing how it plays out in practice.