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Qilin is an idea that began its story in early 2020. At the time the protocol was conceived as a decentralized liquidity aggregator that pools liquidity from different DEXes — very similar to what 0x is now. Over the year, the DeFi space has evolved into a suite of “money legos” that processes over $3 billion daily in asset swapping volume and has another $3 billion in locked liquidity for derivatives trading. With early 2021 witnessing a series of events of breach of trust from the traditional finance world and roaring public interest, capital and liquidity continues to move into DeFi.
Meanwhile, there is one of the most important groups of participants in the DeFi space called Liquidity Providers. While the amount of liquidity provided, referred to as TVL, continues to grow in overall DeFi, the gap between liquidity for asset swapping and the liquidity for derivatives trading is hard to ignore considering the high price fluctuations such as in the crypto market normally attract derivatives trading. However, due to higher risks for liquidity in DeFi’s derivatives trading, the annualized percentage yield (APY) for liquidity pools on derivatives trading protocols is actually higher than in asset swapping. This makes an unconvincing case for the higher APY yield for derivatives trading liquidity being sufficient safeguards against liquidity risks.
For DeFi to become a full-fledged financial system capable of delivering services in both asset swapping and derivatives trading, the need for liquidity risk mitigation has never been stronger. Qilin has hence evolved to meet the challenge of its time.
DeFi Primer: Yield Products & Liquidity Efficiency
The crypto-backed loans currently in DeFi that yield higher APYs than yield products in the traditional financial system are a result of the efficiencies of smart contracts’ algorithmic execution on digital collateral that reduce the intermediate cost of custody, settlement, and escrow in the traditional system. Specifically, in the derivatives trading market, smart contracts reduce the complex dedicated counterparty market-making operations to distributed pooled risk through smart contracts that hold liquidity deposits. Coupled with the perceived high risk in the fledgling DeFi system, these efficiencies naturally attract value to decentralized ledger. As the risk in DeFi converge on the risk profile in traditional finance, the risk-averse nature of capital will lead to a capital migration from TradFi to DeFi.
The efficiency of smart contracts, in essence, reduces the cost of financial operations while enabling higher-APYs products. These products start with derivatives pools based on crypto-asset pairs, but as alluded to above, the efficiencies of decentralized systems should encourage more complex yield-based derivatives to relocate from the legacy system. Qilin helps facilitate this transition by making the decentralized derivatives trading system more liquidity-risk-free and more attractive to both liquidity providers and traders.
There is a massive market for liquidity seeking low-risk or even “riskless” yield-based products. This allows for the pools with various risk-mitigating mechanisms to compete for liquidity. Consistently improving on risk-mitigation attracts liquidity closer to DeFi’s yield.
A Decentralized Derivatives Trading Protocol & A Liquidity Risk Mitigator
Qilin is first a derivatives trading protocol, and optimization of the trader UX is accomplished through ensuring ample liquidity in the liquidity pools. Establishing a competitive risk profile and APY yields for liquidity pools attracts liquidity among the plethora of yield products in DeFi.
1. Liquidity Share Token (LS Token)
Before the use of smart contracts as APY-yielding liquidity reservoirs, the value-accruing instrument of crypto-assets was synonymous with the store of value of the assets. However, liquidity pools now have become the new DeFi-native yield products that have constituted a new asset class. From asset lending to asset swapping to derivatives trading, different assets and asset pairs correspond to different risk profiles and yield returns of the liquidity pools. The ownership of the asset in the liquidity pool on projects like Uniswap is denoted through an instrument called the liquidity provider token (LP token). LP tokens act as proof of ownership of the underlying liquidity collateral provided by the individual liquidity provider. However, the market expectations of the profitability of the liquidity pool as a yield product are not represented by the LP token. That is why Qilin starts with completing the liquidity pool as a yield product with an instrument that measures market expectations of the pool — the Liquidity Share Token.
The Liquidity Share Token (LS Token) represents a new asset class in DeFi based on the liquidity-backed yield products. To measure the profitability of the liquidity pool, the LS Token denotes the value of the underlying share of the pool, as opposed to the value of the underlying liquidity deposit denoted by the LP token. When the total value of the liquidity pool goes up, the value of its shares also increases, reflecting the profitability of the pool, and vice versa when the liquidity pool is at a loss. Further, as the market has expectations on the future value of the pool’s profitability, LS Token’s price fluctuates and may deviate from its underlying value. In essence, LS Token becomes a “share” of the collateral-backed liquidity pool.
In the longer time scale, we expect the LS Token to be one of the primary derivatives of the liquidity pools as they become a more mature yield product.
2. Elastic Liquidity Fund
A demand-adjusted liquidity funding model for liquidity.
Currently, the funding model of liquidity pools on projects such as Uniswap, Aave, and Hegic is open on a rolling basis where the correlation between the demand for liquidity and the value supplied is low. This creates capital efficiency issues such as a low utilization ratio of the liquidity and idle liquidity, and dilutes the yield profile of the pool.
The funding model of Qilin’s liquidity pool adopts demand-adjusted mechanism that adjusts the amount of the fundable liquidity of a pool based on the trading-volume-to-liquidity value ratio that measures the demand. Only when the ratio exceeds a level that is deemed at risk of liquidity insufficiency is the pool open to further funding. Liquidity providers get the full benefit of maximizing capital efficiency in the model.
Initial Liquidity Offering
A new fundraising model for liquidity-based yield products.
Based on Qilin’s Elastic Liquidity Fund, a pool require an initial fund to bootstrap its launch and initial demand. Each pool’s launch is conducted through an Initial Liquidity Offering (ILO) for LS Token sales at a fixed price. Afterwards, the LS Token can be listed on exchanges just likeany other ERC-20 token.
3. Rebase Funding Mechanism
A liquidity-risk-mitigating mechanism that protects liquidity from open positions.
The risk of open positions to the liquidity pool is measured with the ratio of the size of open positions against the liquidity value. When the ratio exceeds a certain threshold, a funding payment is transferred from the open positions to the liquidity pool to hedge against liquidity risks. This incentivizes liquidity against extreme market volatilities without changes to the trader UX compared to the traditional funding rate mechanism.
4. Dynamic Algorithmic Slippage
Similar to Rebase Funding, Dynamic Algorithmic Slippage is a liquidity-risk-mitigating mechanism based on the measure of risk of open positions, but is a implemented through a slippage applied on the AMM.
