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Bend DAO Proposes Emergency Measures As Credit Crisis Escalates

Amara Khatri - Crypto Daily
2022-08-24 09:19
NFT-collateralized crypto loans platform BendDAO initiated measures to course correct itself as a liquidity crisis over the weekend threatened to spiral out of control. The unfolding situation at Bend DAO highlighted the downsides in letting users borrow using their Bored Ape NFTs as collateral.

A Disastrous Liquidity Crisis

Bend DAO allows users to deposit money into the decentralized finance (DeFi) platform that loans the money out while depositors earn a cut from all the accumulating interest payments. However, the collateral is not what you’d expect, pictures of monkeys, pricey punks, and other expensive NFTs. Over the past week, depositors grew fearful that the lender was in a spot of bother, resulting in a bank run.
As depositors withdrew their assets, it led to Bend DAO’s reserves being completely drained. The liquidity crisis peaked as reserves dropped to a low of 5 ETH on Sunday, worth around $23,715 at the time, from over 10,000 ETH that the DAO held in reserve. The massive drop happened after dozens of Bend DAO’s loans slipped into the so-called “danger zone.” This meant that the NFTs held as collateral for these loans could be liquidated.

New Week Brings Relief

Monday saw some of the intense pressure building on the DAO abate as depositors returned to the platform while other borrowers repaid their NFT-backed loans. This relief allowed Bend DAO and its community to address the faulty liquidation mechanism that sparked the weekend crisis. The community is now set to approve a slew of changes to how Bend DAO functions to avoid a similar scenario in the future.

The Problematic Mechanism

Bend DAO shields itself from borrowers that default by auctioning off the NFTs they lock as collateral with the platform. According to Nikolai Yakovenko from DeepNFTValue, the protocol is hard coded to accept “only bids that make the DAO whole.” This ensures that the protocol is able to pay back depositors.
However, things get complicated when no one is willing to bid for the NFTs at prices set by Bend DAO. Dropping NFT prices and apprehension about tying assets into the protocol’s two-day auction window proved to be Bend DAO’s undoing over the weekend, as it was stuck with JPEGs instead of the ETH that it needed. Yakovenko explained the situation further, stating,
“They basically don’t allow the DAO to be leveraged in any way whatsoever. They don’t allow the DAO to take a loss on anything, which as a result makes them take a loss on everything.”

Corrective Measures

Bend DAO accepted that they had underestimated just how illiquid NFTs could potentially become during the bear market while setting the initial parameters. The team also proposed a proposal to change how the protocol operated and help build confidence among depositors. The changes would see the protocol lower the liquidity threshold from its current 95% to 70%. This change would occur gradually.
Additionally, the liquidation amnesty window would also be shortened from two days to four hours. Interest rates would also see an increase to incentivize ETH deposits and repayments further. Bend DAO’s liquidity amnesty program gave borrowers time to “rescue” their NFTs by paying a penalty along with the repayment. However, this worked against the protocol because no bidder wanted to lock their assets in an auction where the borrower could get their NFT back.

Crypto Insolvency Woes Continue

Bend DAO is the latest in a long line of protocols that have had a liquidity crunch in recent months. Crypto lending platform Celsius continues to struggle with liquidity issues and is trying everything to stay solvent. Meanwhile, Three Arrows Capital finally went into liquidation at the end of June.
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