Last week, ICONists were greeted with the encouraging news that multiple teams and individuals were working together to build the first DeFi project on the ICON network:
We’re excited to announce Balanced, the first DeFi project on the ICON Network. Balanced is a collaborative effort between ICX Station, PARROT9, Galen Danziger of Mousebelt, and Dan Brehmer of iBriz-ICONosphere.
Our goal is to create the de-facto form of payment for the ICON ecosystem through giving ICX another use case: collateral.
Some people may already have a deep understanding of how this system works, based on their knowledge of similar DeFi platforms (such as Maker DAO), but for those who don’t have this sort of familiarity, I’m going to use this article to explain just how Balanced will work in practice, and do a bit of an analysis of the various uses cases as well. As part of this, I will also lay out the potential benefits for engaging with this new platform.
How does Balanced work?
To begin, let’s look at how the Balanced announcement summarized the project:
Balanced is a DAO (Decentralized Autonomous Organization). It incentivizes people to deposit their ICX as collateral and borrow tokens pegged to the value of real world assets. The first token will be the ICON Dollar, which is pegged to USD.
There is no ICO and no pre-mine of tokens. Balanced contributors earn (mine) Balance Tokens, which entitle them to governance and rewards from network fees. Only Balance Token holders that actively contribute to the Balanced DAO receive these benefits.
To get a better understanding of just how this will work, I’ll be consulting the project’s whitepaper.
As I break this down in practice, I’m going to create a few characters to help explain this process. Here are a few individuals who will play a role in how this works:
Brad — Brad is a holder of ICX who wishes to borrow against his holdings. He has 1,000 ICX he intends to deposit as collateral to borrow against.
Betty — Betty is also a holder of ICX who wishes to borrow against her holdings. She has 4,000 ICX she intends to deposit as collateral to borrow against.
Trevor — Trevor is an arbitrage trader.
For the sake of this example — and to make it easier to keep track of things — we’ll put the market value of ICX at $1.00.
Brad and Betty both deposit their ICX as collateral. Because Balanced requires a collateral ratio of 400%, this means Brad’s 1,000 ICX and Betty’s 4,000 ICX allow them to receive 250 ICD and 1,000 ICD, respectively.
(Generally, an overcollateralization ratio is fairly standard. With the volatility involved in crypto, this ensures that, even at a significant price drop in ICX, the Balanced protocol will not be “underwater” when it comes to whether or not they have sufficient collateral to match their outstanding loans.)
In exchange for depositing their ICX, Brad will receive 250 ICD and Betty will receive 1,000 ICD. Remember, this is under the assumption that ICX is a dollar at the time of their deposit. If ICX was only worth $0.50, they’d receive 125 ICD (Brad) and 500 ICD (Betty).
What about staking rewards?
Now, you may be thinking “why would I want to deposit my ICX — won’t I lose out on staking rewards?” Fortunately, Balanced has a built in mechanism to deal with this.
Once Brad and Betty have deposited their ICX it first gets deposited into a staking and voting smart contract. That ICX then gets converted into sICX (“staked ICX”). Therefore, when Brad and Betty go to check their balance of collateral in the Balanced protocol, they’ll see that they have 1,000 sICX and 4,000 sICX, respectively.
For as long as their sICX remains as a deposit, they’ll accrue staking rewards on that sICX, based on whatever the network reward rate is.
If Brad or Betty wants to convert their sICX back to ICX, they have two options:
- Endure the duration of the unstaking period, however long that may be based on network conditions.
- Pay a nominal fee to utilize Balanced’s decentralized exchange (DEX) to swap their ICX for sICX.
At this point, they’ll be able to convert their ICD into their original deposit (or less, if they’ve gotten rid of a portion of their ICD).
What keeps ICD stable?
A key component of the Balanced protocol is the stablecoin ICD, the value of which should always be $1. The key to a stable coin’s utility is that it’s holders should have confidence that it will always be worth $1 dollar (assuming it’s a USD-based stablecoin, as ICD is).
But how does it stay at $1?
That’s where arbitrage trading comes into play.
What happens if a holder logs onto an exchange and sees ICD selling for $0.80, rather than $1? Under the Balanced protocol, they have every incentive to buy at that price immediately. That’s because they’ll know that they can instantly convert that ICD into $1 worth of sICX, making a 20% profit for doing basically nothing.
So how exactly does this conversion work? I am going to take a portion of the section of the Balanced white paper that discusses this process, but exchange some amounts and names for the examples we’re working with in this article:
As an example, imagine the total collateral pool is 5,000 sICX and total debt on Balanced is 1,250 ICD. For simplicity purposes, 1 sICX = 1 USD and no fees will be included in this example. Brad accounts for 20% (250 ICD) of the debt and Betty accounts for 80% (1,000 ICD) of the debt. Trevor has purchased 50 ICD on an exchange for only 40 USD and would like to take advantage of the arbitrage opportunity provided by Balanced.
Trevor visits the Balanced dashboard to convert 50 ICD into 50 USD worth of sICX. Brad accounts for 20% of the debt, therefore Brad will automatically sell $10 worth of their collateral to Trevor. In return for selling $10 worth of collateral, Brad’s debt is decreased by 10 ICD (from 250 ICD to 240 ICD). Additionally, Betty accounts for 80% of the debt, therefore Betty will automatically sell $40 worth of their collateral to Trevor. In return for selling $40 worth of collateral, Betty’s debt is decreased by 40 ICD (from 1,250 ICD to 1,210 ICD). In terms of value, neither Brad nor Betty has lost anything. For every 1 dollar’s worth of collateral sold, their debt was decreased by 1 ICD.
Basically, Brad and Betty’s ICX collateral was used to purchase the ICD (in the form of sICX). While they have less collateral, they also have less debt, since the sICX was paid for with IDC. Now, it’s almost certain that more than two people will be participating in this process. In that case, it’s the same outcome, but the amount of sICX that Balanced participants “sell” and the amount of ICD they “receive” will be much smaller percentages, since the transaction is divided among more people.
Think of Balanced as a giant balance sheet that people can increase or decrease collective debts and assets. If you borrow ICD, you’ve added to the collective debt, but also to the collective assets with the ICX you supplied as collateral. If you buy sICX with ICD, you’re reducing the assets but also reducing the debt. Not only does this impact the collective ledger, but it also impacts your own personal ledger as well. The less ICD that the community owes, the less you owe. The less sICX the community has, the less you have.
At the end of the day, everything evens out — debts will always account for assets and vice versa — both collectively and individually.
Now, what happens if an exchange is listing ICD for more than a dollar — let’s say, $1.20?
Well, in that case, the incentive would be for an ICX holder to immediately deposit their ICX as collateral, borrow ICD, and sell it for $1.20, making an immediate profit.
Now, in both examples — traders buying ICD low and converting it to sICX, or traders borrowing ICD low and selling it high for USD — these activities will drive the price of ICD back to a dollar. If a bunch of people see a low price and buy to capture the opportunity, the exchange price will go back up to $1. If a bunch of people sell at $1.20, it’s going to go back down to $1. In either case, the price quickly falls back to $1.
What’s in it for me?
Some of you may be wondering: this is all pretty cool, but why should I want to participate? The Balanced announcement article listed a few examples — some are more obvious than others. I will break each one of them down further here:
Leverage — Deposit ICX into Balanced, borrow ICD, then buy more crypto.
This one should be fairly straightforward. Let’s say you hold a stack of 10,000 ICX that you have no interest in selling. You’ve also been tracking the charts carefully on the price of bitcoin lately and believe the price is about to make a significant jump. Unfortunately, in this scenario, you also have no liquidity at the moment to make a trade.
In this case, you could deposit your ICX as collateral. In exchange, you’d receive 2,500 ICD (assuming the price of ICX is 1 USD). You could then use that ICD to purchase bitcoin. If your prediction is correct and the price of bitcoin rises, you could sell for a profit, and return your capital to Balanced and again have access to your ICX. Then, you’d still have your 10,000 ICX, plus whatever BTC profits you made.
Of course, this isn’t without risk. If you’re prediction is wrong and the price of BTC goes down, you’ll have less ICD (assuming you sell for a loss), meaning you’ll be able to redeem only a portion of your 10,000 ICX.
Mine Balance Tokens — Deposit ICX and borrow against it to mine Balance Tokens. They represent ownership in the Balanced DAO, and include benefits like income from network fees.
Like many other platforms, Balanced provides its users an opportunity to mine its native token. In this case, ownership of Balance Tokens provides a chance to participate in governance, as well as payment in network fees (paid in ICD).
When it comes to governance, Balance Token owners will be able to weigh in on the following adjustments to the platform:
- Adjustments to fees
- Adjustments to the unstaking period
- Adjustments to collateral ratios
- Adding new pegged tokens
When it comes to network fees, “all Network Fees will be split pro-rata amongst qualified Balance Token stakers and paid on a weekly basis,” according to the white paper.
Make Stable Payments — Borrow ICD from Balanced, then use it to make payments without fear of the price fluctuating.
Let’s pretend you’ve been fortunate enough to receive a grant for a project you are building on the ICON network. At the time of your proposal, the cost of ICX was $2, your monthly costs are $10,000, and the project should take 6 months. Accordingly, you ask for 30,000 ICX to cover the cost of the entire project.
Under current circumstances, if the price of ICX drops over time, you’ll have a shortfall. If your employees accept payment only in USD and ICX drops to a dollar (a 50% decrease), you’re basically out of luck.
However, if you deposit your ICX as collateral, you can convert it to ICD over time, ensuring you’ll always have enough USD to satisfy your employees.
Sell ICX without affecting the market — If you borrow ICD, some of your collateral is sold over time to support arbitrage traders. This keeps ICD close to its pegged value, and helps you reduce your ICX position without hurting the market.
Let’s say you have a large ICX position and want to diversify your assets a bit. You want to sell some ICX, but you’re worried about a sale hurting the price of ICX. Instead of selling on an exchange, you could instead put it up as collateral and borrow ICD. You could convert that ICD into fiat or another crypto. Meanwhile, your ICX would end up as collateral on Balanced. You could convert it at some point down the line and get your ICX back, or just ignore it and not ever convert it back. If the latter, you’ve essentially “sold” your ICX without adding selling pressure on the open market (and thus reducing the price).
Offer liquidity on the DEX — Supply liquidity for the Balanced DEX to mine Balance Tokens and earn more ICX.
As part of the protocol, Balanced will provide a decentralized exchange to facilitate liquidity for the following pairs:
- sICX : ICX
- ICD : ICX
- Balance Tokens : ICX
In order to provide adequate liquidity for this DEX, traders who supply ICX liquidity will be eligible to receive a proportional amount of Balance Tokens from 5% of the daily Balance Token mining rewards pool. According to the white paper, “the DEX will function as a liquidity pool rather than the traditional bid and offer style orderbook. Users interested in supplying liquidity will have the ability to deposit assets into a liquidity pool along with a minimum selling price. Orders will be filled on a first-come, first-served basis.”
Trade ICD — Trade ICON Dollars to take advantage of arbitrage opportunities.
This was explained in the preceeding section.
Interest Rate Arbitrage — Take advantage of the 0% interest rate to borrow ICD and sell it for an Ethereum stablecoin. Then lend it at a higher rate using the Ethereum DeFi ecosystem.
Let’s pretend you’ve deposited your ICX and have received 250 ICD. As a result of Balanced’s design, you pay 0% interest when you “borrow” this money.
Now that you have your 250 ICD, you could sell that in exchange for any number of other tokens. In this example, let’s say you sell for USD Coin (USDC), an ethereum-powered stablecoin.
Coinbase provides an opportunity for USDC holders to lend out their holdings for 1.25% per year. This is far from the only example. There are plenty of other platforms and tokens offering varying ROIs (with varying degrees of risk).
In this case, you can effectively leverage your existing ICX by depositing it as collateral. You’ll not only still receive staking rewards, but you can also add another layer of rewards by loaning out your ICD through another stablecoin.
What’s in it for ICON?
So now we see why an individual might have interest in Balanced. But what about the benefits for the entire ICON network? Here are a few:
As a result of the number of ways an individual can profit from this new protocol — either as a miner, arbitrage trader, or general borrower — we have an added set of reasons why it makes sense to own ICX. Knowing that there are opportunties to make money by owning the token is good for demand. More demand means a higher price.
Disincentive to sell
In a similar vein, those who were contemplating selling their ICX may think twice about doing so knowing that they are potentially leaving profits on the table that they could be capturing if they took advantage of Balanced.
Here is a reason listed by the Balanced team for why they are building this platform, from the announcement:
Native protocol tokens like ICX are too volatile for payments. If we use ICX as collateral instead, we can create stable tokens to pay one another within the ecosystem.
In other words, by creating a stable coin built on the ICON network, we allow for an easier mechanism for making payments to those building on and supporting the ICON network, and perhaps beyond that someday as well.
Strengthening the ICON economy
As ICON continues to grow and mature, it will begin to develop it’s own economy of sorts (and arguably has already started to). By implementing an element of traditional finance — primarily lending — in a decentralized manner native to the platform itself, the opportunities to build more DApps, tools, and services will continue to increase. Think of all the wealth and utility that has been created throughout history when people had access to borrowed money, and you can start to let your imagination run as far as what it could do for ICON.
Meanwhile, by depositing ICX into Balanced, ICONists can essentially earn an additional layer of interest on their holdings (through the mining of Balanced Tokens), providing an incentive to provide the collateral necessary to provide an adequate supply of ICD.
While it’s unclear when Balanced will officially launch and other details still have yet to emerge, it is clear that this is an exciting opportunity not only for ICONists but for the network as a whole. It’s certainly a project I’ll be paying a great amount of attention to over the coming months, both during its development and following its launch.