Pantera Partners: Understanding the DeFi Cross-Chain Liquidity Protocol Unbound Finance

Written by: Paul Veradittakit, Partner at Pantera Capital

Translated by: Lu Jiangfei, ChainNews

In the DeFi space, the Automated Market Maker (AMM) model is almost ubiquitous, and we have seen it widely applied in DeFi protocols such as Uniswap and Balancer. The widespread "adoption" of the AMM model can largely be attributed to the explosive growth of "liquidity" on blockchains like Ethereum today. However, even so, assets are still heavily concentrated on a few blockchains/DApps, and users such as liquidity providers (LPs) still cannot fully utilize their capital.

Unbound Finance is a brand new decentralized cross-chain liquidity protocol that builds an ecosystem composed of AMM-composable DeFi native derivatives on Ethereum and other blockchains. Unbound Finance will offer a suite of products aimed at unlocking liquidity from various AMMs across different blockchains, including: synthetic assets collateralized by Liquidity Provider Tokens (LPT), new liquidity pools cross-derived from multiple AMMs, and financial tools that support compound yields and margin trading, among others.

The first flagship product launched by the Unbound Finance protocol is the UND stablecoin (which is pegged to the US dollar and can be obtained by staking LPT). With this stablecoin, liquidity providers can regain a certain amount of liquidity from the liquidity pools they have already locked in AMMs like Uniswap. Liquidity providers can deposit LPT (the tokens they received from AMMs in exchange for providing liquidity) into the Unbound Finance protocol, and in return, they can withdraw loans in the form of UND stablecoins, while also being able to redeem their LPT from the protocol at any time by simply returning the exact amount of UND they minted to the protocol—essentially, this means that users can use their LPT as collateral to obtain interest-free loans without ever facing the risk of liquidation, as the Unbound Finance protocol does not maintain a liquidation engine.

By predicting the critical amount of impermanent loss that LPT must endure, the Unbound Finance protocol can ensure that loans do not face under-collateralization, allowing the protocol to provide incredible lending services. These predictions can be used to estimate the risk of under-collateralization and then set the loan-to-value ratio (LTV) for loans on Unbound, which is the maximum amount of UND that users can mint in exchange for a certain value of collateral. Unbound maintains the peg of UND to the US dollar through variable fees charged for minting UND and its own AMM (currently the UND-DAI pair), and the protocol has already integrated with 12 AMMs on Ethereum, such as Uniswap, Balancer, and Curve Finance.

The Unbound Finance protocol has launched a testnet on Binance Smart Chain (BSC), aiming to incorporate AMMs like PancakeSwap. Soon, Unbound will also integrate with Polygon, Harmony, and other public chains based on the Ethereum Virtual Machine (EVM), aiming to promote the vision of cross-chain derivatives in the DeFi space. If all goes well, the protocol will also launch more products, including: other synthetic assets (such as uETH, a token tracking the price of ETH), virtual AMMs that automatically provide liquidity, and a liquidation engine for extremely volatile and high-risk trading pairs.

Ultimately, for DeFi users like liquidity providers, the Unbound Finance protocol enables them to use their assets that are already locked in common DeFi protocols like Uniswap. Unbound Finance is one of the first DeFi protocols in the crypto market to offer such service capabilities, enhancing cross-chain open liquidity for Ethereum and other blockchains, paving the way for a highly composable cross-chain DeFi future.

The "Illiquidity Shackles" of DeFi Liquidity Pools

In 2018, Uniswap launched the Automated Market Maker (AMM), fundamentally changing the trajectory of the entire decentralized finance (DeFi) space—this was a new way to instantly access massive asset liquidity on the Ethereum blockchain without interacting with order books or inefficient centralized exchanges that are hard to access, allowing cryptocurrency holders and traders to exchange tokens. The AMM model proposed by Uniswap is:

Cryptocurrency holders can provide their assets to a "liquidity pool" (essentially a portfolio composed of two assets, maintaining a constant ratio between the total values of each asset), and then execute trades or "swaps" between the two assets programmatically based on smart contracts.

For cryptocurrency traders, the AMM trading model makes it easier than ever to "instantly exchange" one asset for another. Since the launch of automated market maker services by Uniswap, this trading model has quickly inspired other DeFi protocols (like Curve and Balancer) and has been widely adopted in the DeFi space, becoming almost ubiquitous today.

The widespread "adoption" of the AMM model can largely be attributed to the explosive growth of "liquidity" on blockchains like Ethereum. Essentially, AMMs allow cryptocurrency traders to easily exchange one asset for another at existing market prices, but even so, the concept of "liquidity" in DeFi still has significant limitations. Since AMMs require liquidity providers to lock their assets in the protocol, this results in liquidity providers being unable to use these "locked" assets elsewhere. Additionally, the popularity of AMMs has led to a "side effect," where liquidity and assets are heavily concentrated on the Ethereum blockchain (rather than other alternative blockchains) and a few DApps, making DeFi even more centralized. To truly realize the vision of "decentralized finance"—where users can easily exchange any asset on any blockchain without relying on a few centralized trusted parties—the crypto community needs to propose new and exciting solutions (like derivatives, as well as synthetic assets such as stablecoins and pegged coins) to address the issue of liquidity centralization in DeFi protocols, which is clearly crucial.

What is Unbound Finance?

Unbound Finance is a brand new decentralized cross-chain liquidity protocol that builds an ecosystem composed of AMM-composable DeFi native derivatives on Ethereum and other blockchains. At a higher level, Unbound Finance uses "Liquidity Provider Tokens"—LPT, provided to liquidity providers in exchange for providing liquidity to protocols like Uniswap—as collateral to generate new synthetic assets. These LPTs are typically non-tradable and simply represent a portion of the liquidity pool, but they still hold value, meaning that without "derivative characteristics," the value of LPT cannot be "realized" unless they are redeemed.

Unbound Finance plans to offer a suite of products that can unlock liquidity from existing AMMs, including:

• Synthetic assets (stablecoins, tokens pegged to the value of other assets like ETH or BTC, etc.);
• New liquidity pools cross-derived from multiple different AMMs (for example, combining multiple existing AMMs into a new AMM);
• Oracle price feeds;
• Financial tools that support compound yields and margin trading.

In April of this year, Unbound Finance launched the final version of its testnet on Ethereum, with the first product offered by the protocol being a new stablecoin called UND, which is pegged to the US dollar, fully decentralized, and entirely collateralized by LPT rather than more volatile "traditional" crypto assets like BTC and ETH.

How Does the UND Stablecoin Work?

When users provide liquidity to a Uniswap liquidity pool, in exchange, they receive LPT—i.e., liquidity provider tokens, which essentially represent the "share" of value locked by the liquidity provider in the relevant liquidity pool. For example, if Alice provides 1 ETH and 100 USDC (assuming the market price of 1 ETH in this liquidity is = 100 USDC) to a Uniswap liquidity pool that originally had 9 ETH and 900 USDC, Alice will receive liquidity provider tokens (LPT) that "prove" she holds 10% of the total locked value in this specific liquidity pool. Generally, LPT is considered to be much more stable than "traditional" crypto assets like BTC and ETH, as the value of the assets in the liquidity pool is often actively maintained by arbitrageurs, who correct the prices of the assets in the liquidity pool when they fluctuate to match market asset prices.

In the Unbound Finance protocol, Alice can deposit her LPT as collateral into the protocol, and in exchange, she can obtain UND stablecoins, equivalent to a portion of the current dollar value of LPT minus a small token minting fee (which we will discuss later). Then, Alice can immediately use her UND for various other DeFi products (like other market makers, lending protocols, etc.), meaning Alice can now earn returns as a liquidity provider (by locking assets as liquidity) and continue to participate in the DeFi ecosystem (using the UND tokens she received from Unbound Finance). So, how does she retrieve her LPT? In fact, Alice only needs to provide the same amount of UND she initially received to the Unbound Finance protocol, and her LPT will be unlocked, allowing her to return those tokens to the initial AMM, at which point Alice can regain the share of value she originally enjoyed in the liquidity pool without affecting her share of the trading fee income from the liquidity pool.

It is worth noting that Alice will never face the risk of her LPT being liquidated to other users, as the Unbound Finance protocol does not have a liquidation engine for other users (since synthetic assets use LPT as collateral, LPT is generally non-tradable compared to "traditional" crypto assets like BTC and ETH), which means that the liquidation risks and entry barriers present in the current stablecoin ecosystem can be effectively resolved. Even if the value of Alice's LPT falls below a certain collateral ratio threshold, she does not need to pay the difference and will not be forcibly liquidated. Furthermore, Alice incurs no debt when borrowing UND tokens from the Unbound Finance protocol, and there are absolutely no interest rates; she can redeem her collateral at exactly the same price as when she initially deposited it into the protocol.

Thanks to the following three key features, Unbound Finance is able to provide lending services:

1. A variable loan-to-value ratio (LTV) designed to adjust the number of UND tokens minted by users given a certain amount of collateral. The risk of under-collateralization when using LPT for UND loans primarily stems from impermanent loss, which erodes the value of user assets in the liquidity pool compared to directly holding crypto assets. The Unbound Finance protocol uses an algorithm to predict the likelihood of impermanent loss occurring when loans are under-collateralized, and then sets the loan-to-value ratio based on the prediction results.
2. The value of LPT tokens as collateral is relatively stable, unlike the more volatile "traditional" crypto assets like BTC and ETH;
3. The SAFU fund—this is the insurance fund for the Unbound Finance protocol, where a certain percentage of the protocol's minting fees (currently 40%) will be allocated to this fund, allowing the total amount of the fund to gradually grow. The SAFU fund helps ensure that UND tokens remain pegged to the US dollar while also preventing black swan events.

The UND token is primarily maintained through the variable minting fees on the Unbound Finance protocol (which are pre-collected and can also serve as stability fees) and the AMM on the protocol (mainly the UND-DAI liquidity pool). During price fluctuations, arbitrageurs in the Unbound Finance protocol can correct the price of UND tokens and keep it pegged to 1 US dollar.

What are the Next Steps for Unbound Finance?

At this stage, the Unbound Finance protocol already supports AMMs like Uniswap, Balancer, and Sushiswap, covering almost all of the most popular AMMs on Ethereum—this means that ordinary DeFi liquidity providers holding LPT can immediately start using the protocol. It is reported that the Unbound Finance protocol plans to expand its integration scope to include more AMMs (like PancakeSwap and DFYN) and other blockchain ecosystems (like Binance Smart Chain, Polygon, etc.).

In addition to expanding to other blockchains and DApps, the Unbound Finance protocol also plans to:

• Provide lending services using other synthetic assets (such as uETH, a token that tracks the price of ETH);
• Introduce virtual AMMs to automate liquidity provision;
• Add on-chain price oracles to find accurate prices, minimizing user loss risks;
• Create a liquidation engine for highly volatile trading pairs;
• Build V3 liquidity aggregator contracts, which are currently live on the testnet;
• Deploy a decentralized autonomous organization (DAO) using the native UNB token to promote decentralized governance.

Final Thoughts

The Unbound Finance protocol is one of the most exciting projects in the crypto space today, as it aims to drive DeFi towards true decentralization.

The Unbound Finance protocol allows liquidity providers to reuse assets that are already locked in liquidity pools, significantly expanding the liquidity scope of Ethereum.

The vision of the Unbound Finance protocol is to better support cross-chain and AMM-composable DeFi native derivatives, preventing the liquidity of flagship crypto products like Ethereum and Uniswap from becoming increasingly centralized, and helping more innovative crypto projects access new and updated funding sources.

Ultimately, the Unbound Finance protocol will further enhance cross-chain open liquidity for Ethereum and other blockchains, paving the way for a highly composable cross-chain DeFi future.