Analysis of Gearbox: Leveraged Lending through Credit Accounts

Author: Beichen, Chain Tea House

The leverage ratio of over-collateralized lending is less than 1, thus leveraged lending has emerged.

For investors with higher risk tolerance, they can borrow more liquidity and then trade on Uniswap (selling is equivalent to shorting), which is similar to margin trading in traditional finance.

The recently popular Gearbox Protocol is a leveraged lending protocol that introduces the concept of Leverage as a Service.

1. From Margin Trading to Collateralized Lending

Gearbox was born at the MarketMake hackathon held by ETHGlobal in January 2021. Although it has not officially launched yet, it has over 12,000 followers on Twitter.

Functionally, the services provided by Gearbox are essentially the same as the margin trading services offered by traditional brokerages, but it has clearly restructured margin trading in a Crypto way and has strong DeFi characteristics—AMM, decentralization, composability, etc.

While Compound's over-collateralized lending has a leverage ratio of less than 1, Gearbox can achieve up to 10x leverage, but fundamentally, they are both lending protocols.

Gearbox has two core participants—lenders and borrowers.

Lenders are LPs who aim to earn higher APY. The composition of borrowers is relatively complex, including active traders (characterized by short-term trading, leveraging, and all-in strategies) and LPs from other DeFi protocols who simply want to obtain more funds for mining.

Additionally, there is the role of liquidators.

2. Credit Accounts—Realizing Leveraged Lending

In terms of lending, Gearbox operates similarly to Compound and Aave.

The difference lies in how leveraged lending is realized. Compound uses over-collateralized lending, where the margin trading limit comes from credit (for example, if you provide a bank deposit certificate of 1 million to a brokerage, you can obtain a maximum credit of 500,000), which is easy to understand.

Gearbox achieves leveraged lending in a decentralized manner by establishing a "credit account" for users.

A credit account can be understood as an automatic DeFi wallet, where the user's principal and borrowed funds are stored. All subsequent operations are conducted through this account, such as trading on Uniswap, mining on YFI, and arbitraging on Curve.

Therefore, assets remain in this account, and borrowers cannot withdraw them but can operate them, which ensures the interests of the entire platform.

To further reduce risk, Gearbox only allows credit accounts to interact with specific DeFi protocols and specific tokens.

If the market declines, the credit account faces liquidation risk. Borrowers can add collateral, close positions to stop losses, or be liquidated—the risk model of Gearbox calculates the health factor of the credit account, which anyone can check, and liquidate positions with a health factor of less than 1.

It is important to emphasize that the leveraged lending provided by Gearbox is free, charging only LPs (1% fee when withdrawing from the liquidity pool) and a 5% fee to third-party liquidators.

3. Essentially a Decentralized Wallet

The vision of Gearbox is that users with various needs can borrow and lend on Gearbox without directly interacting with the interfaces of any other protocols, enabling trading, mining, arbitraging, etc.

This goes far beyond the scope of a lending platform and is largely a decentralized wallet, which can also serve as an entry point for the DeFi world.

According to the current beta version, the team has indeed integrated the UI, allowing users to complete lending on Gearbox and directly perform subsequent operations on platforms like Curve, Uniswap, YFI, and Sushiswap.

The composability between different platforms and functionalities provides an operational experience almost equivalent to directly using Gearbox's own products (DEX, Pool, etc.), but the composability is clearly more flexible and open, bringing more DeFi protocols and assets (which will continue to increase in the future).

If wallets are the entry points for DeFi, the current wallets (whether decentralized or centralized) still remain at the browser level in terms of composability and have not achieved true aggregation.

4. An Unformed Economic Model

Gearbox is a leveraged lending platform, and leverage implies risk. So how does Gearbox avoid collapse?

They have a reserve fund, but the reserve fund of Gearbox is not idly held for emergencies; instead, it accumulates in the form of LP tokens.

If compensation is needed for LP losses in the liquidity pool, the LP tokens from the reserve fund are directly burned, thus maintaining the stability of the pool.

Additionally, Gearbox has a governance token, GEAR (an ERC20 token), with a supply cap of 10 billion, which has not yet launched.

Currently, GEAR does not have very clear application scenarios, and the only confirmed function is community governance, with new features continuously being developed.

58% belongs to the community, 11.52% belongs to the company wallet, and it will be locked for 12 months after issuance and then released linearly.

5. A Native Species of DeFi

Gearbox is, to some extent, a native species of DeFi, much like Uniswap, which reconstructs the basic functions of margin trading in traditional finance using Crypto logic, but they are clearly different species.

In addition to the product itself, the birth of Gearbox is also "very DeFi."

Mikael first participated in the hackathon in January this year to build Gearbox, which received a great response at that time.

Ilgiz discovered Gearbox in February, with the intention of investment, and communicated with ivangbi about the project, finding that it indeed had potential, and decided to get involved.

By March, a core group of builders had gathered, actively contacting many DeFi founders, who responded positively and provided feedback as external contributors on product, competitive advantages, and the best ways to approach user groups.

In December, the Gearbox product took shape and was ready for launch.

After being tired of the endless similar clones in the Gamefi field, seeing the innovative projects emerging in the DeFi world makes one feel that the Crypto industry is still thriving…