October 19, 2023 - 7 min read
An institutional-grade money market protocol for Suipians – with robust security guarantees and cross-chain composability.
Money markets essentially give users a peer-to-peer platform for lending and borrowing crypto assets. Lenders earn interest on assets they’ve supplied to liquidity pools, while borrowers can obtain loans at varying rates by locking up collateral. Investors can therefore optimize staking yields and avert unnecessary taxable events while retaining access to liquid capital.
Borrowers need to provide crypto collateral to secure the loans they take out, and the value of the collateral must exceed the borrowed amount to protect lenders in case of default. If a borrower’s collateral value falls below certain threshold percentages, the protocol will require the deposit of additional collateral. Failure to recapitalize the collateralized assets within a given grace period means that the protocol will automatically liquidate a borrower’s collateral, wiping out their entire deposit of collateral.
However, with Scallop’s soft liquidations, borrowers shouldn’t find themselves in this position so long as prudence has been taken with regards to risk management. Nevertheless, please do your own research and weigh your own risk tolerance before engaging with any investment products – explanations in this article should not be considered financial advice.
Sui is developed by Mysten Labs, and just launched its incentivized testnet in August 2022. The Sui Mainnet then went live in May of 2023. Sui is a Layer-1 blockchain, meaning it provides the underlying infrastructure for validating, settling, and recording transactions on a public ledger. Like other Layer-1 chains, Sui has its own native token ($SUI) and also supports other tokens which can be created and participate in Sui’s network.
Sui focuses on near-instant transaction finality and low latency settlements. It also uses a new smart contract programming language called Move, meant to improve upon Solidity using principles from the Rust language. Move is easy to use for developers and is built to optimize the functionality of smart contracts while minimizing the shortcomings that have been discovered within Solidity by devs over the years.
Scallop is a DeFi money market protocol built operating within the Sui blockchain ecosystem. Money markets provide users with P2P lending and borrowing opportunities, often using different tiers of interest rates based on the amount of collateral a borrower deposits. Also, utilizing the native Scallop token ($SCA) provides discounted rates and other incentives, which we’ll get into later.
Similar to Compound’s collateralized model, Scallop also tokenizes user debts on the protocol in the form of sCoins (Scallop Market Coins). sCoins are similar to liquid staking derivatives in the sense that users receive tokens as proof of ownership regarding token deposits. Also, sCoins can be subsequently used for derivative financial products which include debt obligations.
$SCA and sCoin do not trade precisely 1 to 1. That is, users will receive varying amounts of sCoin in exchange for the Scallop token depending on the exchange rate at the time. As interest accumulates and your share of the circulating supply increases, the exchange rate will adjust to reflect the new market dynamics.
Scallop uses a Trilinear interest rate model that offers three distinct tiers, each of which are triggered at different levels of capital utilization. When borrowers use more leverage, Scallop ensures that liquidity providers are compensated with higher yields to match increased risk of default and subsequent liquidation. That means depositing more funds gets you a more attractive interest rate, though it decreases your liquidity regarding the deposited collateral.
Borrowers tend to deposit stronger or more stable assets in order to borrow a more volatile asset for short term trading. Similarly, borrowers are often quick to reduce their leverage as borrowing costs rise. So, striking a balance between one’s risk tolerance and opportunity cost regarding asset allocation is the name of the game here. Scallop’s Trilinear Interest Rate Model is thus optimized to give lenders and borrowers a greater degree of responsiveness regarding changing market conditions.
Scallop utilizes a soft liquidation mechanism to cultivate a flexible and just environment for both lenders and borrowers. Once the collateral falls below the threshold, Scallop initiates a grace period notice, giving borrowers opportunities to increase their collateral or repay a portion of the loan so as to bring collateral levels to a healthy balance.
If corrective action isn’t taken in time, Scallop begins a gradual liquidation process. A portion of the borrower’s collateral is then sold on the market to recapitalize the lender and protocol. The liquidation process continues until the loan is either repaid or the collateral value reaches a specific threshold.
Scallop offers rewards to liquidators who repay outstanding loans and take the borrower’s collateral at a discounted price, and also imposes a liquidation penalty on borrowers who default. This penalty is collected when the defaulted collateral is sold.
Upon liquidation, the penalty is usually bigger than the reward – and the Scallop Treasury acquires the difference. For instance, the penalty is 10% while the reward is only 5%, meaning the liquidation reserve factor is 5%.
Blockchain Oracles supply off-chain data for automated use via smart contracts, like real-world asset prices or fluctuations in foreign exchange rates. Secure price feeds are essential for tracking market fluctuations, collateral balances, and determining the conditions for liquidation. Miscalculations, or even the slightest bit of latency at a crucial moment, can wreak havoc on automated agreements like smart contracts.
Erroneous inputs will inevitably lead to erroneous outputs; it is only a matter of how much damage is done, which ultimately depends on how far off the price feeds were and how large of a transaction was erroneously executed. Automation requires pristine data for smart contracts to interoperate, not to mention how this extends to other forms of automation and concepts like smart cities. To protect against price manipulation, Time Weighted Average Price (TWAP) oracles are used to filter out Byzantine nodes or other outliers.
Supra is a primary provider for price feeds on the Scallop protocol with its Distributed Oracle Agreement, or DORA. Supra leverages a novel consensus mechanism and node infrastructure that boasts the capability to settle hundreds of thousands of transactions per second while maintaining the highest standards regarding security guarantees. This includes fail-safe measures, multi-source data collection, and a geographically distributed node network. For more on Supra’s Oracles, VRF, and Bridgeless HyperNova – see the Research Section for whitepapers, litepapers, and dev docs.
Decentralized, highly scalable Oracles like Supra’s DORA are absolutely critical for cross-chain interoperability, as well as legacy institutions wishing to migrate their own infrastructure to interoperate with Web3 rails. As adoption grows and more assets are tokenized for on-chain use, the need for liquidity to flow trustlessly and seamlessly from one ecosystem to another will create more demand for Oracle price feeds and validation services. Applications looking to make the jump to a poly-chain world will migrate to implementing Supra Oracles, which ultimately have even stronger security guarantees than state-of-the-art Layer 1 blockchains out there.
Scallop money markets provide greater financial opportunities for both banked and unbanked individuals by leveraging the Sui blockchain and its fantastic community. It’s also censorship resistant in comparison to financial custodians which may freeze your funds. However, users should exercise caution when using DeFi due to the classic risks inherent to the space like hacks, lost keys, sending funds to the wrong address, or having assets lost when a custodian platform went bust.
Moreover, the ability to earn yields on digital assets in a permissionless and trustless environment is extremely attractive for investors looking around a world gunked up with regressive technology, burdensome taxes, and other centralized power structures ready to strip-mine the value out of every transaction. Scallop offers an easy-to-use lending platform that gives users the liquidity they need without the high barriers to entry that traditional financial products often have.
Moving forward, Scallop has a lot of momentum going for it. For instance, it recently secured a spot in the Cointelegraph Startup Program. What’s more, in October Scallop passed a milestone of $6M TVL on its protocol, making it one of the fastest-growing dApps in the Sui ecosystem. We’re expecting to see some more fireworks from this exciting Sui project, a DeFi juggernaut in the making, and powered by Supra’s Oracles no less.
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