Synthetix V3: Collateralized Debt Positions (CDPs)

Introduction

Collateralized Debt Positions (CDPs) are a fundamental component of many DeFi protocols, including Synthetix. They allow users to deposit collateral and borrow against it, creating a system of over-collateralized loans. This article delves into the intricacies of CDPs, their real-world examples, how they function in other DeFi protocols like MakerDAO, and their implementation in Synthetix V3.

What is a Collateralized Debt Position?

A Collateralized Debt Position (CDP) is a financial arrangement where a user deposits an asset (the collateral) into a smart contract and receives a loan in the form of a stablecoin or another asset. The loan is over-collateralized, meaning the value of the collateral is greater than the value of the loan. This over-collateralization ensures that the loan is always fully backed, even if the value of the collateral decreases. If the value of the supplied collateral falls below the liquidation ratio, the collateral is liquidated to settle the generated debt.

Real-World Examples

A real-world example of a CDP is a mortgage. When you take out a mortgage to buy a house, the house serves as collateral for the loan. If you default on your mortgage payments, the bank can seize the house to recoup its losses. In this case, the house is the collateral, and the mortgage is the debt position.

CDPs in Other DeFi Protocols: MakerDAO

MakerDAO is one of the most well-known DeFi protocols that utilize CDPs. In MakerDAO, users can deposit Ether (ETH) as collateral to mint DAI, a stablecoin pegged to the US dollar. The deposited ETH is locked in a Vault, MakerDAO's version of a CDP. If the value of the deposited ETH falls below a certain threshold, the Vault can be liquidated, and the ETH is sold to ensure that all outstanding DAI is fully backed.

Collateralized Debt Positions in Synthetix

In Synthetix, CDPs are implemented and used through a system of vaults, pools, and markets. Users deposit collateral into vaults and delegate their collateral to pools, which in turn generate stablecoin credit against this collateral to provide liquidity to various markets. This system allows Synthetix to facilitate the creation of a wide range of onchain financial products.

Vaults

In the V3 iteration, users deposit governance-approved collateral into vaults to generate sUSD, the Synthetix ecosystem stablecoin. Drawing parallels, a V3 vault resembles MakerDAO's and Liquity's CDP. Synthetix, however, enables CDP owners to delegate collateral to pools, helping to fuel derivative markets for traders.

Pools

LPs delegate their collateral to pools, which act as pooled CDPs, providing liquidity to markets and enabling developers to generate liquidity for onchain financial products. These markets then generate fees, benefitting LPs. Pool owners govern the liquidity distribution to markets. For instance, the Spartan Council Pool would use governance SCCPs to decide liquidity distribution across markets.

Markets

V3's markets, with liquidity from pools, facilitate the creation of onchain derivatives. Once delegated liquidity, markets can access sUSD, fostering a liquid environment for trading. By participating in well-designed markets with suitable fee structures, liquidity providers can earn trading fees.

Example Markets: Perpetual Futures (like Synthetix Perps), Options (like Lyra), Spot (like Spot Synths), Insurance, Lottery (like Pool Together), etc.

Liquidations

When the collateralization ratio of a particular liquidity position drops below the liquidation collateralization ratio for its corresponding collateral type, the position may be liquidated. When this occurs, the collateral and debt associated with the position are distributed among all of the other liquidity positions participating in the pool with the same collateral type pro-rata (after a fixed amount of the collateral is provided to the liquidator, typically a bot, as an incentive).

Anyone can check if a liquidity position can be liquidated with the isPositionLiquidatable function. If this function returns true, then the position may be liquidated with the liquidate function. The address calling the function will receive liquidationRewardD18 per the getCollateralConfiguration function (or all of the position’s collateral if it is less than this amount).

Borrowing sUSD in Synthetix: Interest-Free Loans

One of the unique features of Synthetix is the ability for users to borrow sUSD against their collateral without having to pay any interest or issuance fees. This is a significant advantage over other DeFi protocols, which often charge interest on loans.

In Synthetix, users can deposit any ERC-20 token approved by the Synthetix governance into a vault. Once the collateral is deposited, users can mint sUSD up to the collateralization ratio set by the governance. The minted sUSD can be used within the Synthetix ecosystem or traded on other platforms.

The absence of interest or issuance fees makes borrowing sUSD in Synthetix particularly attractive. However, it's important to note that while there are no direct fees, there are risks associated with borrowing. If the value of the collateral falls below the liquidation ratio, the position can be liquidated, and the collateral can be sold to cover the debt.