Introduction to Surge: Protocol Overview
99% of tokens cannot be lent or borrowed
Despite over $11B in TVL, DeFi lending protocols only support a small number of highly liquid tokens to be loaned or collateralized.
The vast majority of tokens remain incompatible with DeFi lending protocols due to the lack of reliable and manipulation-resistant price feeds. This includes long-tail tokens, LP tokens, NFTs and vault tokens.
For DeFi lending TVL and usage to scale, all tokens should be supported as loan and collateral options.
While some DeFi protocols already pursued this problem, the current solutions introduce significant tradeoffs such as elevated supplier risk, short-term loan maturities, high risk premiums, among others.
Algorithmic collateral ratio
One approach that hasn’t been explored yet is a dynamic collateral ratio as a function of utilization rate over time as an alternative to a function of price feeds.
Surge protocol introduces the concept of the surge threshold, a utilization rate threshold at which the pool collateral ratio gradually starts to fall.
Below is a chart that illustrates the change of the collateral ratio based on the utilization rate of a hypothetical Surge pool:
In the hypothetical pool above, the pool starts with the maximum collateral ratio of 50 : 1, meaning for every 1 unit of collateral tokens, a borrower is allowed to borrow up to 50 units of loan tokens. This collateral ratio is independent of the prices of both tokens.
If the collateral token value decreases in relation to the loan token, suppliers start removing liquidity to avoid bad debt. As the utilization rate of the pool rises above the surge threshold (in this case, 80%), the pool enters the surge state and its collateral ratio starts to fall at a constant rate over time.
If the pool collateral ratio falls under the collateral ratio of any active borrowers, they become liquidatable. In the chart above, Borrower 1’s collateral ratio is at 35, while the pool collateral ratio falls down to 30. Borrower 1 becomes liquidatable. However, Borrower 2 avoids liquidation by maintaining more collateral per token borrowed.
As the utilization rate of the pool returns back below the surge threshold, the pool enters the recovery state and its collateral ratio starts to rise back to the original maximum collateral ratio.
However, if the utilization rate never returns back below the surge threshold, the collateral ratio will continue to fall down to 0, liquidating all active borrowers. This ensures that the pool maintains sufficient liquidity to allow suppliers to exit, especially at times of high withdrawal demand.
Permissionless pool deployment
Deploying a new Surge lending pool is as simple as deploying a Uniswap pair. Anyone can deploy a lending pool on any of the supported chains.
Pool deployers determine all parameters of the pool. Once the pool is deployed, these parameters cannot be changed by anyone including the pool deployer or anyone else.
Pool parameters are:
- Loan token address: Valid non-rebasing ERC20-compliant token.
- Collateral token address: Valid non-rebasing ERC20-compliant token.
- Maximum collateral ratio: The default collateral ratio while the pool is not in surge or recovery states.
- Surge threshold: The utilization rate threshold that activates the surge state and deactivates the recovery state.
- Collateral ratio fall duration: The duration of the collateral ratio fall from max to zero.
- Collateral ratio recovery duration: The duration of the collateral ratio recovery from zero to max.
- Interest rate model: Two interest rate ranges between zero percent utilization, the surge threshold and 100% utilization.
Once the pool is deployed, anyone can use it to lend or borrow. There may exist multiple pools for the same loan/collateral pair. Pools will likely be adopted more than others based on the optimal combination of risk parameters for both lenders and borrowers and the available amount of liquidity within each pool.
Liquidations
Unlike traditional DeFi lending protocols, borrowers do not become liquidatable based on fluctuations in price. However, on the other hand, they are exposed to fluctuations of the pool collateral ratio due to changes in liquidity.
Since the pool collateral ratio falls at a constant rate during the surge state, borrowers can predict the minimum duration before they may be liquidated based on the collateralization of their loan.
When a borrower becomes liquidatable, any liquidator is able to claim the borrower’s collateral in exchange for repaying their debt.
Liquidity defragmentation
Since Surge adopts the isolated pair model as opposed to a cross-margin model, some might argue that this model could lead to liquidity fragmentation.
In cross-margin pools, the risk is shared among all pool participants and everyone’s position is as risky as the weakest asset in the pool. Isolated pairs, however, segregate risk, allowing more capital and risk premium efficiency (better borrow rates).
We aim to solve the problem of liquidity fragmentation by introducing a supply-side aggregration layer that sits on top of Surge pools. Lenders can choose to directly supply liquidity into individual Surge pools or they can aggregate their deposits into vaults with a limited managerial role.
For example, anyone would be able to deploy a Surge USDC vault that diversifies into multiple Surge pools. The vault manager actively reallocates capital across different pools on behalf of depositors in exchange for a performance fee.
Vaults create a market for DeFi risk managers and provide lenders the option to passively delegate risk management to anyone they want. Vaults also efficiently provide liquidity to borrowers wherever it is needed the most.
Surge vaults will not yet be included in the initial protocol launch.
What’s next?
Surge is a hyperstructure. Because that means that it cannot be paused or upgraded after launch, we will be sharing a private testnet release with our Discord members. After testing, we plan to deploy Surge on Ethereum, L2s and other EVM chains (in that order).
For now, follow Surge on Twitter.
