This is an article written by Mercurial’s community member @tiddernips to explain PAI. If you have more questions, you can ask him and our other knowledgeable members, in our discord!
Introduction
Stablecoins serve as the bedrock of most DeFi protocols. Since the Summer 2020 DeFi explosion, the total supply of stablecoins has exponentially grown reaching over $100+ billion in total supply. In the past few months, we have seen a hyper-accelerated growth in protocols looking to build DeFi applications on Solana.
Two of the most prominent in the bunch are Mercurial Finance and Parrot Finance. Mercurial Finance is focused on building highly concentrated, multi-token liquidity pools that will serve as a “plugin” feature for other DeFi protocols looking to outsource deep liquidity and the preferred destination when looking to swap stables on Solana. Parrot Finance is an over-collateralized protocol that aims to maximize capital efficiency for users. PAI is the native stablecoin of the Parrot protocol and serves an instrumental purpose in the functionality of Parrot.
High composability is essential for DeFi and the recent strides by both Mercurial and Parrot are progressive first steps. In this article, I will cover topics about PAI/pBTC, Parrot Finance vaults, liquidations, and the collaboration between Mercurial and Parrot.
What is Parrot Finance?
Parrot Finance is an over-collateralized protocol that uses crypto assets to back the total debt issued by the protocol. Parrot’s over-collateralized stablecoin is known as PAI. Parrot also offers a synthetic Bitcoin, pBTC, that users can mint. pBTC is able to maintain peg parity because the protocol is over-collateralized which adds a security layer to the overall protocol. Having more than enough capital to pay off the protocol’s issued debt is essential otherwise user’s would not be able to redeem their previously deposited assets at full value.
Users on Parrot Finance are able to deposit a variety of crypto assets, eventually including LP tokens, as collateral into Parrot vaults. Within these vaults, users are then able to mint PAI after depositing crypto collateral into the vault of choice. Because Parrot is “over-collateralized” and the user is essentially taking a loan out with Parrot, the user is required to deposit MORE collateral than they can mint in PAI/pBTC. This safety precaution is for the security of the protocol to remain solvent.
Parrot Vaults
Parrot offers a variety of vaults but in essence, there are two types of vaults a user can deposit into. Volatile vaults and Stablecoin vaults. The volatile vaults will carry more inherent risks than stablecoin vaults, but allow a user to free up stagnant capital without selling any of their spot positions. Stablecoin vaults would never liquidate a user on Parrot Finance. In the future, Parrot plans on incorporating multiple types of collateral a user can deposit including LP tokens. This ability to free up a multitude of stagnant capital positions will allow a user to achieve maximum capital efficiency. However, volatile vaults can liquidate a user’s vault. When a user deposits into a Parrot vault and mints PAI or pBTC, they will be shown a liquidation price, collateralization ratio, and a borrow rate. Each of these is important for users to understand before depositing so I will cover each individually. Each vault has a different borrow rate so it is important to check before depositing.
Liquidations
First and foremost is the liquidation price presented to the user. This is an estimated value of the deposited asset at which the user’s vault will be liquidated. Liquidations are when the protocol comes in and pays off a user’s debt to bring their collateralization ratio back to a healthy level. Any loss of user’s funds is due to liquidation penalty which is currently 5%. When a user’s vault falls below the collateralization threshold, liquidation occurs. Vaults that have stablecoin as collateral (USDT, USDC, USDC+Earn) and PAI as the loan will never liquidate on a user. The USDC-pBTC vault can be liquidated during highly volatile events. Liquidations occur because the value of the deposited assets by the user is falling dangerously close to the value of the borrowed assets a user minted (PAI/pBTC). If that were to occur, the Parrot protocol would become “under-collateralized” and PAI/pBTC would become unpegged from their expected value as users would realize they will not be able to redeem PAI/pBTC for full value.
The Parrot Team released a detailed explanation of how liquidations work. For example purposes I will use the Parrot team’s example below:
Liquidation Examples
Stablecoin Vault Liquidation: “First, let’s examine a simple case of using USDC as collateral to mint PAI. When a user deposits 101 USDC as collateral, the maximum quantity of PAI they can borrow is 100. For a successful mint to take place using the USDC-PAI pair, the collateral ratio of USDC: PAI must be greater than or equal to 101%. When a user deposits a stable coin as collateral, there will be a nominal change in collateral ratio as time passes, due to the 0.10% borrow rate that is currently in place. Liquidation is not possible when a stablecoin is used as collateral. However, in the future, this could change to protect the protocol from black swan events if USDT/USDC were to depeg”
Volatile Vault Liquidation: “On the other hand, if a user deposits volatile assets as collateral, such as SOL, SRM, and various LP tokens (in the future), the collateral ratio will decrease significantly as the price of the asset declines. When the collateral ratio falls below the liquidation threshold for a volatile asset, liquidation occurs. This is done because the value of the collateral is dangerously close to falling below the value of the borrowed assets. If this were to happen, the protocol would become undercollateralized and the assets it lends out (PAI, pBTC, etc.) would become unpegged as people realize that they won’t be able to redeem them for their full value.
In this example, we will be using SOL as collateral to mint PAI. In the figure below, we have input “1” for the amount of SOL we’ll be depositing, and we would like to mint the maximum amount of PAI possible while meeting the 150% minimum collateral ratio, which in this case would be 22.8 PAI.
We should pay attention to the liquidation price displayed, which is $28.50. If SOL drops to this price, our collateral ratio would drop below 125%, which is the “liquidation ratio”, where liquidators will come in and repay our debt. As the price approaches the liquidation ratio, you should consider:
- Depositing additional SOL as collateral, or
- Repaying some (or all) of the PAI debt Ideally, we’d want to keep the collateral ratio above 150%.
Note: Liquidation does not occur while the collateral ratio is in the buffer range between the liquidation threshold for SOL (125%) and the minimum collateral ratio used during the minting process (150%). Let’s consider what happens if we DO get liquidated and what we end up with after liquidation. Using our previous example:
- We deposited 1 SOL
- To mint 22.8 PAI
- The current price of SOL is $34.90 If the price drops below the liquidation price of $28.50, the liquidator comes in and:
- Liquidator repays 22.8 of our PAI debt
- Liquidator gains 0.80 SOL (i.e. 22.8 PAI / $28.50 )
- Liquidator gets 0.040 SOL as liquidation rewards (5% of 0.8 SOL)
- We get ~0.16 SOL returned to our vault. (1 SOL minus what the liquidator had taken)
- We still have 22.8 PAI under our control, in our wallet, or in a staking pool somewhere. Suppose that we immediately purchase SOL back with PAI, we’d get our original amount of SOL back. Our loss due to liquidation is 0.04 SOL, or about $1.50.
Collateralization Ratio and Borrow Rate
The collateralization ratio is the ratio between the value of the user’s deposited assets and the value of their borrowed assets. For example, let us say SOL is trading at $30. A user deposits 5 SOL into the SOL-PAI vault on Parrot and wants to mint 50 PAI. His collateralization ratio would be 300%. If SOL were to fall in value while the user retained the 50 PAI debt, their collateralization ratio would begin to decrease. If SOL fell to a value of $25, the user’s new collateralization ratio would be 250%.
The last metric listed on the vault is the borrow rate. This is an annualized percentage of how much the user would owe as an interest to the Parrot protocol. The SOL-PAI vault currently has a 0.2% Borrow Rate. This means if a user were to mint 100 PAI in SOL-PAI Parrot vault, after 1 full year of borrowing that 100 PAI, the user’s debt would increase to 100.2 PAI (0.2 PAI more than the initial debt).
Mercurial x Parrot Collaboration
Upon release of Mercurial’s Mainnet Beta product, the two teams were able to strike a collaborative deal on the very first multi-token stable pool built on Solana. This marks a monumental milestone for the entire Solana ecosystem as the infrastructure for multi-token stable pools has yet to be built out on Solana. The Mercurial team is building a very unique product that no other protocol on Solana compares directly to. The utilization that highly concentrated, multi-token stable pools bring to the DeFi scene building on Solana will help jump-start new and existing projects looking to build products that will need deep stablecoin liquidity.
This composability between Mercurial and Parrot is essential to accelerate each other’s growth. PAI, the native stablecoin of Parrot, will need deep liquidity throughout the Solana ecosystem to maximize its full potential. Mercurial is focused on creating highly concentrated, multi-token stable pools and will need as many LPs as possible for that. By combining forces, Mercurial and Parrot’s symbiotic relationship can help exponentially grow each other’s protocol.
For the launch of this new pool, Mercurial and Parrot created a co-liquidity mining program that rewards LPs with two tokens instead of one. Rewards are distributed to LPs in the form of Mercurial’s $MER token and Parrot’s $PRT token(currently not on market). This Co-Liquidity initiative formed is the first of many for Mercurial.
More important than anything in a young, vibrant ecosystem that is rapidly growing is quality products. Without the actual applications, everything goes bust! This is why having truly dedicated teams that are engaging with the community and responsive to constructive criticism are essential to success. The teams need the communities and the communities need the teams. By working together and constantly engaging in ways to better the protocol and overall ecosystem, we can create a thriving multi-chain ecosystem.
$PRT token is not released currently, rewards will be retroactive. Track your future $PRT rewards at https://parrot.fi/rewards. For more details on the co-liquidity mining program visit.
