DeFi Insight: DeFi-native leverage by Gearbox

Leverage is a financial tactic that uses borrowed funds to boost an investment’s potential return. In layman’s terms, an investor or trader borrows money to increase his exposure to a particular class of assets, endeavors, or financial instruments beyond what would be possible if he relied solely on his own capital. Leverage typically allows investors to increase their purchasing power in the market. Although the fundamental concept of leverage is the same in both traditional finance and cryptocurrency, borrowing is where there is a significant difference. It would be nearly impossible to borrow money on credit because the only identity on the blockchain is just a public address. To put it another way, DeFi borrowing is typically completely collateralized. One such protocol is Gearbox. Gearbox is a generalized leverage protocol allowing anyone to get leverage in a decentralized way and use it across various other protocols in a composable way.

Authors: Valentin Kalinov, Christian Viehof

DeFi-native Leverage

Gearbox’s leverage can be applied to other protocols such as Uniswap, Curve, Convex or Lido. Some use cases include margin trading, leverage farming and more. The protocol has two sides to it: passive liquidity providers who want to earn APY on their deposits and active farmers such as individuals or even other protocols who borrow those assets. Leverage seekers (acting as borrowers) can obtain up to 12x leverage in a fully decentralized manner. The core vision of Gearbox is to become a DeFi leverage middle layer while being 100% permissionless.

Figure 1: Passive pools for liquidity providers (source: gearbox.fi)

The protocol introduces a new DeFi primitive: Credit Accounts. A Credit Account is an isolated smart contract that contains both the user funds and the borrowed funds. This is where the leverage happens. After a borrower opens an account, all the operations go through this account and the assets stay in it as well. Credit Accounts act as automated DeFi wallets where borrowers keep their positions and can program them the way they want. Credit Accounts have specific whitelisted actions available. An important metric of Credit Accounts is the health factor.

Figure 2: Credit Accounts (source: gearbox.fi)

Credit Accounts are isolated smart contracts with specific whitelisted actions and assets. Such an architecture ensures a higher degree of safety for both the user funds and the borrowed funds per account. The health factor of a Credit Account checks the condition of the portfolio and liquidates the position under a certain health factor threshold.

Figure 3: The Health Factor (source: docs.gearbox.finance)

According to the DAO governance process, minimum and maximum borrow limits are used to enforce the limits on Credit Accounts at the contract level; these limits are subject to change.

The protocol collects fees for various operations; a portion of these fees goes to the Reserve Fund and the remaining portion goes to various protocol operations. The protocol charges for various operations to remain financially self-sufficient. The spread between the APY that liquidity providers receive and the fee farmers pay for borrowing their assets is taken into account by the protocol.

Figure 4: Gearbox TVL (source: dune.com)

Composability

The enormous variety of parts that make up the DeFi ecosystem can be compared to “money legos.” Anyone can use them in various ways to interact with them, taking advantage of a level of capital efficiency that is significantly higher than that of the conventional system. DeFi’s financial Legos come in the form of yield optimization, lending protocols, liquidity protocols and more. DeFi allows users to engage with as many protocols as they wish. Composability is the term used to describe how well-integrated a design system’s components are. Different components can work together in various combinations in a system that is more composable. The following example demonstrates Gearbox’s composability:

Farming Long

  • Open a USDC-denominated Credit Account. For example, 100.000 USDC x 6 leverage = 600.00 USDC.
  • Swap all the USDC from the account to ETH. ETH long is open.
  • Next step would be to put that ETH into some farm which generates APY

You currently hold a position in ETH that is paying you reward rates that are (potentially) higher than the borrowing rates on the USDC that you must pay. It’s a free leveraged trade. The latest version of Gearbox adds Multicalls, where borrowers have access to complex 1-click strategies. It is worth noting that Credits Accounts are not open to everyone. Gearbox must first whitelist the addresses of potential borrowers in order to access these functionalities. In addition to that, there are also minimum requirements to use leverage. These are subject to change, but an example limit would be a minimum deposit of 10k USDC to use 10x leverage.

Figure 5: Possible leverage strategies (source: gearbox.fi)

Liquidity Mining

Gearbox offers a liquidity mining (LP) program with its own GEAR token. The program is focused on depositors. The GEAR token is part of the DAO governance structure, and it is non-transferable (can be changed by DAO voting). A new batch of GEAR tokens is distributed to lenders every few weeks. The supply of GEAR is capped at 10 billion.

The classification of GEAR according to the ITC:

Figure 6: The GEAR Tokenbase entry (Source: https://itin.itsa.global/Y0YMKD9J5)

Economic Purpose (EEP): GEAR is listed as a Governance Token (EEP22NT02). The token is non-transferable. Therefore, it is listed as a Non-Transactional Utility Token and is currently only used as part of the protocol’s governance. This might change with a future DAO vote.

Industry Type (EIN): The issuer of GEAR is active in the field of Decentralized Lending, Saving and Asset Management (EIN06DF02).

Technological Setup (TTS): GEAR is an Ethereum ERC-20 Standard Token(TTS42ET01). The Class “Ethereum ERC-20 Standard Token” captures every token that is implemented by means of the ERC-20 Standard on top of the Ethereum blockchain. A unique feature of the GEAR token is the non-transferability.

Legal Clam (LLC): The GEAR token does not entitle its holder to any legal claim or rights against the issuing organization; therefore, it is listed as a No-Claim Token (LLC31).

Issuer Type (LIT): The dimension “Issuer Type” provides information on the nature of the issuer of the token. GearBox Protocol Limited develops the Gearbox protocol. Therefore, the issuer type of GEAR is Private Sector Legal Entity (LIT61PV)

Regulatory Framework (EU) (REU): The dimension “Regulatory Status EU” provides information on the potential classification of a token according to the European Commission’s proposal for a Regulation on Markets in Crypto Assets (MiCA, Regulation Proposal COM/2020/593 final). The GEAR token qualifies as a Utility Token (REU51UT) according to the definition provided in Article 3 (5) of Regulation Proposal COM/2020/593 final.

The International Token Standardization Association (ITSA) e.V.

The International Token Standardization Association (ITSA) e.V. is a not-for-profit association of German law that aims at promoting the development and implementation of comprehensive market standards for the identification, classification, and analysis of DLT- and blockchain-based cryptographic tokens. As an independent industry membership body, ITSA unites over 100 international associated founding members from various interest groups. In order to increase transparency and safety on global token markets, ITSA currently develops and implements the International Token Identification Number (ITIN) as a market standard for the identification of cryptographic tokens, the International Token Classification (ITC) as a standard framework for the classification of cryptographic tokens according to their inherent characteristics. ITSA then adds the identified and classified token to the world’s largest register for tokens in our Tokenbase.

  • The International Token Identification Number (ITIN) is a 9-digit alphanumeric technical identifier for both fungible and non-fungible DLT-based tokens. Thanks to its underlying Uniform Token Locator (UTL), ITIN presents a unique and fork-resilient identification of tokens. The ITIN also allows for the connecting and matching of other media and data to the token, such as legal contracts or price data, and increases safety and operational transparency when handling these tokens.
  • The International Token Classification (ITC) is a multi-dimensional, expandable framework for the classification of tokens. Current dimensions include technological, economic, legal, and regulatory dimensions with multiple sub-dimensions. By mid-2021, there will be at least two new dimensions added, including a tax dimension. So far, our classification framework has been applied to 99% of the token market according to the market capitalization of classified tokens.
  • ITSA’s Tokenbase currently holds data on over 4000 tokens. Tokenbase is a holistic database for the analysis of tokens and combines our identification and classification data with market and blockchain data from external providers. Third-party data of several partners is already integrated, and API access is also in development.

Remarks

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Valentin Kalinov is an Executive Director at International Token Standardization Association (ITSA) e.V., working to create the world’s largest token database, including a classification framework and unique token identifiers and locators. He has over five years of experience working at BlockchainHub Berlin in content creation and token analysis as a project manager at the Research Institute for Cryptoeconomics at the Vienna University of Economics and token analyst at Token Kitchen. You can contact Valentin via valentin.kalinov@itsa.global and connect on Linkedin if you would like to further discuss ITSA e.V. or have any other open questions.

Christian Viehof is an Executive Director at the International Token Standardization Association (ITSA) e.V., working to create the world’s largest token database, including a classification framework and unique token identifiers and locators. He completed his Bachelor in Economics at the University of Bonn, the Hong Kong University and the London School of Economics and Political Science with a focus on Behavioral Economics and Finance. Currently pursuing his Master of Finance at the Frankfurt School of Finance and Management, you can contact him via christian.viehof@itsa.global and connect with him on Linkedin, if you would like to further discuss ITSA e.V. or have any open questions.

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International Token Standardization Association

The International Token Standardization Association (ITSA) is a not for profit organization working on holistic market standards for the global token economy.