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What transpires in the event that a phone call for a multimillion dollar margin call goes unanswered?
For Solend, the second-largest decentralized finance (DeFi) outpost in Solana, last week, that unsettling possibility almost materialized into a nightmare. One of its biggest users, a wallet with $107 million in USDC borrowed against $170 million in SOL collateral, was completely missing and on the verge of liquidation.
In an effort to warn the anonymous account of its impending demise, developers tried Reddit posts, on-chain messages, and even Twitter memes. To prevent a disastrous on-chain liquidation that, according to project leaders, could bring down Solend and possibly even Solana, the whale account needed to either provide more collateral or reduce its position.
The hasty attempt to save Solend detonated into a dispute over authority and governance that led to accusations of hypocrisy against DeFi on Crypto Twitter and elsewhere.
The whale was finally awakened by CeFi juggernaut Binance, according to the fictitious co-founder of Solend, Rooter, who spoke to CoinDesk. On Rooter's behalf, the biggest cryptocurrency exchange in the world sent a message to the account.
According to screenshots provided to CoinDesk, the user emailed Rooter on June 21 and stated, "I’m sorry that this issue has caused concern in the Solana community and with the Solana team. There’s no hard feelings about the recent governance proposal."
The most severe crisis was resolved without the need for any cascading liquidations after the whale made contact and started redistributing its Solend bets into other Solana DeFi outposts, such as Mango Markets. Despite the significant amount of brief schadenfreude, the price of SOL has increased enough to calm down the entire situation.
The failure of Solend's liquidation came as the volatile crypto markets shook DeFi protocols of all stripes, forcing purportedly decentralized governing bodies to make difficult decisions that have a long-lasting impact on protocol users.
That might result in a messy cocktail. Programmatic smart contract code, free from human biases that might, for example, lead a banker to deny a loan to a minority group, is intended to be the immutable law of the land in "decentralized finance."
Real life is, of course, more nuanced.
The reason for Solend's crisis was that its protocol had no restrictions on the size of a borrower. That result: The vast majority of the USDC loans and SOL collateral for Solend was accounted for by a single whale. If the price of SOL dropped too low, the risk of liquidating that collateral existed.
When user collateral drops too low, Solend's smart contracts automatically send liquidation sell orders to DEXs. They are completely programmed. They do not thoroughly assess whether a trade will cause the markets, or even worse, the chain, to crash.
Even though SOL trades for billions of dollars every day, most of that activity takes place on centralized exchanges rather than the much less active DEXs, where DeFi cousin Solend routes its trades. Because DEXs lack the liquidity to absorb the whale's dump, the price of SOL would plummet (by as much as 60% or 80%), before buyers arbitraged it back up.
Rooter claimed that this in and of itself was a problem: "It’s such a crazy art arbitrage opportunity and liquidation opportunity that bots would just flock." In the past, that kind of activity brought down the entire Solana blockchain.
Solend made sure to bear the majority of the suffering. Bad debt, a depleted treasury, and a disgruntled user base would be the results. If the smart contracts operated as intended, Rooter predicted that "it’s basically over for us and our users will lose a ton of money."
He remembered the outreach program and said, "We really have to do something now."
With a "margin call" to clients, bankers in traditional finance can address a similar snafu by outlining the risks and explaining the need for more collateral to secure a loan. They are aware of the identities of their counterparties, and the borrower is reachable by phone or email. The case with pseudonymous DeFi is different (though a handful of startups are working on inter-wallet messaging solutions, none of which Solend used).
Since they were unable to communicate privately, Rooter posted their request for the whale's attention on Twitter. This frightened users into withdrawing large sums of money from Solend, emptying the vaults much like a bank run would. Rooter acknowledges the tweets' failure.
“It kind of exacerbated our problems because then not only were we dealing with a risk that something might happen, but we’re dealing with an immediate problem that people’s funds were frozen.”
They came up with a contentious plan to give Solend Labs "emergency powers" over the whale's collateral as their fix. When it took over, the caretaker company "gracefully" liquidated the whale using off-chain, over-the-counter (OTC) trading desks, effectively avoiding the market zero day. It would end the crisis, stabilize the markets, and return the USDC to the whale.
Nevertheless, it would supersede smart contracts that were intended to be in control.
The optics got painful at that point.
Code changes for many DeFi protocols are left to the community. Voting on new listings, rate increases, partnerships, and other issues is available to their token holders. The more tokens a user has, the more authority it has. Even though it is a popular system, it is not perfect for managing ostensibly decentralized systems.
A DAO vote had not ever been conducted in Solend. However, Rooter argued that the community needed to be made aware of the contentious solution. It put forth SLND1, the "emergency powers" package, on June 19. The vote was approved by 97.5 percent with just enough people voting to reach the 1% quorum six hours later.
Underneath SLND1's apparent victory, a less appealing picture emerged: the outcome was determined by a single wallet holding 1.01 percent of the voting tokens, or a "ballot whale," if you will. Without its involvement, SLND1 would not have reached quorum and would have failed on the technical. It was only successful because it received an affirmative vote.
Rooter claimed that after worrying about the low SLND1 turnout, Solend's team asked the ballot whale to cast a ballot. The whale, who is active on Discord, was only asked to participate, not to vote yes or no, according to him. The voting whale complied.
“Users of the protocol have generally been very supportive. And then the critics tend to be like people on Twitter who have no stake or no deposits,” according to Rooter.
Rooter and the team proposed a new vote, SLND2, which would invalidate the first because the opposition to SLND1 was so vocal and the media attention so intense. After the ballot whale intervened, it was also approved.
As Rooter put it, "the whale, again, basically swayed the whole vote."
After much deliberation - the whale did not want to act in order to please "Crypto Twitter's armchair experts," according to Rooter - The ballot whale voted yes with 14 seconds to spare despite technical difficulties.
The community approved what is essentially a new borrower ceiling at $50 million in a final vote on SLND3 on June 21. This was also planned to lessen whale risk. (It also passed thanks to the crucial "yes" vote from the ballot whale.)
By this time, Rooter's parallel outreach campaign had at last succeeded: Binance had attracted the borrower whale's attention and were in email contact. The issue gradually got better over the course of the following few days.
Regarding the Solend situation, Binance declined to comment.
A representative from the exchange confirmed that it has previously acted as a middleman between project teams and account holders. According to the spokesperson, Binance never divulges user information without consent.
There is a lot of repetitive harm. VC community observers in Solana told CoinDesk that they believed Solend's series of governance votes had dealt the company an unrecoverable blow.
One researcher stated on Monday that the issue is "inertia versus terrible governance decisions." Which force would prevail was uncertain to him.
In contrast to lower-tier Solana DeFi lenders like Larix, Hubble, and Oxygen, Solend's total value locked (TVL) has decreased by 10% in the past week and by nearly 60% in the past month. The majority of the redistribution of the whale went to Mango Markets.
Rooter expressed optimism in his last Friday interview with CoinDesk. By that point, Solend had successfully navigated the crisis without experiencing a disastrous liquidation.
“I think this sentiment is kind of improving. I mean, the PR blowback has also blown over at this point. Solend lost a bunch of TVL. But, you know, people can use it now,” Rooter said.
The second-largest DeFi project on Solana is still Solend.
By fLEXI tEAM