Preparing the launch. zSOL Mechanisms

LP Finance is excited to announce that the launch of the first synthetic asset, zSOL is just around the corner. In this article, the basic mechanisms of zSOL and how users can potentially benefit from the protocol are explained.

LP Finance Protocol Overview

LP Finance is a synthetic asset issuance protocol on Solana. Users can deposit collateral and mint/borrow synthetics interest-free. Users can have a similar experience to borrowing on lending protocols, however, more profound knowledge of the protocol is required for safe investments.

Initially, zSOL would be the only synthetic asset supported on LP Finance, which could be minted/borrowed by depositing the following collateral tokens.

• SOL (Solana)
• mSOL (Marinade Staked SOL)
• stSOL (Lido Staked SOL)
• UXD (UXD Stablecoin)
• SRM (Serum)
• SAMO (Samoyed Coin)

More collateral tokens would be onboarded as users request and the liquidity is sufficient in DEXs.

zSOL could be minted/borrowed interest-free with an initial fee of 0.5% (Fee exempt for $LPFi stakers). With this, users can create multiple strategies such as leveraged staking (mSOL&stSOL) or leveraged short-selling. Strategies would be explained in the upcoming articles.

Basic Mechanism of zSOL

As written above, zSOL would be the first synthetics in LP Finance. zUSD, zBTC, zETH, etc. are expected to launch in order as liquidity is prepared for each asset. Each synthetic would have a different mechanism, tailored to its use cases.

As Solana (SOL) is a native asset on the Solana blockchain (no bridge risks) and has a well-built liquid staking protocol (Marinade Finance), these factors are accounted to the design of the architecture.

The basic mechanism is inspired by MakerDAO rather than Synthetix (Global Debt Model) for a more conservative approach. On top of this, “Protocol Debt Vault” is introduced to increase safety in liquidation, stability, and protocol revenue.

Protocol Debt Vault (PDV)

Protocol Debt Vault allows the protocol to accrue collateral and debt continuously. But why would a protocol want a debt position to increase over time and how can the debt position increase?

Let’s take a look at three cases of how a protocol debt vault can be used.

Case I. Typeless Repayment

Typeless repayment is a simple concept, which allows users to repay not only the borrowed token but also alternative tokens. On LP Finance, zSOL debt could be repaid in zSOL, mSOL (Marinade Staked SOL) and stSOL (Lido Staked SOL).

Users can benefit from typeless repayment by repaying when zSOL is above peg. Let’s look at the flow.

Let’s assume zSOL price is above the peg.

1. User has a debt position of 100 zSOL and 10,000 SRM collateral.
2. User repays in mSOL with a 0.05% + Δ (peg)% discount.
3. User redeems collateral.
4. User’s repaid asset is now added to PDV’s collateral.
5. User’s debt is now PDV’s debt.

With the following steps, now the user’s position is closed and PDV has an increased debt position, which could be essentially thought of as “debt transfer”. PDV’s position cannot be liquidated as mSOL is programmed to increase in value relative to SOL. If PDV’s position continuously increases, LP Finance would be able to generate SOL staking revenue without investing or purchasing SOL.

From typeless repayment, users can repay at a discount while LP Finance gains a revenue stream.

Case II. Peg Stability Module (PSM)

Peg Stability Module is a mechanism to increase the stability of stablecoins by allowing users to redeem tokens at 1:1 ratio.

DAI has a PSM which allows users to mint DAI at 1:1 ratio by depositing USDC and vice versa if sufficient USDC exists in the PSM vault. Even if PSM increases stability, this violates the decentralization of stablecoins.

For zSOL, the PSM pair would be mSOL and stSOL, which does not violate decentralization. Let’s take a look at how the PSM works for zSOL.

• Swap zSOL →mSOL/stSOL (1:1 Value)

1. Deposit/burn a zSOL
2. Withdraw b mSOL/stSOL from PDV (1:1 based on value if balance exists)
3. PDV balance updated

From the PDV’s perspective, users are repaying PDV’s loan and withdrawing collateral.

• Swap mSOL/stSOL →zSOL (1:1 Value)

1. Deposit a mSOL/stSOL to PDV
2. Mint b zSOL (1:1 based on value)
3. PDV balance updated

From the PDV’s perspective, users are adding PDV’s collateral and borrowing zSOL.

Case III. Liquidation Engine

In traditional liquidation methods, a stability pool is utilized to prevent bad debt due to a lack of liquidity in DEXs. This method has a risk when an insufficient fund is provided to the pool. For users, they can purchase tokens at a discount, but as they are purchasing volatile assets, a loss could occur.

zSOL is liquidated advancing PDV. Here are the steps.

1. Account’s liquidation threshold is reached.
2. Swap all collateral to SOL using Jupiter Aggregator.
3. Mint mSOL with swapped SOL using Marinade Finance.
4. mSOL added to PDV’s collateral.
5. zSOL loan of the liquidated account transferred to PDV’s debt position.

Essentially through this step, zSOL is not bought back and burnt, which would be a factor for zSOL to fall below peg. However, as PSM exists, users can redeem mSOL for zSOL, which would prevent depeg.

With this method, there is a possibility of bad debt occurring when swapping collateral to SOL. Therefore, the deposit cap would be set for tokens other than SOL, mSOL, and stSOL. Additionally, collateral tokens would be carefully decided based on their existing liquidity in DEXs.

Over time as LP Finance protocol matures, a stability pool would be added to process liquidations along with the PDV liquidation engine to bring higher efficiency and security.

Treasury Revenue Structure and Distribution

Often protocols neglect revenue structures, but it is essential for any business to have a proper revenue structure to benefit investors.

In the section above, protocol debt vault is explained in detail. PDV is essential for LP Finance’s revenue structure other than fees.

Following is a list of revenue points.

• Deposit Fee (0.5%)
• PSM Swap Fee (0.1%)
• Liquidation Fee (5%~25% based on collateral)
• PDV Staking (From mSOL&stSOL collateral in PDV vault)

These revenues would be distributed to vote-escrowed LP Finance DAO tokens ($veLPFI) after the IDO, which would be announced soon after the launch.

If you have more questions or are interested in the protocol, follow our socials and feel free to ask!

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