NFT lender BendDAO is voting on protocol changes to bring down the liquidation threshold for bad debt on the platform after lowballing the illiquid nature of NFTs.
NFT lending platform BendDAO is determined to employ wholesale protocol changes to navigate a stewing liquidity crisis. This is after the platform underestimated NFTs’ illiquid nature when faulty auction mechanics exposed the drawback of allowing Bored Ape Yacht Club (BAYC) holders to borrow money against their NFTs.
The situation caused the NFT-collateralized cryptocurrency loans platform to lurch through an almost catastrophic liquidity crisis over the weekend. Fluctuating floor prices have put 45 out of the 272 BAYC NFTs used as collateral for BendDAO loans are now in the “danger zone,” the term used to signal that NFT collateral is at risk of being auctioned off. That tantamounts to $5.3 million worth of BAYC NFTs at risk of being liquidated.
The 272 BAYC NFTs tied to BendDAO as loan collaterals account for 2.72% of the entire collection. Hence, any imminent fire sale could be huge. The threat of a mass liquidation could affect not just BAYC, which is considered one of the most prominent NFT collections, if not the most important, but also other blue-chip NFT collections.
BendDAO’s Near Crisis
From the outside looking in, BendDAO seems to function like a traditional bank—some customers deposit money into the decentralized finance (DeFi) platform, which then loans the money out. Depositors get a cut of the interest payments on loans. The loans are backed by collateral in the form of NFTs.
BendDAO accepts seven blue-chip NFTs as collateral, including BAYC, Mutant Ape Yacht Club, CryptoPunks, Azuki, and CloneX. However, some borrowers defaulted on their loans due to ballooning interest rates for loans taken from the platform and their NFTs’ decreasing floor price value.
As a result, at the end of last week, dozens of BendDAO loans dropped to the platform’s danger zone, which meant NFTs held as collateral were at risk of being liquidated. In fact, some NFTs have already been put up for auction with minimal demand.
The low demand could be due to several reasons. First, BendDAO’s protocol dictates that starting bids must be higher than the debt’s value and 95% of the underlying NFT collateral’s floor price. Second, auction liquidators must lock up their ETH for 48 hours. Both parameters did not sit well with liquidators since the debt’s value can be higher than the floor price, making the deal unfeasible.
The situation prompted fearful depositors to collectively withdraw their assets, fueling a bank run on Sunday that depleted BendDAO’s reserves to just Ξ 5, down from over 10,000 ETH.
How BendDAO Abated the Crisis
BendDAO saw an opportunity to turn things around and abate the pressure on its business on Monday when some depositors returned to the platform while some borrowers paid back their NFT-backed loans. The respite allowed BendDAO’s community to deal with the faulty liquidation mechanics that sparked the near-crisis.
The community is now in line to approve several protocol changes to how BendDAO runs its system. A proposal has been submitted to change the parameters mentioned in the previous section, and community members must vote for or against the proposition.
“We are sorry that we underestimated how illiquid NFTs could be in a bear market when setting the initial parameters […] After a comprehensive review and discussion, it’s time to make a proposal to help ETH depositors to build confidence,” the proposal stated.
The BendDAO community has until Tuesday to vote for the changes in parameters. The protocol changes include a 5% decrease in the liquidation threshold on a weekly rolling basis. So, the implemented change will start at 85% on August 30, dropping to 70% on September 20.
Incidentally, the threshold refers to the spread between the floor price and the starting bid that liquidators can place when the NFT collateral from a defaulted loan is auctioned off. The protocol change likewise includes a call to reduce the auction lock-up period from 48 to four hours and increase interest rates to incentivize more ETH deposits and repayments.
A change to BendDAO’s 48-hour amnesty program is necessary as the platform’s “liquidation protection”—giving borrowers time to “rescue” their NFTs by repaying the loan and penalty—worked against the protocol. Bidders were scared of locking their assets up in an auction that could end with borrowers clawing their NFTs back, or worse, paying for an asset that has fallen even farther in the interim.
Some voting results have already been tallied, and most votes indicated support for the protocol changes. BendDAO community members with 20 million veBEND tokens (staked version of BEND—the protocol’s native token) have voted in favor of the proposition, which amounts to 98% approval for the protocol changes. Hence, the motion will likely pass and take effect immediately.
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