What is Defrost Finance?
Defrost Finance is a decentralized protocol that allows you to leverage LP Tokens or other pool tokens from Avalanche and cross-chain protocols as collateral for generating H2O. Loans using your LP tokens as collateral are paid in the form of H2O (soft pegged to the U.S. dollar) and each vault requires maintaining a healthy collateral position.
What is the motivation behind Defrost?
DeFi protocols have developed into an asset class worth tens of billions of dollars. A big part of these assets is stablecoins secured by centralized currencies, such as USDT and USDC. Decentralized stable coins such as DAI only account for a small part of the total supply of stable coins. This means that most stable coins are centralized. There are great needs and potential for decentralized stablecoins natively born in DeFi.
At the moment there is no native stable coin on Avalanche. Defrost Finance will solve this by generating its H2O stablecoin from collateralized LP Tokens both on Avalanche and through decentralized cross-chain bridges. We aim to release a large number of native stablecoins on Avalanche, which should help to defrost the frozen liquidity and feed the demand for expanding the DeFi ecosystem on the chain.
Moreover, Defrost Finance accepts almost exclusively LP tokens from Dexes and interest-bearing tokens from lending protocols as collateral. So for example, a user can deposit USDC/DAI LP tokens from Traderjoe, which entitles its holder to fees from Traderjoe's USDC/DAI pool, to Defrost Finance. The user can then generate H2O against USDC/DAI LP tokens and harvest further rewards.
It’s a powerful combination to retain yield bearing capabilities while also gaining the ability to borrow.
What are H2O and MELT?
H2O is a decentralized, collateral-backed cryptocurrency soft pegged to the U.S. dollar. All circulating H2O is generated from the smart contracts and can be used to repay loans on the Defrost protocol. You can redeem the idle collateral at any time, provided that it satisfies the collateral requirement.
MELT is a governance token issued by Defrost, with a fair launch distribution model. MELT can be used for rewards, fees, insurance and voting power in the protocol. It incentivizes early users to use the Defrost protocol. The total supply of MELT is capped at 100,000,000.
The Defrost protocol generates highly liquid stable assets as H2O, by using idle, less liquid assets, like the liquidity provider tokens, which normally exists as locked capital that can't be put to further use. You can use the protocol to stake your LP Token, using them as collateral to mint H2O, and then repay your loan in the future. In this way, you do not need to cash out your LP tokens to obtain liquidity.
By defrosting LP tokens into a liquid asset as H2O, Defrost protocol gives users automatic leverage, by staking the LP tokens in contracts, rather than selling them. H2O is used in the same manner as any other cryptocurrency: It can be freely sent to others, used as payments for other assets and services, be held as a hedge against market volatility, and more.
H2O is collateral-backed money whose value is soft pegged to the US Dollar and kept stable through a framework of financial incentives. Users can use H2O to save, lend, borrow, give to charity, make investments, cover business expenses, or buy goods and services.
It works well as a medium of exchange, store of value, and unit of account. A decentralized digital economy needs stable money in order to function. H2O solves this problem and enables a wide range of financial activities and applications that have previously been untenable due to the volatility of legacy cryptocurrencies like Bitcoin.
H2O is a soft-pegged currency, so there is no assurance that it will perfectly track the value of the US dollar. Rather, it maintains a free-floating peg that experiences low volatility against the USD. It achieves this through a combination of external market forces, internal economic incentives, and policy tools controlled by MELT token holders.
If H2O demand consistently exceeds H2O supply, or vice-versa, it creates a signal that MELT holders need to adjust the H2O savings rate, which is the tool for influencing the H2O demand. Raising the H2O Savings Rate increases the demand for holding H2O; lowering the rate decreases the demand for holding H2O. This ultimately translates to a stable H2O peg.
Stability Fees are another policy tool that can be used to adjust the supply side of H2O. Decreases in a Stability Fee, meaning lowering the cost of borrowing, can incentivize the additional creation of H2O. Similarly, increasing Stability Fees can reduce H2O generation.
Arbitrageurs also contribute to the short term stability of the peg by taking advantage of price differences across various H2O markets.
What does the so-called collateral mean?
Collateral is the cryptocurrency asset that the borrower pledges as a guarantee that the loan is going to be repaid. In the case of Defrost, these are LP tokens with a proven record of being relatively stable. Defrost only supports popular LP Tokens from Avalanche and other popular cross-chain LP Tokens as collateral.
How do I borrow (mint H2O) from Defrost?
To borrow (mint H2O), you must open a vault and deposit a certain amount of collateral (LP Token) into it. Then, you can withdraw a certain amount of H2O so that your collateral ratio is not lower than the minimum requirement of the corresponding Vault. Please pay attention to the collateral ratio when the LP tokens' value changes, as you may get liquidated if it falls below the minimum level.
What is the minimum collateral ratio?
The collateral ratio expresses the ratio of the real-time value of LP Token to the real-time value of the loaned H2O. When the collateral ratio is lower than the specific collateral ratio set by a certain vault (ie the minimum collateral ratio ), the user's collateral will be allowed to be liquidated by a third party. Different vaults will be defined with different minimum collateral ratios.
What does it mean if you get liquidated?
If the debt value starts getting close to eclipsing the collateral's value, the smart contract will automatically allow third parties to bid on the collateral to cover the debt that is outstanding to the DeFi protocol. DeFi liquidation is the process by which a smart contract sells crypto assets to cover the debt.
Will I get liquidated if the H2O price is above 1 USD?
No, the contracts only record the amount of H2O minted as the debt, not the value. This is to prevent the system from H2O price manipulation attacks.
What if my vault is liquidated?
Liquidation is the process of selling collateral to cover the amount of H2O a user has generated from their Vault. Liquidation helps to ensure that H2O is always backed by an appropriate amount of collateral by closing out Vaults that are under their minimum required collateral ratio for their given collateral type.
Since the liquidator repaid the debt by liquidating the collateral, you don't have to repay the liquidated amount. But you will lose all or part of the collateral.
There are several risks associated with using Defrost Protocol and H2O, ranging from smart contract bugs to suboptimal parameters set in the protocol. You can check our security and risk page for more details.