[Company Watch] Ruler + Cover, the Wild Card of Defi

One of things making Decentralised Finance interesting is that innovation does not usually come from big houses. It was just like the best search engine was not made by Microsoft.

Ruler Protocol is one of these innovation, a lending protocol with no liquidation mechanism. Before Ruler, the lending space of crpyto is pre-dominantly the MakerDao way: collaterialise with assets, borrow, and take the risk of being liquidate. Today, lending platforms like AAVE, Compound, or new platforms like Cream also work based on this principle and tens of billions being supplied and borrowed. It is effective, however, it’s not efficient. One reason is that suppliers of funds cannot decide on the interests rates — it’s given by the market and suppliers can only decide to take it or not.

For instance, supplying $USDC to AAVE is pretty much lending with no idea what’s the yield, or yield based on utilisation, which is totally related to nothing and unpredictable. It might not see to be an issue, when the interests rate are generally high. But if Defi is to survive long-term, it’s not going to work only this way. Imagine you going into a bank, and the bank only tells you that your interest rates depend on how much other people are borrowing; if you are a money manager and you have a cost of funds, you cannot decide whether to put money in AAVE neither because there’s no certainty.

Ruler Protocol addressed this issue by making the debt portion tradable. This is a very simple change but it’s fundamental.

How Ruler Protocol works is simple:

• You still need to collateralise. Putting down 1 ETH will allow you to borrow 750 DAI.
• There’s no liquidation mechanism. If ETH falls below 750 (in this case, by end of March), you can walk away with the DAI you borrowed and forfeit the ETH.
• You are given a pair of tokens (if you borrow 750 DAI), 750 rc tokens and 750 rr tokens. Each rc tokens can redeem 1 DAI after end of March, or redeem the collateral. So there’s a market price for rc token, e.g. 95 cents of DAI. This is the amount you can borrow — the moment you sell the rc tokens, its price x 750 is the amount you effectively borrowed.
• You can repay the debt and get back your 1 ETH any time before end of March, by paying Ruler Protocol 750 Dai and 750 rr token (or partially).

The design that rc tokens are tradable gives lenders and borrowers a lot of flexibility. For borrowers, it’s a fixed rate loan, as borrowers lock in the amount of DAI to receive and to be repaid at the moment of borrowing.

For suppliers, similarly they lock in an interest rate when they buy the rc tokens with DAI. Further, the debt is tradable, as rc tokens representing the debt are tradable. Theoretically, rc tokens are discounted DAI and its value will increase gradually to 1 DAI as time approaches to the end of the borrowing period.

Last but not least, liquidity providers of DAI and rc tokens place an important role in the Ruler Protocol’s design. Similar to the role of liquidators of any decentralised borrowing platform, liquidity providers of DAI and rc token pair make sure the trading of rc tokens and the Ruler Protocol debt market is efficient.

Liquidity providers of rc tokens and DAI have relatively small impermanent loss, as rc tokens are close to 1 DAI, esp when the borrowing during is not long, e.g. one month. For now, Ruler Protocol’s pricings are distorted by the mining incentives, so it’s hardly reflecting the market rate. Theoretically without mining incentives, and if AAVE has a borrowing rate of 12% per annum, rc token representing one month borrowing of 1 DAI will be at 99 cents of DAI, or 1% discount. Then the impermanent loss for this will be negligible. (Further, if the suppliers only provided DAI, they are also effectively suppliers themselves by the virtue of having half of their holdings to be rc tokens exchanged via DAI.)

However, it does not mean providing liquidity for rc tokens and DAI are risk free. In the event that ETH follows below 750, borrowers can have a the choice of not paying their debt of 750 DAI, and forfeit the ETH collateral. In such case, rc token can claim a pro rata share of the collateral and it’s less than 1 DAI. E.g. If the ETH price is 600 DAI at the end of the borrowing period, then each rc token can claim 1/750 of 1 ETH, which is only 600/750, or 0.8 DAI.

This can be mitigated by purchasing insurance on Cover Protocol. It’s effectively a credit default swap. The price of CDS is also market priced, as it’s tradable.

In addition, if you are not confident about Ruler Protocol, insurance can be purchased on Cover Protocol as well. For more details on how Cover Protocol works, please refer to our earlier articles on Cover.

Cover Protocol and Ruler Protocols are made by the same team.

As a customary way of kicking start any defi project today, the Cover + Ruler team is offering lucrative mining rewards to early adopters. There are a few ways that you can benefit from them:

• Provide liquidity in Ruler Protocol for DAI and rc tokens for WBTC, ETH and COVER underlyings. The yield of this alone is 200% plus. In addition, the yield of holding rc tokens now is about 150%. That gives you a total yield of close to 300% (200% + 1/2 of 150%), although it’s only from now to end of March. The risks are the prices of RULER, and also the Ruler Protocol risks.
• Provide liquidity in Cover Protocol for the Credit Default Swap. The mining yield now is also close to 300%. The risk is that in the event that the collaterals fall below the initial prices by end of March. If you hold both Claim and NoClaim tokens, you are not exposed to the risks of the default; but as the value of NoClaim token drops, there will be a bit of impermanent losses (likely a few %). On top of that, there’s Cover Protocol risks.
• Provide liquidity in Cover Protocol for the insurance tokens for Ruler Protocol. This is the same as providing liquidity for insurance of any other projects on Cover. Please refer our earlier articles for details. In the event of default, you are not exposed to the default risks but the value of NoClaim will drop and you will suffer some impermanent loss (likely several %).

And as all the mining rewards are paid in RULER — the yield is a matter of the price stability of Ruler Protocol and the team. From Cover to Ruler, we see that the team is continues to lead the innovation in defi product designs, and getting maturer from earlier fall-backs. Look forward to more innovations from the Ruler + Cover team.

(Serenity Team, 7 March 2021, Twitter: https://twitter.com/SerenityFund)