Table of Contents
The Lava Loans protocol (v2) is a scheme designed by Lava constructing upon Discreet Log Contracts (DLCs) to facilitate a trustless Bitcoin collateralized mortgage system. The massive implosion available in the market final cycle brought on by centralized platforms facilitating Bitcoin backed loans confirmed that left unchecked, such services and products can current an enormous systemic danger to the complete market within the ecosystem.
Lava seeks to supply the identical utility customers of such centralized platforms sought in a decentralized and atomic style, utilizing DLCs.
DLCs, for these unfamiliar with the idea, are a wise contract designed to settle a sure manner relying on the end result of some occasion outdoors of the Bitcoin protocol, i.e. the value of Bitcoin, the end result of a sports activities sport, and many others. That is carried out by relying on an oracle, or a set of a number of oracles, who signal a message testifying to the precise consequence of the true world occasion. These signed messages are used as the premise for adapter signatures that unlock particular pre-signed transactions that settle the contract a sure manner.
The advantage of DLCs is they are often carried out privately. So long as the oracle(s) publish the keys they may use to signal outcomes for particular occasions at particular occasions, any person can take that data and assemble pre-signed transactions to settle accurately based mostly on the vary of potential outcomes with out the oracle ever realizing {that a} contract exists. The oracle merely publicly broadcasts the signed message on the acceptable time, and that provides each customers all of the wanted data to settle the contract accurately.
Lava is designed to utilize a modified variant of DLCs, along with stablecoins on different networks, with a purpose to facilitate a bitcoin collateralized mortgage that may be entered into atomically and trustlessly (i.e. guaranteeing that the lender can’t acquire management of bitcoin with out releasing management of the stablecoin to the borrower).
Instantiation
The funding of the DLC is a two step course of within the Lava protocol, given the requirement that the stablecoins given in trade for the collateral being locked within the contract should be atomic. Within the first section, the borrower creates a script that permits them to say their coin again after a timelock, or permits the lender to finish the funding with a hash preimage and signature from the borrower. They then signal a transaction that strikes the cash from this staging handle into the DLC. The lender then exchanges a hashlock to be used later within the protocol with the borrower.
From this level, the lender must fund an analogous atomic trade contract with the borrower on the chain internet hosting the stablecoin. This contract permits the borrower to say the stablecoins with the identical preimage used to finalize the DLC on Bitcoin, or the lender to reclaim the stablecoins after a timeout. The contract on the alt-chain can also be collateralized with additional stablecoins that stay within the contract, and can’t be claimed again by the lender till after the completion of the contract. This will likely be defined later.
After the setup section, the borrower releases the preimage to the hashlock, claims the stablecoins, and permits the lender to maneuver the bitcoin from the staging handle right into a finalized DLC. At this level the contract is lively.
Execution
In the course of the lifetime of the contract there are three ways in which the mortgage may be settled, both at expiry or throughout its lifetime. Firstly, the lender can execute the DLC with the borrower’s adaptor signature, and an attestation of the present worth from the oracle(s). Secondly, the borrower can execute with the lender’s adaptor signature and an attestation from the oracle(s). Lastly, the borrower can repay the mortgage on the alt-chain, enabling them to say again bitcoin collateral when the lender claims their reimbursement and stablecoin collateral. All of those execution paths disperse the suitable quantity of bitcoin to each events based mostly available on the market worth attested to by the oracle(s).
The reimbursement path makes use of the second hash preimage that the lender generated in the course of the setup. The DLC script is modified permitting the borrower to say again the collateral at any time in the course of the contract lifetime so long as they’ve the preimage to that the lender has generated. On the alt-chain, the stablecoin contract can also be established to require the lender to disclose that preimage to say again their reimbursement and collateral.
This development for reimbursement is added to take care of the motivation the place a reimbursement is made, however the lender doesn’t finalize the reimbursement as a result of the curiosity cost on the mortgage excellent is bigger than the curiosity that might be earned from them issuing a brand new mortgage. That is additionally the explanation that the lender is required to collateralize the alt-chain contract with additional stablecoins, creating an incentive for them to redeem a reimbursement. With out doing so, they can not declare the collateral again, thereby creating an incentive for them to honor the reimbursement and launch the bitcoin collateral even when there’s a monetary incentive as a result of curiosity funds to not accomplish that.
As soon as the lender releases the preimage to say again the reimbursement and the stablecoin collateral, the borrower is then able to unilaterally spending the DLC output by utilizing the launched preimage. This ensures that the borrower is ready to unilaterally reclaim their bitcoin collateral after the lender takes possession of their mortgage reimbursement.
Liquidation and Protected Guards
Just like the DLC Markets proposal, Lava helps a liquidation process. Within the case that the oracle attests to a worth that’s beneath a pre-defined liquidation degree, pre-signed transactions akin to the liquidation occasion can be utilized by the lender to say the whole thing of the collateral. That is to ensure that in the course of the occasion of an enormous worth swing that lowers the collateral worth past the mortgage worth, the lender is able to liquidating it when essential to cowl the stablecoin worth the borrower claimed. In any other case, they might be confronted with the danger of ready till the contract expiry and being caught with bitcoin that’s much less precious than what they’ve lent out, leading to a monetary loss for the lender.
Along with the liquidation process, there’s additionally an emergency restoration choice out there lengthy after the contract expiry. Throughout arrange signatures for pre-signed transactions lengthy after the contract expiry are exchanged. These are used within the occasion that the oracle(s) fail to ship signatures on worth attestations, or within the occasion that the borrower stops cooperating with the lender, or vice versa.
The lender is able to utilizing certainly one of these to say the whole thing of the bitcoin collateral within the occasion the oracle(s) don’t attest to the value, or the borrower turns into non-cooperative in that case. That is to make sure that the bitcoin within the DLC is rarely susceptible to being burned. For comparable causes, a transaction timelocked for lengthy after the lender’s is accessible. This permits the borrower to ultimately declare again their collateral if the oracle(s) and lender develop into unresponsive.
Conclusion
By barely modifying the DLC protocol to incorporate a fundamental hashlock, and the introduction of the liquidation mechanism just like DLC Markets, the Lava protocol has created a variant of DLCs completely fitted to bitcoin collateralized lending. Whereas the dependence on oracles nonetheless exists, like with any DLC protocol or software, the entry and exit of the mortgage is totally atomic and trustless between the borrower and lender.
This proves an immense quantity of worth in subtly tweaking present Bitcoin contract constructions to suit particular use circumstances, and provides a pathway to assembly a extensively demanded want within the ecosystem that doesn’t current the systemic danger of instability that centralized equivalents created previously.
