Backstop Solution

Xlend implements a three-tiered backstop solution:

1. Liquidation

The initial step in a backstop mechanism involves the liquidation process, which is triggered when a borrower’s health factor falls below 1. This step is designed to prevent under-collateralized positions from affecting the lending pool.

In cases where liquidation is not sufficient to cover the bad debt due to rapid market downturns or extreme price volatility, the backstop proceeds to the next step.

2. Safety Staking Vaults (in progress)

If the liquidation process fails to fully cover the bad debt, Safety Staking Vaults designed in the protocol will be used to absorb the remaining shortfall.

In this mechanism, participants stake mainstream assets (USDC, ETH, etc.) into the Safety Staking Vaults, earning rewards but taking on the risk of slashing. If bad debt occurs, a portion of the staked tokens is used to cover the deficit.

This approach helps reduce insolvency risk by aligning incentives between asset stakers and the protocol’s stability, while also offering another layer of protection before reaching the final backstop.

3. Rainy Day Fund

As the final layer of defense, the Rainy Day Fund is deployed if both liquidation and RiskReap Vaults are insufficient to cover the bad debt.

This fund is a reserve managed by the protocol’s team, specifically designed to handle extreme insolvency events. It serves as an emergency buffer, covering any remaining bad debt after other mechanisms are exhausted.

The fund is generally built up over time through a portion of protocol fees, reserve factors, or strategic allocations from governance.

This multi-layered backstop solution aims to protect against systemic risks and ensure the protocol’s solvency, even during extreme market stress. It offers a cascading defense mechanism that prioritizes liquidations, utilizes community staking, and resorts to the protocol’s emergency reserves as a last resort.