When a silo (market) experiences an insolvency event, it likely becomes unusable and should be deprecated.
How does that happen?
Any silo can accrue bad debt for a variety of reasons, leading to an insolvency event. Typically insolvency occurs when borrowers of a certain token asset choose not to pay off their loans because the value of those loans exceed the value of the collaterals they leave behind. In such a case, borrowers leave open borrow positions that keep incurring borrowing interest rate.
The utilization of the borrowed asset in the insolvent silo often reaches 100%. When the utilization reaches such a critical level, the dynamic interest model jacks up the borrowing interest rate exponentially without any upper limit in an attempt to attract deposits. Depositors in the impacted silo might see lending interest rates in the thousands percent. Whilst the lending rate is extremely high, any lender that chooses to deposit into this silo should beware that their tokens will not be withdrawable since any new deposits will be used to offset the bad debt.
When a silo accrues bad debt, it must be deprecated to prevent any additional lenders from depositing funds. However, since there can only be one primary silo per a token asset, deprecating the silo leads to a token asset losing its lending market. To overcome this issue, the SiloDAO, through on-chain voting, can deploy a new primary silo to replace the deprecated one.
- 1.$ABC experiences a price exploit causing bad debt to $ETH lenders in the ABC-ETH Silo.
- 2.$ETH in the ABC-ETH Silo is fully borrowed, resulting in 100% utilization rate (no more ETH to borrow) and extremely high $ETH lending APY.
- 3.$ETH borrow positions incur increasing borrowing interest rate that in turn increases the size of the bad debt. The dynamic borrowing interest rate keeps increasing even when there is no borrowing happening.
- 4.Any user that has already deposited ETH, or deposits in the future, will be unable to retrieve their funds since utilization rate is at 100%.
- 5.ABC-ETH Silo becomes defunct.
- 1.Prospective $ETH lenders that choose to deposit into the ABC-ETH Silo will NOT be able to withdraw their funds since $ETH will be used to offset the Silo’s bad debt.
- 2.Since any future ETH deposits into the ABC-ETH Silo will not be withdrawable, $ABC holders have no market on Silo on which to borrow against their token.
- 3.To prevent $ETH lenders from losing their deposit, the ABC-ETH Silo will be labelled “ABC-ETH Silo (Deprecated)”, indicating that the Silo should not be in use anymore.
Deprecated silos only appear to wallets that have open positions in the deprecated Silo. Other wallets connected to the Silo’s web application will not be able to view deprecated Silos. This measure prevents users from using deprecated Silos accidentally.
- 1.A governance proposal can be run to create a new ABC-ETH Silo. The new Silo becomes the primary ABC-ETH Silo.
- 2.If the cause of the bad debt in the deprecated Silo was a price oracle exploit, the DAO may choose to launch the new lending market with a different oracle.
- 3.This process of deprecation and creation can be repeated as many times as needed in the event there are multiple instances of insolvency to a token asset.