Why we invested in Parrot Protocol

Not financial advice.

Introduction

We are thrilled to announce our investment in Parrot Protocol, which is building a suite of DeFi products that enable the value locked within liquidity provider (LP) tokens to be accessible. Today, there are billions worth of tokens locked in various DeFi applications — within liquidity pools and yield generating strategies. In many cases, these LP tokens remain unutilized even though they carry an intrinsic value. This investment thesis will dive into how unlocking this locked value will be a fundamental component in elevating both efficiency and composability within DeFi, and why Solana is the optimal blockchain for this revolution to begin.

Primer on DeFi & LP tokens

Decentralized Finance (DeFi) attracted huge attention in 2021, exploding onto the cryptocurrency scene with its aim to disintermediate real-world centralized financial functions by utilizing smart contracts on blockchains or “programmable money”.

  1. Permissionless borrow/lend markets (Aave / Maker / Liquity)
  2. On-Chain Derivatives (Synthetix / dYdX / Opyn)
  3. Yield Optimizers (Yearn / Compound)
  4. Liquid staking pools (Lido)
Source: DeFi Llama
  1. Money markets: To secure deposits as collateral
  2. Derivative platforms: To post as collateral
  3. Yield Optimizers: Deposits are deployed in various strategies
  4. Staking Pools: Staked assets are delegated to validators etc..
  • >$26Bn locked on major Ethereum DEXs
Source: Dune Analytics
Source: The Block

Current Problems

Currently, there are limited use-cases for LP tokens. They are predominantly deposited into staking pools to gain liquidity mining (LM) rewards; however, LM only last for a limited period of time, and there are many instances where LM is not available. As DeFi protocols mature, LM may potentially be significantly scaled back as token issuance reaches its supply ceiling.

  1. Oracle Attacks — LP tokens are susceptible to oracle attacks since their price is usually fetched via an on-chain oracle. Specifically in the case of warp.finance, their lack of understanding of Uniswap’s TWAP data left them vulnerable to an exploit.
  2. Complex liquidations — LP tokens add additional steps and complexity to the liquidation process. In the event of cascading liquidations, there is a downward spiral that worsens the situation:

Parrot Protocol

Parrot Protocol is laying the foundation for enhancing efficiency and liquidity within the Solana DeFi ecosystem. They are taking a step-wise approach to creating a liquidity and lending network, starting with their own stablecoin PAI as the common unit of account. PAI is an essential component to moderating risk as it centralizes the exposure taken across multiple collateral types.

The Solution

Below, we will walkthrough a user’s journey on Parrot Protocol.

  • Gain yield by deposit PAI into a stablecoin pool / yield-farming strategy
  • Execute delta-neutral strategies while maintaining yield on native asset
  • Hedge market risk by using PAI as collateral on derivative platforms

Synthetic Assets

The open-sourced and freely-competitive nature of DeFi frequently results in multiple protocols building products that address similar issues. Free competitive forces are often beneficial to any nascent industry as it encourages constant innovation by incumbents and disruptors alike. At this early stage, there is ample room for protocols to distinct themselves from competitors via niche features and use-cases, thus allowing multiple competing protocols to co-exist. However, this results in a common problem that arises — the fragmentation of liquidity across various protocols.

Why build on Solana?

Parrot protocol chose to build on Solana’s high-performance blockchain as it alleviates some of the aforementioned pain points experienced on other L1s like Ethereum. High transaction speed, low latency and ultra-low costs are all factors that contribute to the usability of Solana’s blockchain. The costs of transacting on Ethereum L1 are prohibitively high — most transactions under $1000 are impracticable. In that respect, there is a huge opportunity for Solana to capture. For our thesis on Solana’s highly performant infrastructure and its benefits, please see our Solana investment thesis here: https://sinoglobalcap.medium.com/why-we-are-bullish-on-solana-c2be784cfdf6

Benefits for Borrowers

The added benefit of denominating all debt in its self-issued stablecoin PAI is that Parrot can afford to bear greater risks by delaying the liquidation process. A lengthier liquidation period allows users more time to re-collateralize their debt positions to prevent liquidation events. This is possible as Parrot can internalize the cost of bad debt by selling its PRT token to mint more PAI, which is used to supplement any losses. However, there is a fine line to thread between user-friendliness and accumulating debt.

Parrot Staking Pool

Staking SOL tokens is an integral part of securing the security of the Solana network. Users have 2 options, they can either choose a specific validator or alternatively pick a liquidity staking pool. Parrot’s staking pool allows users to delegate their SOL tokens into a pool, where Parrot then spreads out that stake across a variety of different validators. This diversification would be operationally cumbersome for any one user to do alone. However, the benefit of this diversification is immensely significant towards increasing the security, decentralization and censorship resistance of the Solana network as a whole!

Roadmap

In future, Parrot intends to build on its existing infrastructure and PAI stablecoin by:

  1. Perpetual trading product with virtual AMM (vAMM). PAI will be used as protocol controlled value (PCV), where Parrot can utilize it to arbitrage the perpetuals if its perp price deviates from spot. The advantage of a vAMM is that it does not require any native locked liquidity, ensuring that Parrot does not cannibalize any liquidity within its other products. Users can utilize their minted PAI as collateral to gain perpetual exposure within any chosen token.

PRT Token

Value accrual to the native PRT token is essential to the long-term sustainability of the protocol.

  1. Borrow interests from PAI
  2. Liquidation penalties
  3. Portion of borrow fees from lending market
  4. Trading fees from Perpetual trading (since vAMM does not require LPs, all fees can be directly captured by Parrot)

Risks & Threats

1. Competition: With upcoming developments in making Solana EVM-compatible, Parrot faces strong headwinds from Ethereum native incumbents that will deploy their tried-and-tested, crowd-favorite protocols on Solana. These protocols will certainly attempt to make full use of Solana to publish features that were previously infeasible on Ethereum — accepting LP tokens as collateral being one of these features. Furthermore, there are other Solana-native protocols that are also deploying competing LP collateral features.

  • If its value significantly decreases, the protocol controlled value held by Parrot may meaningfully diminish.

Conclusion

We believe that Parrot Protocol has the right vision and expertise to successfully execute their planned roadmap and will be a driving force in optimizing the efficiency and composability of the DeFi landscape as a whole. Their multi-chain approach is powerful in its ability to garner the support of a vast range of DeFi users, who currently have no viable alternative to unlocking the value within their LP tokens. This should ultimately drive more value onto the Solana ecosystem, and expose a larger audience to the benefits of a highly performant blockchain.

A team of former consulting, Wall Street, private equity, government, and corporate veterans accelerating the blockchain revolution