Why we invested in Parrot Protocol

Not financial advice.

Introduction

Primer on DeFi & LP tokens

DeFi has solidified its position as a mainstay in the crypto conversation with over $171Bn total value locked (TVL) according to DeFi Llama below. This meteoric rise over the past year has been largely attributable to several innovations, including (non-exhaustive list):

  1. DEXs & Automated market makers (Uniswap / Sushiswap / Curve)
  2. Permissionless borrow/lend markets (Aave / Maker / Liquity)
  3. On-Chain Derivatives (Synthetix / dYdX / Opyn)
  4. Yield Optimizers (Yearn / Compound)
  5. Liquid staking pools (Lido)
Source: DeFi Llama

A common denominator within these innovative DeFi applications is that they require liquidity to be locked onto their platform for various reasons –

  1. DEXs / AMMs: In liquidity pools to facilitate trading
  2. Money markets: To secure deposits as collateral
  3. Derivative platforms: To post as collateral
  4. Yield Optimizers: Deposits are deployed in various strategies
  5. Staking Pools: Staked assets are delegated to validators etc..

The 2 graphs below illustrate the staggering amounts of value locked within them:

  • >$40Bn locked on 3 major lending protocols
  • >$26Bn locked on major Ethereum DEXs

DApps will typically issue a liquidity provider (LP) token to depositors as a claim on their deposited assets.

Source: Dune Analytics
Source: The Block

Current Problems

Since LP tokens essentially represent a claim on the underlying assets, they have been long touted as an efficient tool that could be utilized as collateral. Unlocking the value within these LP tokens is a critical part of increasing the capital efficiency of the DeFi ecosystem as a whole.

However, protocols have been cautious to accept LP tokens as collateral, since they carry additional risk and complexities.

  1. Security Risk — Protocols expose themselves to the smart contract and security risk of the LP tokens’ underlying protocol and multiple underlying tokens. An exploit on the originating protocol could render the LP tokens valueless.
  2. 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.
  3. 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:

This multi-step process introduces uncertainty — between the time of LP token liquidation and original tokens being sold, the token price could have fallen considerably. Taking this into account, the native blockchain must be sufficiently fast enough to process the liquidation before the token price diverges too far.

Parrot Protocol

The fungible nature of tokens and the composability that DeFi enables means that supported assets do not need to be native to Solana. They can be securely bridged over from any other blockchain like Ethereum, and deposited onto Parrot to take advantage of the new possibilities enabled by Solana’s high-performance infrastructure. Parrot anticipates that users may not want to bridge across their native ETH/BTC/Altcoin tokens as their favorite farms/pools might only exist on Ethereum. Parrot overcomes this problem by accepting LP tokens such that users are not faced with the opportunity cost of bridging native tokens over. This allows these users to extract further value from their principal investment by leveraging the value locked in LP tokens as collateral to borrow assets.

The Solution

Step 1: Mint — Think of this as Maker 2.0. Parrot accepts deposits of tokens (SOL, ETH, BTC), interest-bearing tokens (ibETH, aBTC), staking derivatives (stSOL, stETH) and LP tokens to mint stablecoin PAI.

This is essentially a non-custodial money market, where PAI is the only asset users can ‘borrow’. When users deposit any supported token into Parrot and mint PAI, they effectively unlock the dollar value within them while maintaining exposure to their original asset, pool or farm.

Step 2: Earn — Parrot will further increase efficiency by automatically deploying native tokens (SOL, ETH, BTC, USDC) into yield farming strategies, allowing users to earn extra yield on their deposits. Any LP tokens can also be deposited into LM pools to ensure that users capitalize on any LM programs.

Step 3: Invest — With the liquid PAI stablecoin in hand, users can utilize it in a variety of use-cases:

  • Gain more exposure to their native asset (SOL, ETH, BTC)
  • 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

For example, various staking services (Steaking, Marinade, Socean, Chorus One) allow users to deposit SOL in their staking pools to earn a proportion of validator rewards. Depositors will receive staking pool tokens (stSOL, mSOL, prtSOL) that represent their underlying position. The issue is that these different staking pool tokens are not composable. There will need to be a different liquidity pool for each staking derivative, which further fragments liquidity — resulting in an inefficient market with higher slippage and higher rates.

Parrot solves this by enabling any staking derivative to be deposited as collateral to mint pSOL — effectively concentrating liquidity around Parrot’s own synthetic SOL asset that serves as a common unit of account. As the collateral (stSOL / mSOL) continually accrues validator rewards, it theoretically increases in value against the borrowed asset (pSOL) — potentially removing the risk of liquidation. If users were to deposit stSOL directly to mint PAI, they would be faced with the risk of liquidation if the SOL price falls.

Going forward, Parrot will support a variety of synthetic assets that will serve similar purposes towards enhancing liquidity and overall efficiency of the Solana ecosystem.

Why build on Solana?

Specifically for Parrot protocol, Solana offers the advantage of being able to combine multiple processing steps into a single transaction. This allows LP tokens to be liquidated more efficiently if necessary. In addition, a key benefit is that oracles on Solana update prices multiple times a second and can also provide a measure of confidence around that price’s accuracy.

The combination of being able to consistently and accurately market-to-market debt positions and swiftly liquidate underwater positions is paramount to maintaining the integrity of Parrot protocol. Thus, Solana is best suited to accommodate LP tokens as collateral.

Benefits for Borrowers

Parrot Staking Pool

The main drawback within staking pools is that users must wait for the end of an epoch before their staked SOL can be withdrawn. Parrot enhances the staking experience by offering a prtSOL — SOL pool such that users can immediately utilise their staked SOL by swapping prtSOL for SOL.

Roadmap

  1. Extending its non-custodial money market to offer isolated lending markets. This allows Parrot to accommodate longer-tail assets by ring-fencing any potential risks in an isolated environment. Simultaneously, this enables holders of long-tail tokens the opportunity to gain yield by depositing, while also giving potential borrowers a permissionless market to borrow long-tail tokens. In future, Parrot can broaden the accessibility of DeFi value locked by potentially delegating lending capacity to off-chain lenders with real-world borrow demand (ie. micro-financing or pay-day loans). This is a novel concept that will undoubtedly augment the way that traditional borrowers access capital.
  2. 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

The protocol will gain organic revenue from the variety of services that it provides:

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

All this accumulated revenue will be used to purchase PRT from the open market. Instead of burning the PRT, the protocol will reward network participants with the purchased PRT. This ensures the longevity and sustainability of Parrot’s liquidity mining program to continually incentivize usage of the protocol.

In addition, a portion of PRT tokens will be used to secure the solvency of the system within an incentivized insurance pool. This will form a backstop against any shortfall in the lending market.

To encourage governance participation and long-term alignment of the community, users also can stake their PRT to obtain the governance token gPRT. The longer the staking period, the greater the voting power and reward incentive given.

Risks & Threats

2. Stablecoin Peg: Parrot may also be plagued by common issues faced by stablecoin issuing protocols: a potential de-pegging of PAI. This may lead to drastic consequences:

  • If its value significantly increases, the value of all borrowings (in PAI) will increase, effectively lowering the collateralization ratio for every debt position
  • If its value significantly decreases, the protocol controlled value held by Parrot may meaningfully diminish.

Parrot does have multiple avenues at its disposal, such as dynamically moderating the PAI borrow interest rate and the liquidity mining or minting APY incentive to encourage corrective actions.

Conclusion

Disclaimer: This content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained here constitutes a solicitation, recommendation. endorsement or offer by Sino or any third party service provider to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction.

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