The mSOL Depeg Incident

On December 12th, 2023, the Solana ecosystem experienced a significant event that sent shockwaves through its DeFi landscape. A whale investor suddenly sold approximately $8 million worth of mSOL (Marinade Staked SOL) on the open market, causing a temporary but severe depeg of around 15% from its usual value relative to SOL. This incident triggered a cascade of liquidations across various Solana DeFi protocols, exposing differences in how lending platforms like MarginFi and Solend handle risk management and price oracles.

The mSOL token, a liquid staking derivative representing staked SOL, typically trades at a slight premium to SOL due to accrued staking rewards. However, the large market sale created a sudden liquidity crunch, causing the price to diverge significantly from its expected value. This deviation highlighted the importance of robust risk management systems and sparked a debate about the best practices for handling such scenarios in decentralized finance.

MarginFi vs Solend: Two Approaches to Risk Management

The mSOL depeg incident brought to light two distinct philosophies in managing risk within DeFi lending protocols. MarginFi, represented by co-founder Edgar Pavlovsky, and Solend, represented by co-founder Rooter, each defended their approach to handling asset pricing and liquidations during the podcast.

MarginFi's approach prioritizes using market prices for all assets, including liquid staking tokens like mSOL. Edgar emphasized the importance of reacting to real-time market conditions to protect the protocol's solvency. He stated, "We like to price assets to their market price, agnostic of what asset we're talking about." This philosophy extends to stablecoins as well, acknowledging that even assets designed to maintain a peg can experience deviations.

Solend, on the other hand, takes a more nuanced approach, particularly with mSOL. Rooter explained that Solend uses the SOL oracle price instead of the mSOL oracle for pricing mSOL as collateral. He justified this decision by citing historical issues with the mSOL oracle and the inherent relationship between SOL and mSOL prices. Rooter argued, "Throughout the last two years, we've seen many issues with the M-soul Oracle. And, you know, this is to be expected somewhat given that there are way more quotas on the Sol Oracle."

The Oracle Debate

At the heart of the disagreement between MarginFi and Solend lies the implementation of price oracles. Oracles play a crucial role in DeFi by providing external price data to smart contracts, which is essential for determining collateral values and triggering liquidations.

MarginFi advocates for using direct market price oracles for all assets, including derivatives like mSOL. Edgar explained their position: "We continue to look at market prices regardless of the asset that we're considering." This approach aims to reflect the most current market conditions and respond quickly to any price movements, even if they may be temporary.

Solend's strategy involves using the SOL oracle price as a proxy for mSOL. Rooter defended this choice, stating, "We use the Solana Oracle instead of the M-soul Oracle for the M-soul asset. And the reason for that is that it's a lot more reliable." He pointed out that the SOL oracle has more price quoters (31 vs 14 for mSOL) and typically shows 80-90% higher confidence intervals.

The debate highlights a fundamental question in DeFi risk management: Should protocols prioritize immediate market reactions or aim for stability based on theoretical relationships between assets?

Liquidation Mechanisms and Profitability

Both MarginFi and Solend agree on the critical importance of liquidations in maintaining protocol solvency. However, they differ in their approaches to executing liquidations and incentivizing liquidators.

Edgar emphasized the significance of liquidator profitability: "Liquidator profitability is the number one most important metric from the liquidator perspective." He explained that MarginFi designs its risk models assuming that only in-house liquidators will operate during extreme market conditions, as third-party liquidators may become unreliable in times of high uncertainty.

Solend's approach to liquidations has evolved over time. Rooter described their transition from a first-come-first-served model to an auction-based system: "In Solent V2, we changed it to this kind of auction model where basically the bonus that the liquidators get is slowly increasing over time." This model aims to balance speed with execution quality, ensuring that liquidators with access to better liquidity sources can compete effectively.

Both protocols recognize the challenges faced during extreme market events, such as the FTX crisis, where many third-party liquidators ceased operations due to market uncertainty. This underscores the need for robust, protocol-controlled liquidation mechanisms to maintain stability during black swan events.

The Importance of Liquidator Incentives

Liquidators play a crucial role in the DeFi ecosystem by helping to maintain the solvency of lending protocols. Both MarginFi and Solend recognize the importance of creating the right incentives for liquidators to ensure they remain active and effective, especially during market turbulence.

Edgar from MarginFi stressed the concept of liquidator profitability as a key metric: "If liquidators are not confident in the moment that they will be profitable, they won't choose to participate in a liquidation scheme." This insight drives MarginFi's approach to risk modeling, where they assume that liquidators will only act when it's profitable for them to do so.

Solend's experience during the FTX crisis highlighted another aspect of liquidator behavior. Rooter noted, "During FTX it was actually an extremely lucrative time to run liquidators in our bots. You could have made in a day what you would have been like the whole year, if not more. But a lot of people were just, you know, there's so much uncertainty around exchanges and just everything." This observation underscores that profitability alone may not be sufficient to ensure liquidator participation during extreme market events.

Both protocols have responded to these challenges by developing more sophisticated liquidation engines and improving their in-house capabilities. This trend towards protocol-controlled liquidation mechanisms reflects a growing understanding of the complexities involved in maintaining a healthy DeFi ecosystem.

Cross-Collateralized vs Isolated Pools

The debate also touched on the structure of lending pools within DeFi protocols. Cross-collateralized pools allow users to deposit multiple asset types as collateral, potentially increasing capital efficiency but also introducing systemic risks. Isolated pools, on the other hand, separate different assets to contain risks but may reduce overall efficiency.

While not extensively discussed in the podcast, both MarginFi and Solend have implemented features to address these trade-offs. MarginFi's approach leans towards flexibility, allowing users to choose their risk exposure. Solend has introduced isolated pools for certain assets to mitigate systemic risks while maintaining cross-collateralized options for more established assets.

The ongoing evolution of pool structures reflects the DeFi industry's efforts to balance user choice, capital efficiency, and risk management. As the ecosystem matures, we may see more nuanced approaches that allow protocols to fine-tune their risk profiles while meeting diverse user needs.

The Future of DeFi Lending

Both Edgar and Rooter shared their visions for the future of DeFi lending, highlighting trends towards more sophisticated risk management and user-centric designs.

Rooter expressed interest in exploring peer-to-peer (P2P) lending models: "I've been thinking a ton about like P2P kind of order books based loans, and kind of similar to what Blur has done with Blend." He sees potential in allowing users more control over their counterparty risk, although he acknowledges the challenges in maintaining capital efficiency and user experience.

Edgar emphasized the importance of focusing on lenders' needs: "From an addressable market perspective, I think that lenders outnumber borrowers on a user basis, something like 99.9% to one." This perspective drives MarginFi's approach to product development and risk management, prioritizing the safety and returns for liquidity providers.

Both leaders agreed that the future of DeFi lending would likely involve more granular risk management tools, potentially allowing users to customize their risk exposure. This trend aligns with the broader movement in DeFi towards greater user autonomy and tailored financial products.

Governance and Decentralization

The conversation touched on the challenges of governance in DeFi protocols, particularly in the context of risk management. Both MarginFi and Solend recognize the limitations of current governance models and are exploring alternatives.

Rooter highlighted the issues with traditional DAO governance, citing examples from Ethereum's ecosystem: "Like we see on Ethereum, like Aave, they have a Dow to, for any small change, the parameters requires this, you know, elaborate voting process. And we saw this being a real issue with the courage incident." He suggested that a more streamlined approach to risk management might be necessary to respond quickly to market changes.

Edgar emphasized the importance of building autonomous systems that can operate effectively without constant human intervention. This aligns with the goal of true decentralization, where protocols can maintain stability and adapt to market conditions without relying on centralized decision-making processes.

The debate around governance reflects a broader conversation in the DeFi space about balancing decentralization with operational efficiency. As protocols evolve, we may see new governance models emerge that can better handle the complexities of risk management in a decentralized context.

The Role of Tokens and Incentives

The podcast discussion ventured into the controversial topic of token incentives and "points" systems, which have become prevalent in the Solana ecosystem and broader DeFi space.

Rooter expressed concerns about the potential abuse of points systems: "I think points are really important in crypto. They're the lifeblood. Like, we wouldn't be where we are today as an industry without tokens bringing people in, all this excitement." However, he cautioned against prolonged teasing of token launches through points programs, which he sees as potentially predatory.

Edgar took a more measured stance, acknowledging the power of incentive systems while emphasizing the need for long-term value creation: "Incentive systems should be just in input to that, right? When you look at how successful incentive systems have worked outside of crypto, right, where we've seen kind of the most mature incentive systems, you see that incentivizing long-term contribution, long-term participation, often with more abstract value proposition, right, is what is most effective."

Both leaders agreed that while tokens and incentives play a crucial role in bootstrapping liquidity and user adoption, the focus should be on creating sustainable ecosystems that provide long-term value to users and contributors.

Transparency and Public Discourse

An interesting point of contention arose regarding the value of public versus private conversations about protocol design and risk management. Edgar advocated strongly for public discourse: "I think public conversation is super, super important." He argued that open discussions about potential vulnerabilities or areas for improvement ultimately strengthen the ecosystem by allowing for community-driven scrutiny and innovation.

Rooter, while agreeing on the importance of transparency, cautioned against what he perceived as slanderous or unconstructive criticism: "I do agree with you that putting things publicly is good, but I feel that the way that you guys have been doing it has been more slanderous than anything else." This exchange highlighted the delicate balance between fostering open dialogue and maintaining professional relationships within the industry.

The debate underscores a broader trend in the DeFi space towards greater transparency and community involvement in protocol development and risk management. As the industry matures, finding the right balance between open discussion and responsible disclosure will be crucial for building trust and resilience in decentralized systems.

Learning from Past Crises

Both MarginFi and Solend have been shaped by their experiences during past market crises, including the collapse of FTX and other major disruptions in the crypto space. These events have influenced their approaches to risk management and protocol design.

Rooter listed a series of incidents that Solend has navigated: "There was a lot of Solana downtime, network issues. There's one that was like 17 hours, but for some time, there was one like every week, and that was basically an incident for us. There were multiple Oracle mispricings that caused incidents." These experiences have led Solend to adopt a more conservative approach to risk management, prioritizing stability and reliability over immediate market responsiveness.

Edgar emphasized the importance of building systems that can withstand extreme market conditions: "I'm constantly thinking about teller risk scenarios, right? Like, my entire day is waking up and going, all right, like Solana Plummets 80% in a day, right? Market depth is at, you know, P95 bad, right? Everything is, you know, everyone's pulling out, things are cascading." This focus on tail risk scenarios drives MarginFi's approach to protocol design and risk modeling.

The discussion highlighted how past crises have led to more robust and resilient DeFi protocols, with both teams continuously refining their strategies to better handle future market shocks.

The Importance of User Education

While not explicitly discussed in the podcast, the conversation implicitly touched on the critical need for user education in the DeFi space. The complex nature of risk management strategies, oracle implementations, and liquidation mechanisms underscores the importance of helping users understand the risks and trade-offs involved in using DeFi protocols.

Both MarginFi and Solend have taken steps to improve transparency and provide educational resources to their users. However, the industry as a whole faces ongoing challenges in making complex financial concepts accessible to a broader audience.

As DeFi continues to evolve and attract more mainstream attention, protocols will need to invest heavily in user education and intuitive interfaces that can abstract away complexity while still allowing users to make informed decisions about their risk exposure.

Collaboration vs. Competition in the Solana Ecosystem

The podcast revealed both collaborative and competitive aspects of the relationship between MarginFi and Solend. While there were clear disagreements on certain approaches to risk management, both teams expressed a desire for a healthy, diverse ecosystem on Solana.

Edgar emphasized the importance of having multiple strong players in the lending space: "I think if Margin Fai is the only lending platform on Solana or within the relevant space where, you know, we're compared, I think that's a problem. I think it's a huge problem, right? I think there needs to be like a critical mass of multiple venues."

Rooter, despite expressing frustration with some of MarginFi's public statements, concluded the discussion on a positive note by highlighting aspects of MarginFi that he admired: "I saw your light mode. I think it's a really great idea and quite well executed. I think, yeah, it really simplifies the UI for new users. I think you guys are really ambitious team who ship a lot."

This exchange demonstrates the complex dynamics within the Solana DeFi ecosystem, where protocols must balance competition with the need for collaboration to drive overall growth and innovation.

The Role of Audits and External Validation

While not extensively discussed in the podcast, the importance of audits and external validation for DeFi protocols was implicitly acknowledged throughout the conversation. Both MarginFi and Solend have undergone multiple audits to ensure the security and reliability of their smart contracts.

The discussion about risk management and oracle implementations highlights the ongoing need for rigorous testing and validation of DeFi protocols. As the industry matures, we may see the emergence of more standardized benchmarks and stress tests for lending platforms, similar to those used in traditional finance.

External validation from respected security firms and continuous monitoring by the broader DeFi community will remain crucial for building trust and ensuring the long-term viability of decentralized lending protocols.

Addressing Volatility in Liquid Staking Derivatives

The mSOL depeg incident brought attention to the unique challenges posed by liquid staking derivatives (LSDs) in DeFi lending protocols. These assets, which represent staked tokens while allowing holders to maintain liquidity, can experience periods of increased volatility or temporary deviations from their expected value.

Both MarginFi and Solend recognize the importance of LSDs in the Solana ecosystem but differ in their approaches to managing the associated risks. MarginFi's strategy of using market prices aims to capture real-time volatility, potentially leading to more frequent liquidations but also providing faster protection against sustained depegs.

Solend's approach of using the underlying SOL price for mSOL collateral seeks to smooth out short-term volatility, potentially reducing unnecessary liquidations but also introducing the risk of delayed reactions to genuine depegs.

As liquid staking continues to grow in popularity across various blockchain ecosystems, DeFi protocols will need to refine their strategies for handling these assets, balancing the benefits of capital efficiency with the need for robust risk management.

The Impact of Network Performance on DeFi Risk Management

The discussion touched on Solana's historical network performance issues and their impact on DeFi operations. Rooter mentioned, "There was a lot of Solana downtime, network issues. There's one that was like 17 hours, but for some time, there was one like every week, and that was basically an incident for us."

These experiences highlight the interdependence between blockchain infrastructure and DeFi protocols. Network congestion or downtime can severely impact the ability of lending platforms to execute liquidations, update oracle prices, or allow users to manage their positions effectively.

Both Margin and Solend have had to develop strategies to mitigate the risks associated with network issues, such as implementing circuit breakers or failsafe mechanisms. As Solana continues to improve its network stability and performance, DeFi protocols built on the platform will benefit from increased reliability and the ability to implement more sophisticated risk management strategies.

The Evolution of Liquidation Mechanisms

The podcast revealed how both MarginFi and Solend have iteratively improved their liquidation mechanisms based on real-world experiences and changing market conditions.

Solend's transition from a first-come-first-served model to an auction-based system demonstrates the protocol's efforts to balance speed with execution quality. Rooter explained, "In Solent V2, we changed it to this kind of auction model where basically the bonus that the liquidators get is slowly increasing over time."

MarginFi's focus on in-house liquidation capabilities reflects a trend towards more protocol-controlled liquidation processes. Edgar emphasized, "We run all of our risk models off of the idea that only the in-house liquidators that we manage ourselves on the core team are operating."

These evolving approaches to liquidations showcase the DeFi industry's ongoing efforts to create more efficient, fair, and resilient systems for maintaining protocol solvency.

The Challenge of Cross-Chain Risk Management

While the discussion focused primarily on Solana-based protocols, the challenges of cross-chain risk management were implicitly present in the conversation. As DeFi ecosystems expand across multiple blockchains, lending protocols face the additional complexity of managing risks associated with cross-chain assets and bridged tokens.

The mSOL depeg incident, while confined to the Solana ecosystem, hints at the potential for broader cross-chain contagion in more interconnected future scenarios. Both MarginFi and Solend will likely need to consider cross-chain dynamics in their risk models as the DeFi landscape becomes increasingly interoperable.

This evolving challenge presents opportunities for innovation in risk management strategies that can account for the unique properties and potential vulnerabilities of cross-chain assets.

The Role of MEV in DeFi Lending

Maximal Extractable Value (MEV) was not directly addressed in the podcast, but its implications for liquidations and overall protocol health are relevant to the discussion of risk management in DeFi lending.

As liquidation opportunities can be a source of MEV, the design of liquidation mechanisms can significantly impact the distribution of value between liquidators, protocols, and users. Both MarginFi and Solend's approaches to liquidations must consider how to balance efficient liquidations with fair value distribution and protection against predatory MEV strategies.

The ongoing development of MEV-resistant designs and the potential integration of MEV-capture mechanisms into protocol treasuries represent an important frontier in DeFi risk management and economic design.

The Potential for Regulation and Its Impact on DeFi Lending

While not explicitly discussed in the podcast, the specter of regulation looms over the entire DeFi industry, including lending protocols like MarginFi and Solend. The approaches to risk management, oracle implementation, and liquidation mechanisms may need to evolve in response to future regulatory frameworks.

Both protocols' emphasis on robust risk management and user protection aligns with potential regulatory priorities. However, the decentralized nature of these platforms and the novel financial products they offer present unique challenges for traditional regulatory approaches.

As the regulatory landscape for DeFi continues to develop, lending protocols may need to find innovative ways to comply with emerging standards while maintaining the core principles of decentralization and open access.

Conclusion: The Ongoing Evolution of DeFi Risk Management

The debate between MarginFi and Solend following the mSOL depeg incident offers valuable insights into the complex world of DeFi risk management. It highlights the diverse approaches protocols can take to handle market volatility, ensure solvency, and protect users' assets.

Both teams demonstrate a deep commitment to building robust, resilient lending platforms that can withstand the unique challenges of the cryptocurrency market. Their differing philosophies on oracle implementation, liquidation mechanisms, and overall risk management strategies reflect the ongoing experimentation and innovation in the DeFi space.

As the Solana ecosystem and the broader DeFi industry continue to mature, we can expect further refinements in risk management practices. The lessons learned from incidents like the mSOL depeg will undoubtedly contribute to the development of more sophisticated, user-friendly, and resilient DeFi protocols.

Ultimately, the healthy debate and competition between projects like MarginFi and Solend drive innovation and improvement across the entire ecosystem. By continuously challenging and refining their approaches to risk management, these protocols are paving the way for a more stable and accessible DeFi future on Solana and beyond.

Facts + Figures

• On December 12th, 2023, a whale investor sold approximately $8 million worth of mSOL on the open market, causing a temporary depeg of around 15% from its usual value relative to SOL.

• MarginFi has $350 million supplied in their protocol as of the podcast recording date.

• Solend uses the SOL oracle price instead of the mSOL oracle for pricing mSOL as collateral.

• The SOL oracle has 31 price quoters compared to 14 for the mSOL oracle.

• Solend's confidence intervals for SOL prices are typically 80-90% higher than for mSOL.

• MarginFi uses an exponential moving average with a one-hour time window for their market price oracle.

• Solend transitioned from a first-come-first-served liquidation model to an auction-based system in their V2 release.

• During the FTX crisis, many third-party liquidators ceased operations due to market uncertainty.

• Solend experienced multiple incidents related to Solana network downtime, including one that lasted 17 hours.

• The price of SOL dropped from $250 to $10 in a relatively short period during past market turbulence.

• Lenders are estimated to outnumber borrowers on lending platforms by a ratio of 99.9 to 1.

• Solend's recent points program rewards included Solend tokens, 5th tokens, and Tensorians, with Tensorians reaching a value of 110 SOL.

Questions Answered

What caused the mSOL depeg incident on December 12th, 2023?

The mSOL depeg incident was caused by a whale investor suddenly selling approximately $8 million worth of mSOL on the open market. This large sale created a liquidity crunch, causing the price of mSOL to temporarily deviate by around 15% from its usual value relative to SOL. The incident triggered liquidations across various Solana DeFi protocols and exposed differences in how lending platforms handle risk management and price oracles.

How do MarginFi and Solend differ in their approach to pricing mSOL as collateral?

MarginFi uses market prices for all assets, including mSOL, prioritizing real-time market conditions. They employ an exponential moving average with a one-hour time window for their market price oracle. In contrast, Solend uses the SOL oracle price instead of the mSOL oracle for pricing mSOL as collateral. Solend justifies this approach by citing historical issues with the mSOL oracle and the inherent relationship between SOL and mSOL prices. They argue that the SOL oracle is more reliable, with more price quoters and higher confidence intervals.

What changes did Solend make to its liquidation mechanism in V2?

Solend transitioned from a first-come-first-served liquidation model in V1 to an auction-based system in V2. In this new model, the bonus that liquidators receive slowly increases over time. This change aims to balance speed with execution quality, ensuring that liquidators with access to better liquidity sources can compete effectively. The auction-based system is designed to incentivize liquidators to provide the best execution rather than simply being the fastest to respond.

How do MarginFi and Solend approach liquidator incentives?

Both protocols recognize the importance of liquidator profitability, but they have different strategies. MarginFi emphasizes the critical nature of liquidator profitability and designs its risk models assuming that only in-house liquidators will operate during extreme market conditions. They believe third-party liquidators may become unreliable in times of high uncertainty. Solend, on the other hand, has developed an auction-based system to balance incentives and execution quality, while also improving their in-house liquidation capabilities following experiences during market crises like the FTX collapse.

What are the main challenges in DeFi governance highlighted in the podcast?

The podcast highlighted several challenges in DeFi governance, particularly in the context of risk management. Traditional DAO governance models, like those used by Aave on Ethereum, can be slow and cumbersome, requiring elaborate voting processes for even small parameter changes. This can hinder quick responses to market changes or emerging risks. Both MarginFi and Solend recognize the need for more streamlined approaches to risk management that can operate effectively without constant human intervention. The discussion emphasized the ongoing challenge of balancing decentralization with operational efficiency in DeFi protocols.