Chapter 3: Liquidity Pools

Chapter 3: Liquidity Pools

One of the obstacles encountered during the provisional liquidation of Auros was how to deal with the various liquidity pools utilised by the Companies. During the liquidation, the liquidity pool presented two challenges which we discuss below.

The JPLs were advised that Auros had borrowed from communal lending pools facilitated by the smart contract technology provided by a liquidity pool. This technology allows decentralised, anonymous lenders, known as liquidity providers (LPs), to loan cryptocurrencies to the smart contract pool. The smart contract then allows borrowers to withdraw funds as open term uncollateralised loans.

In accordance with the smart contract protocol, the borrowers accrue interest where the interest rate is a function of the pool’s utilisation rate; i.e the more funds that have been drawn down, the higher the rate of interest to be earned. This incentivises borrowers to repay funds.

The liquidity pool provides incentives for LPs to deposit funds, and partners with Credora (the metrics provider to the platform) to make it a KYC-less form of lending for the end assets owners. The liquidity pool borrowing works through the process of a “utilisation curve” whereby the amount borrowed or the capital level in the pool attracts a sliding scale of interest rates.

The Company had engaged with two lending pools - one hosted on the Polygon blockchain and one on the Ethereum blockchain.

The first challenge:

With regard to the Polygon pool, due to the high number of LPs in the Polygon pool and the current credit crunch being experienced by the crypto market, as soon as any repayment is made to the pool, LPs automatically withdraw the funds, thereby ensuring that the borrowing and repayment thresholds effectively remain unaffected by repayments. This is usually because the pools are watched by “bots” and the withdrawals happen immediately. Accordingly, in this particular instance, there was an ongoing requirement, every 5 days, to pay a minimal amount into the pool in order to maintain the required threshold.

The JPLs sought advice from BVI counsel and, with due regard to the value of the payments to be made, the reputational damage of a public default and in the interest of continuity of business where it is that a restructuring is still likely, the JPLs authorised the payment to the liquidity pools.

The second challenge:

This particular lending protocol is fully decentralised, where the end lenders are anonymous. As such, neither the JPLs nor the Authorised Managers were able to enter into a Debt Restructuring Agreement with the end lenders. Nor could the JPLs negotiate with the liquidity pool itself, which merely provides the technology but does not interfere with the participants. In practice, this meant seeking to identify each LP in the pool, which was neither possible nor feasible, given the nature of how these protocols work.

You will recall that, at a high level, the restructuring was effected by way of separate contractual arrangements with the respective creditors in order to vary the original terms of the debts rather than utilising a BVI statutory restructuring mechanism. The way that the liquidity pool was treated for the purposes of effecting the restructuring and the immediate payments to ensure fairness and parity with the other creditors was that the Company made a payment into the smart contract pools from which they borrowed, on the same percentage terms as all creditors. This allowed LPs the opportunity to withdraw. These transactions are fully on chain and visible.

The JPLs’ risk-based and commercial approach to the novel issues presented by the liquidity pools was important in ensuring the restructuring was able to proceed.

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