Treasury Proposal | Liquidity Funding for Heiko Money Market and sKSM/KSM LP

Summary

Parallel Heiko team proposes to borrow from Kusama Treasury a total of 30,000 KSM to supply to the Heiko Money Market and Heiko Swap KSM/sKSM LP. This injection of liquidity of KSM, the base asset of Kusama, into Heiko DeFi ecosystem will help freeing up the previously locked assets of crowdloan participants and KSM stakers, significantly improve the capital efficiency of the Kusama ecosystem, and further drive the KSM related economic growth and adoption.

We propose to:

add 20,000 KSM from the KSM loan into the Heiko Money Market for a better KSM liquidity for crowdloan contributors to borrow against their cKSM;
add 10,000 KSM into sKSM/KSM liquidity pool on Heiko AMM allowing KSM stakers to swap between their sKSM and KSM with a low slippage

Background

Heiko Network

Heiko Network is the Kusama network-based DeFi super DApp protocol that features a composable and interoperable ecosystem of community-focused decentralized applications. The DApps include liquid staking, AMM, decentralized money market, liquid crowdloan, stream protocol (DAO tooling), wallet, and yield farming applications. The protocol is committed to building a decentralized future that empowers the community, by increasing DeFi accessibility, capital efficiency, and security.

Our Polkadot-based sister network Parallel Finance is one of the largest parachains in the Polkadot space with over 300K+ active users and $550M+ TVL[1], and we are backed by some of the most accomplished investors in venture capital and veterans of the financial services space, including Sequoia, Founders Fund, Coinbase, Polychain etc.

Problems & Solutions

Problem 1 - Illiquidity of Staked KSM

Traditionally, staking in the Kusama network has been about locking up your KSM with an unlock period of 7 days in exchange for a fixed, predetermined staking reward. Despite the steady passive income through the act of staking, the opportunity cost of missing out potential high yields provided by various DeFi protocols or missing the immediate price appreciation can be too great[2].

Given the nature of staking as a fundamental mechanism to provide network security, the unwillingness of token holders to stake their KSM posts a serious threat to the liveliness of the blockchain and hinders the further decentralization of Kusama network.

Heiko Liquid Staking as a Solution to Problem 1

Parallel Finance team who is behind the leading liquid staking service provider on Polkadot, Parallel Liquid Staking Dapp (with 1,640,508.28 DOT staked[3] at the time of this proposal), launched its Kusama counterpart Heiko Liquid Staking aiming to resolve this exact dilemma.

At the time of this proposal, 31,122.49 KSM[4] had been staked through Heiko Liquid Staking service.

By staking KSM through Heiko Liquid Staking Dapp, users will receive back sKSM, an interest-bearing certificate for the underlying KSM, which can then be used across the Heiko ecosystem for yield and lending purposes. Not only does sKSM free up stakers’ locked liquidity by allowing them DeFi opportunities within the Heiko ecosystem, it can also be traded instantly for KSM on Parallel AMM, therefore giving users immediate access to liquid KSM that can be used across the whole Kusama network without worrying about the 7 days lock-up period.

However, to maintain the exchange rate between sKSM and KSM within a reasonable range, a deep sKSM/KSM liquidity from a reliable source needs to be secured. Hence, we propose to use 10,000 KSM of the KSM loan to strengthen the liquidity on this pair.

Problem 2 - Illiquidity of KSM contributed to Crowdloan

A mechanism unique to Polkadot/Kusama network, crowdloan happens when a native project needs to borrow DOT/KSM from its supporters for a certain period of time in order to win a parachain slot during slot auctions.

Crowdloan contributors are required to lock their KSM for 48 weeks (the entire lease period) in exchange for a certain amount of native tokens provided by slot auction participating projects.

Similar to the problem with staking, a long lock-up period where contributors can neither use or trade their KSM can be economically unfeasible to some KSM holders. Not only does this concern prevent crowdloan participation from said holders, the inability to move their KSM might also result in dismay in unseasoned previous crowdloan participants during volatile market conditions, therefore further lowering the participation rate of future crowdloans.

We believe that the decrease in crowdloan participation (see fig.1) is the direct consequence of this fear of illiquidity.

Below is a graph showing the average KSM needed to win slot auction in each batch[5]

fig.1 Decline in the average KSM needed to win the slot auction
Batch 1 to Batch 8

Heiko Liquid Crowdloan as a Solution to Problem 2

Heiko Liquid Crowdloan Dapp can serve as an efficient solution to the problem mentioned above, as proven by its sister product on Polkadot network, Parallel Liquid Crowdloan, with a TVL of 130,154,549.31 DOT[6] in total.

At the time of this proposal, 79,405 KSM has been contributed through Heiko Liquid Crowdloan:

Instead of contributing their KSM directly through Polkadot.js, users can participate in crowdloan through Heiko Liquid Crowdloan Dapp and receive back cKSM, a certificate for the underlying KSM that can be redeemed 1:1 at the end lease period. Similar to sKSM, cKSM can also be used across DeFi products provided by Heiko or be traded for liquid KSM on Heiko AMM.

What is special about cKSM is that due to its KSM 1:1 redeemable nature, cKSM can serve as collateral to be borrowed against for KSM up to 50% of its value without the risk of getting liquidated through the unique Liquidation-Free Loan option on Heiko Money Market (more information can be found in the Liquidation-Free Loan section).

Borrowing & Lending in DeFi

Borrowing & lending service is at the core of a DeFi ecosystem. It can drastically improve the capital efficiency of the ecosystem, by allowing the lenders to earn an interest on their idle assets and the borrowers to either leverage their position or simply get access to liquid capital without selling core assets.

A native borrowing & lending service with deep liquidity is crucial to the growth of a maturing DeFi ecosystem like Kusama.

Heiko Money Market

Heiko Money Market is the leading lending & borrowing service native to Kusama network. It is the sister project to Parallel Money Market launched on Polkadot network. At the time of this proposal, the two projects now have a combined TVL of $60,365,296[7].

Liquidation-Free Loan

Liquidation-Free Loan is a service that Heiko Money Market offers specifically to cKSM holders. As discussed above, cKSM can be redeemed for KSM at a 1:1 ratio at the end of the lease period. From a financial standpoint, cKSM can bee seen as a 48-week zero-coupon bond on KSM, and the KSM-denominated value of cKSM at the time of cKSM maturity is determined when cKSM is being issued.

Therefore, Heiko Money Market will be able to calculate the maximum amount of KSM that can be borrowed against a certain amount of cKSM without incurring liquidation risk to the borrower. By selecting the Liquidation-Free Loan option, cKSM holders will be able to borrow up to 50% of their cKSM value in KSM with no risk of getting liquidated. For detailed information on Liquidation-Free Loan and the math behind it, please refer to Parallel Finance gitbook[8].

The unleash of liquidity in KSM locked in crowdloan through liquidation-free loan provides another layer of farming yield for cKSM holders and helps escalate the overall long-term yield of KSM above its NPOS reward level.

And as cKSM holders can have access to liquidity and earn farming yield, it helps lower the crowdloan participants' expectation of rewards they make directly from crowdloan. This helps reduce costs for projects in the Kusama ecosystem to bid for parachain slots and in turn attracts more dev forces to the ecosystem.

In order to maximize the capital efficiency of Kusama DeFi ecosystem and to enhance the user experience of crowdloan participants and KSM stakers, we propose to supply 20,000 KSM of the KSM loan into the Heiko Money Market.

Mission Alignment and Proposal

Our goal at Heiko Network is to help grow Kusama into a mature, healthy ecosystem by providing the necessary DeFi infrastructure that it needs. To accomplish this goal, we must take the lead on addressing issues that are unique to the current situation our ecosystem is in, and trying to solve them with proven methodologies and required financial services.

The issues that we identified above are:

Staked KSM is not sufficiently liquid within the Kusama DeFi ecosystem
KSM contributed to crowdloan is not sufficiently utilized within the Kusama DeFi ecosystem
A lack of sufficient KSM liquidity on Kusama native lending/borrowing services, preventing the growth of capital efficiency with the Kusama DeFi ecosystem

In order to accommodate these issues, we propose to use the 30,000 KSM grant in the following ways:

Stake 5,000 KSM using the Heiko Liquid Staking DApp for ~4608 sKSM, and then supply 5,000 KSM + ~4608 sKSM received to the sKSM/KSM pool;
Supply 20,000 KSM to the Heiko Money Market

Rationale

Liquidity Support for sKSM/KSM Pool

Currently the sKSM/KSM pool has $450K liquidity. And for the average retail user who swaps 10 KSM (~$600) to sKSM, his slippage is now 0.27%. This is not bad, but definitely not great. For larger-sized swaps, say someone swapping 1,000 KSM to sKSM, his slippage is 21.56%, which is unacceptable considering the close value peg of sKSM to KSM by exchange rate. After adding the 10,000 KSM liquidity into the pool, the two slippages become 0.11% and 10.38%.

This considerable reduction of slippage will make the swapping between sKSM and KSM much more seamless and will therefore lower the psychological threshold for KSM staking. Knowing that they are able to trade their staked KSM for liquid KSM freely without suffering a high slippage, KSM holders will be more likely to stake their idle KSM for a passive income.

Liquidity Support for Money Market

The main reason we are focusing on this proposal for providing KSM liquidity on Heiko Money Market is to allow crowdloan participants to borrow liquid KSM against their cKSM holding.

Parachain winners raised on average 79,486 KSM. By providing our money market with a 20,000 KSM liquidity grant, we will enable users to leverage their crowdloan position by 25.2%. This will significantly boost overall investment in the Kusama ecosystem by enabling users to borrow more DOT without liquidation risk, which they can then utilize:

to contribute in upcoming crowdloans;
to leverage on their KSM position;
to earn extra yield within and without Heiko SuperDApp;
for other purposes

With all the additional utilities unlocked by Heiko Money Market, KSM contributed to crowdloan will no longer be considered simply as an idle, locked asset, but a new derivative asset that can bring in more opportunities, and an abundant borrowable KSM supply will be crucial in making it a reality.

Expected Benefits for Kusama

Better Consensus Security

With a deep sKSM/KSM liquidity on Heiko AMM and a deep KSM liquidity on Heiko Money Market, the users are now allowed to either swap their staked KSM for KSM or borrow KSM against their staked KSM. The opportunity costs of KSM staking will be significantly mitigated, and more users will be willing to stake their KSM and further improve the consensus security of Kusama network.

More Vibrant Crowdloan Participation

Combining a deep KSM liquidity and Liquidation-Free Loan option, Heiko Money Market will unlock the full potential of cKSM and allow crowdloan participants to practice different yield strategies both within and without the Heiko ecosystem. Or they can simply use the cKSM as collateral and borrow KSM for their own purposes without worrying about a liquidation caused by market fluctuation. Knowing that their KSM will not be locked for a long period of time, more KSM holders will be encouraged to participate in the future Parachain Crowdlown.

Overall Improved Capital Efficiency

As more and more parachain assets are integrated into the Heiko Money Market, the overall capital efficiency of the Kusama network will grow geometrically. We believe that a lively money market with deep liquidity is the last missing piece that will bring all parachains and their respective community together and merge into a giant web3 ecosystem that is Kusama.

Security

The business logic of Heiko Super DApp is embedded in the Rust based smart contract that have been audited several times by top security auditors in the cryptocurrency industry. And since inception, there have been 0 successful attacks against our platform, protocol, or any other part of our ecosystem, including our bridges.

Below is a list of audits we have done so far (click for full report):

Substrate Parachain Audit by Trail of Bits

Money Market Substrate Pallet Security Audit by Halborn

Parallel Blockchain Audit by SlowMist

Liquidity Loan and Repayment process

Loan Request

Out of the total 30,000 KSM loan taken from Kusama Treasury:

20,000 KSM will be provided to Heiko Money Market;
5,000 KSM will be converted into ~4,608 sKSM (staked KSM) using Heiko Liquid Staking;
5,000 KSM, along with the ~4,608 sKSM will be added to sKSM/KSM liquidity pool on Heiko AMM

Loan Repayment

A total of 30,000 KSM plus interests generated from staked KSM will be fully repaid on the last day of the 12 months loan period.

KSM Liquidity Shortage Emergency Plan

In the case of a KSM liquidity shortage on repayment day, that is if the utilization rate of Heiko Money Market is high and not enough KSM is left for loan repayment withdrawal, Parallel team will take measures listed below to ensure a timely loan repayment:

Withdraw all available KSM from Heiko Money Market;
Transfer all available KSM from Heiko Reserve to fund manager wallet;
Swap HKO from Heiko Treasury to enough KSM to make up for the remaining loan and transfer to fund manager wallet for loan repayment

Managing the Funds

Oversight

The entire borrowing and repayment process will happen in a fully on-chain and 100% transparent fashion. The address of the fund manager account will be announced publicly before the fund is transferred from Kusama Treasury and we invite all interested parties to oversee every single transaction signed during the process. Any questions/concerns regarding the borrowing and repayment process will be publicly addressed.

Borrowing Process

A new fund manager account will be created and the address will be announced publicly;
30,000 KSM will be funded by Kusama treasury directly to the fund manager account and all future transactions will be performed from this account;
5,000 KSM will be used to mint ~4,608 sKSM;
Another 5,000 KSM + the received ~4,608 sKSM will be paired and added to sKSM/KSM liquidity pool on Heiko AMM;
20,000 KSM will be directly supplied to Heiko Money Market.

Repayment Process

sKSM/KSM will be fully withdrawn from the Heiko AMM and redeemed for ~10,950 KSM into the fund manager account;
20,000 KSM will be withdrawn from the Heiko Money Market to the fund manager account;
~30,950 KSM will be transferred from the fund manager account to the Kusama treasury address

Reporting

Our team will inform the community and on-chain council of updates throughout development. Comments can also be posted through Polkassembly, in the timeline section of the original on-chain proposal.

Monitoring on AMM

Weekly Active Users: Number of unique accounts that have made at least 1 trade within the last week;
Weekly Volume of sKSM/KSM Pair: Total trade volume of the sKSM/KSM pair;

Monitoring on Money Market

Weekly Supply of all Supported Assets: Total supply value and supply value by asset;
Weekly Borrow of all Supported Assets: Total borrow value and borrow value by asset;
Weekly Utilization: Total utilization rate and utilization rate by asset;
Weekly APY Rate: Lend APY by asset and borrow APY by asset;
Weekly Interest Paid: Interest paid by asset;

Risk and Potential Mitigation

Risk 1: Substrate Pallet Runtime Risk

Mitigation: the KSM loan taken from Kusama Treasury will be used to provide liquidity within the Heiko SuperDapp which has been thoroughly audited and battle-tested. (See audit reports here)

Risk 2: KSM Liquidity Shortage

Mitigation: More assets within the Kusama ecosystem such as aUSD, KAR, MOVR will be supported as borrowable assets in Heiko Money Market, therefore lowering the liquidity pressure on KSM. And if KSM Liquidity Shortage does happen, please refer to “KSM Liquidity Shortage Emergency Plan” for the mitigation strategy.