“How do you protect me from risk?”
It’s a fair question, and one of our most common.
To answer it, I’ll take you deep into our operations to get a better understanding of the mechanics of our platform as well as the safety measures we include to protect you.
But before we start, please remember that no business, no matter how diligent, can remove every conceivable risk. We can, however, take measures to mitigate those within our control, as you’ll discover below…
How we protect investors
Borrower default and collateral devaluation
When investing with Constant, you’re lending your money to an overcollateralized borrower. In other words, someone who has staked 150% of the loan amount in cryptocurrency. If they default on the loan or their collateral value falls to 110% of your principal plus earned profit, we sell the collateral to repay you.
Now, this only works if we can sell that collateral quickly enough, otherwise the proceeds might not cover your principal and earned profit. Therefore, we cap each collateral type by trading volume and liquidity. This minimizes the chances of us being unable to sell collateral, but it can’t guarantee a successful sale.
Our exchange partner might go down, for example, or network congestion could slow transactions. However, these are very minor risks — there are hundreds of exchanges to choose from, and network congestion has yet to prove an issue. Whatever happens, we’ll continue trying to sell the collateral to repay you.
It’s worth remembering that cryptocurrencies can be sold at a moment’s notice under most conditions, making them ideal for short-to-medium term investment. Property, on the other hand, which is common among other P2P lending platforms, is more problematic. You’d wait months or even years for your money back, and liquidation thresholds are too impractical to implement.
UPDATE — September 11th 2019:
Following the Flex upgrade, deposit insurance is no longer guaranteed. Instead, deposits are protected by collateral put up by users of Compound Finance’s liquidity pool. For more information, please read the Flex update.
UPDATE — December 30th 2019:
All customers can now choose between Flex or Prime Trust for their balance. For more information on Flex, please read the Flex update. All non-ETH borrower collateral is now escrowed with BitGo, an SEC approved custodian, and ETH will continue to be escrowed in smart contracts.
Constant is designed to be non-custodial. When you send money to us, we send it to our trust partner, Prime Trust, which stores your money across multiple FDIC-insured bank accounts, with combined coverage of $130M.
Since we don’t hold your money, we can’t run off with it, and as it’s held in trust on your behalf, we nor our creditors can use the money to offset potential bankruptcy debts.
However, it takes around one business day to receive, process, and transfer your money to the Prime Trust escrow, so we’re not 100% non-custodial yet. Until we’ve built the infrastructure to automate this process, we must ask you trust us for this relatively short period. Once the money is with Prime Trust, it’s FDIC-insured, and once on loan, it’s backed by cryptocurrency collateral.
Why we don’t ask you to wire Prime Trust directly?
Simple: it will cost you too much and take too long. If you wired Prime Trust directly — especially from abroad — this would cost anything from $25 to $60 and take up to a week to arrive. Instead, you can do a local transfer to one of our US bank accounts and it be with us in a day or two.
How we protect borrowers
To borrow from one of our investors, you need to secure the loan with cryptocurrency collateral. This gives our investors the confidence to lend you their money. If you default (fail to repay), we’ll sell the collateral to repay your investor. Similarly, if the value of your collateral falls to 110% of your investor’s principal and earned profit, we’ll also sell it.
As cryptocurrency is a volatile asset, we ask you to put up 150% of the loan amount in your chosen cryptocurrency to give you some leeway should the value fall. Selling your collateral is always a last resort, and we’ll let you know if you approach the liquidation threshold. In fact, we warn you three times:
- Once at 125% of the investor’s principal and earned profit.
- Again at 120% of the investor’s principal and earned profit.
- And finally at 115% of the investor’s principal and earned profit.
This gives you three opportunities to top up extra collateral and avoid a sale. But please keep an eye on your loan during the term as these warnings might reach you too late in a flash crash.
Custodial risk and smart contracts
As mentioned earlier, Constant will eventually be 100% non-custodial. In the meantime, there is some custodial risk depending on the collateral you use to secure your loan. To understand this, I need to explain a little bit about smart contracts.
A smart contract is a self-executing contract, written in code, that lives on the blockchain. When certain criteria are met, the smart contract performs an action, such as transferring cryptocurrency or updating a database. Since smart contracts are entirely automated, they can administer loans without human intervention. This is efficient, and prevents human error.
For example, if you secure your loan with ETH, we ask you to send it to a smart contract escrow on the Ethereum blockchain. Whenever you repay, the smart contract releases your collateral from escrow. The smart contract will also initiate a sale if the collateral falls in value or you don’t repay.
There are a few limitations, though. Currently, we feed the smart contract the pricing data it relies on to make liquidation decisions. The smart contract won’t sell collateral, either. It only permits us to withdraw the collateral from the escrow when the conditions for a sale are met. Then, it’s up to us to sell the collateral.
This particular limitation is a business decision. Smart contracts work well with decentralized exchanges, but not the centralized ones we rely on to liquidate collateral. So for the time being, we do some of the smart contract’s work to keep our promises to investors, ensuring there’s always someone for you to match with.
Finally, the smart contract escrow works for ETH only. From August 2019, it will support all ERC-20 tokens (tokens issued on the Ethereum blockchain). We’re also working with other blockchains like EOS and TOMO to develop smart contract escrows on their respective blockchains.
In the meantime, we store bitcoin and non-ERC-20 tokens in multiple wallets hosted on AWS and Google web servers. The key to these wallets is stored on a password-protected database accessible by our CEO and CTO only. In the next quarter, we’re introducing an IP whitelist which will further restrict access to this database.
UPDATE - February 10th, 2020
As of December 19th, we now store a portion of our collateral tokens in Bitgo-insured cold wallets. This includes most of our ERC20 tokens as well as a host of other coins listed on the Bitgo site.
Considerations for non-ERC-20 cryptocurrencies
We’ve looked at various other ways to mitigate the custodial risk of non-ERC-20 cryptos, but none have proven suitable:
- Using a hardware wallet kept in a secure location off-site. Still custodial, and severely limits our ability to liquidate collateral quickly.
- Pegging a non-ERC-20 token to an ERC-20 token. While Wrapped Bitcoin (WBTC) or similar would be ideal, liquidity is too low.
We have a team of over 20 developers working hard to solve the problem of custody. Meanwhile, we’ll continue taking the utmost care in protecting your collateral.
Risk is everywhere. It’s part of life. Choosing which risks to tolerate and which to avoid can get a little complicated. And while we can’t make that decision for you, we can make it easier by being transparent. I hope that’s enough to help you decide, and if you have any other questions, please drop us a line at email@example.com or send us a message on Telegram.
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