In August 2024, Lendasat introduced a novel loan protocol, designed to address the inherent risks of custodial lending platforms. By leveraging Bitcoin's self-custodial nature, the Lendasat protocol allows borrowers to secure loans without transferring ownership of their assets. If you haven’t had a chance to explore our whitepaper, this blog post will guide you through the protocol and its advantages.
We’ll explore how Lendasat works, the technology behind it, and why it stands out as a solution for Bitcoin-collateralized lending. Diagrams will help break down each stage of the protocol, so you can understand the mechanisms step-by-step.
Bitcoin Lending, the Right Way
Bitcoin, as a decentralized and self-custodial asset, offers users a chance to be their own bank. However, the current landscape for Bitcoin-backed loans often forces users to hand over their Bitcoin to custodians—introducing a set of serious risks:
- Custodian risk: Entrusting a third party with your Bitcoin exposes you to theft, mismanagement, or outright fraud.
- Opaqueness: Traditional platforms don’t offer transparency on how assets are handled.
- Regulatory risk: Centralized custodians are vulnerable to regulatory changes that may lead to asset freezing or seizure.
Lendasat eliminates these concerns by enabling escrow-less lending. Borrowers retain control of their Bitcoin, using Discreet Log Contracts (DLCs) and Hash Time-Locked Contracts (HTLCs) to govern loan agreements without middlemen. With these cryptographic tools, Lendasat removes the need for trust in centralized entities, offering a fully transparent and secure lending process.
How Lendasat Works
The protocol operates between two parties: Bob (the borrower) and Lydia (the lender). Bob wishes to borrow stablecoins, locking his Bitcoin as collateral, while Lydia provides the loan principal in stablecoins, looking to earn interest.
Let’s dive into how the protocol works, step by step.
1. Opening the Loan
The loan process starts with both parties locking assets in cryptographically secured contracts.
1.1 Secret Generation
- Bob generates a collateral secret,
b. - Lydia generates a loan secret,
l.
1.2 Bob Locks Bitcoin Collateral
Bob locks his Bitcoin in a Discreet Log Contract (DLC). The DLC involves an oblivious oracle1 that can attest to certain events, such as the price of Bitcoin at loan maturity. If necessary, an oracle attestation can be used at loan maturity to determine how the collateral should be split between Bob and Lydia.
Additionally, Bob locks Lydia's claim on her share of the collateral behind the hash of the collateral secret,
H(b). Lydia will need to know b to be able to claim her portion of the collateral unilaterally.Key Insight: Unlike traditional escrows, the DLC ensures that Bob retains control of his collateral throughout the loan process. The oracle attestation is only needed to help settle the contract if Bob and Lydia fail to cooperate.
1.3 Lydia Locks the Principal
Lydia, in turn, locks the loan principal in an HTLC on Ethereum (or another smart contract-enabled blockchain2 or L2). This HTLC is designed so that Bob can only claim the principal if he reveals
b.- Condition 1: Bob must provide the preimage to
H(b)i.e.b. - Condition 2: If Bob doesn’t act in time, Lydia can recover her funds after a timelock expires.
1.4 Bob Claims the Principal
Bob, now seeing the loan principal is locked up, reveals the secret
b to claim it. This revelation allows Lydia to later claim part of the Bitcoin collateral, but only if Bob defaults on repayment or in the event of a liquidation.2. Cooperative Repayment
If Bob is ready to repay the loan:
- Bob locks the repayment amount in an HTLC on Ethereum, this time using
H(l)as a hash lock. - Lydia claims her repayment, revealing
l. - Bob uses
lto unlock the entirety of his Bitcoin collateral from the DLC.
When Things Go Sideways
Not all loans proceed smoothly. Here’s how Lendasat handles common scenarios when the loan doesn't go as planned.
1. Lender No-Show
What happens if Bob locks up his Bitcoin collateral, but Lydia disappears before providing the principal?
In this case, Bob can unilaterally recover his Bitcoin after an early collateral refund timeout built into the contract. This timeout prevents Bob’s collateral from being stuck indefinitely, a common safeguard in decentralized contracts.
2. Borrower Fails to Claim the Loan
Similarly, if Lydia locks up the principal and Bob does not claim it, both parties are protected by respective timeouts:
- Lydia recovers her principal after a shorter refund timeout on Ethereum.
- Bob gets his Bitcoin collateral back after a longer refund timeout.
These dual timeouts ensure neither party’s assets remain frozen for too long.
3. Unilateral Repayment
If Bob defaults or Lydia doesn’t claim her repayment, the protocol shifts to non-cooperative repayment through the DLC. In this case, the protocol involves an oracle attestation to the Bitcoin price at loan maturity. Lydia receives an amount of Bitcoin collateral equivalent to the loan’s value (plus interest) based on the oracle's attestation. The remaining collateral goes back to Bob.
This mechanism ensures that even in the worst case, Lydia can still recover her funds by liquidating part or all of Bob’s Bitcoin collateral.
Keeping the Loan Alive: Liquidation and Collateral Management
One of the key challenges of lending is managing Loan-to-Value (LTV) ratios. If Bitcoin’s price falls significantly, Lydia might have to liquidate part of the collateral to cover the outstanding loan.
Here’s how Lendasat addresses liquidation:
- If the LTV ratio approaches a critical threshold, Lydia can trigger an oracle-based liquidation of the Bitcoin collateral before loan maturity. This protects the lender from losses due to market volatility.
- Liquidation relies on the same DLC mechanism that handles non-cooperative repayment, ensuring a smooth, automated process for collateral distribution.
The protocol also allows Bob to increase his collateral if necessary, by splicing into the DLC with more funds, keeping the loan in good standing and avoiding liquidation.
Technical Appendix: How HTLCs and DLCs Combine
HTLCs: Enabling Cross-Chain Functionality
An HTLC (Hash Time-Locked Contract) is a foundational building block for cross-chain operations. It allows Bob to lock collateral on one chain (Bitcoin) while simultaneously claiming funds on another (Ethereum). In Lendasat, HTLCs govern the locking and claiming of both loan principal and repayment on the Ethereum chain.
DLCs: Securing Conditional Payouts
A Discreet Log Contract (DLC) is used to ensure that Bob’s Bitcoin collateral is only accessible to Lydia under specific conditions, like a default or liquidation event. The DLC relies on oracles to determine the correct payout based on the Bitcoin price at loan maturity or liquidation.
Combining these two technologies allows Lendasat to create a trustless lending mechanism that spans multiple blockchains.
Conclusion
Lendasat redefines Bitcoin-collateralized lending by eliminating custodial risk and empowering borrowers to retain control of their collateral. Using HTLCs and DLCs, our protocol creates a trustless environment where both lenders and borrowers are protected, even in the event of non-cooperation or default.
For those interested in a deeper technical understanding, please refer to our whitepaper, and stay tuned as we continue to refine the protocol and unlock new possibilities for decentralized finance.
