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Clone Protocol: creating liquid markets for non-native assets on Solana

February 1, 2024

In conclusion

“You should have gone for the head” –(Thanos in Avengers: Infinity War)

Solana, as a layer 1 blockchain and as a community, has seen the worst of its days after the FTX saga, and now it seems as if the party is back on! I mean, all of the metrics show it, the charts show it, and the activity on the chain is flourishing in a euphoric way reminiscent of the chain's early days. 

But what could be the reason for this? Well, one reason I tend to agree with is that despite the dark days, Solana never lacked in key fundamentals. In terms of transaction speed, Solana averages a processing speed of about 65,000 TPS, literally more efficient than other chains with much higher TVL. On the other hand, Solana is also cheap, making it a haven for those unwilling to spend a fortune on the other chain (not mentioning any names). 

Solana’s reawakening, however, is interesting to watch. First, the memes are popping, and it seems serial degenerates from other chains now view Solana as the home for meme culture. But for how long would they continue to speculate on just memes? With the amount of liquidity being bridged to Solana, it is only a matter of time before such liquidity begins to seek things of value beyond a meme culture. 

It is at this juncture that there is a serious deficit. For example, Defillama’s chain index only shows about 125 protocols are native to Solana. When compared to Ethereum, Solana is almost 10x short. 

Less native protocols equals less native tokens. Where is the fun in that? You tell me. 

Moreso, we would like to imagine that, like Thanos, for Solana to wield the infinity stones of the blockchainverse, two areas need to be nailed:

  • More liquidity. By this, we mean liquidity that is utilized effectively rather than sitting idle in wallets waiting to punt the next memecoin.
  • A reason to stay. We cannot repeat the last cycle where people came to plunder the spoils on Solana only to return to Ethereum when the music stopped. 

Thankfully, as the avid reader of our articles that you are, when have we presented a problem without a solution? Like always, we have found an interesting team solving this issue with an interesting approach. 

Strap in! This is going to be worth it. 

What is the Clone Protocol? 

For any crypto-pilled folk who’ve been in the Crypto space since 2018, when you hear a protocol named Clone, you may instinctively think it’s some form of derivative asset protocol, and that assumption wouldn’t be far off the mark. 

Clone originates from the many attempts and failures of DeFi protocols to create the ultimate platform to trade synthetic assets. The protocol carefully examines the limitations of a few progenitor applications, such as Synthetix on Ethereum, limited by over-dependence on its native token for collateralization of its debt pool model, as well as Mirror protocol, a victim of the LUNA crash, and lastly, the struggles of Synthetify on Solana to bootstrap liquidity to its own debt pool mainly because they were a fork lacking in first mover advantage and introspectively because the debt pool model was inherently flawed. 

Clone, however, is a lot different from synthetic assets protocols; it accounts for more efficient trading mechanics that are scalable. It only deals with non-native tokens and adopts a novel strategy called Cloned assets (clAssets) to address the issue outlined in the initial paragraphs— bridging the divide between the surge in activity on Solana and the requirement for significant assets for trading.

Cloned assets, or clAssets in this context, can mirror any asset not native to the Solana blockchain. For example, ARB is native to the Arbitrum blockchain, an EVM layer 2. In a situation where ARB starts to exist on Solana, it’ll be referred to as a non-native asset. The same can be said for other assets like $OP on optimism, $Manta on the Manta network, and so on. 

One could argue that the ability to trade these assets is already possible on Solana via perpetual exchanges like Drift. While they might be somewhat right, trading these assets on a Solana-powered perpetual contracts protocol is not hassle-free. There are challenges with getting exposure to non-native assets using Perpetual contracts, one of which is that beyond speculation on the price movements of these assets, they cannot be utilized (borrowing, lending, used for collateral) within the broader Solana DeFi ecosystem.

Moreover, the associated costs and complexities with trading non-native assets on Perp contracts can be a deterrent for traders with nuances like funding rates or borrow rates, making Perp contracts structured or optimized for high-leverage, shorter-term trades than long-term. In addition, the liquidity of non-native assets on these perp protocols might not be consistent, thereby leading to inefficiencies in the overall trading experience. Some of these inefficiencies include slippage issues and a lack of steep and robust liquidity, especially when it comes to assets with low trading volumes. 

While bridged assets offer the potential to introduce any non-native token to Solana, the scarcity of bridged liquidity arises from the considerable risks that liquidity providers face when establishing new liquidity pools. There has to be a better way. 

A New Approach (CLS)

When it comes to actually utilizing the Clone protocol, there are two main facets:

  • The Comet Liquidity System 
  • The cAMM

The Comet Liquidity System (CLS)

You’ve all probably heard of a comet at some point, right? You know, that body in space that doesn’t really have its own orbit and keeps passing closer and closer to the sun until eventually it gets too close and disintegrates. 

Well, the Comets in the CLS are somewhat similar. 

The CLS is inspired by Uniswaps V3’s concentrated liquidity mechanism. I’m sure most of you know what it is by now. You provide liquidity within a price range, and if the price stays within that range, you make money; if it goes out of it, you lose money. The tighter the range, the higher the yield, and vice versa. 

With the CLS, an LP can create a Comet. To do this, they need first to deposit some level of collateral. Afterwards, they choose an amount of collateral and a pairing clAsset they wish to borrow to provide liquidity. To make Comet creation more convenient, the collateral will be provided using USDC on mainnet, allowing for Comet creation or LPing using just USDC.  

What sets the CLS apart is the fact that it is cross-margined, single-sided, and introduces LPing with leverage. So what this means is that rather than providing concentrated liquidity to a specific pool, CLS allows LPs to provide liquidity using only USDC with leverage across all cloned asset pools simultaneously!

Clone AMM (cAMM)

The fact that the CLS is single-sided and cross-margined means that one single source of collateral (USDC, for example) can back liquidity across multiple clAsset pools simultaneously. 

This is exactly what helps set the cAMM apart from the rest of the competition. 

While AMMs traditionally base prices depending on the ratio of the two assets in a pool, this interlinked CLS system makes it so that the cAMM dynamically harnesses liquidity just before trade execution. 

Here’s how it goes 

When a trade is initiated, the cAMM aggregates resources from all the different Comets made by LPs. The liquidity is activated at the oracle price at which the trade is made, and the liquidity is also shifted based on the collective surplus or debt held by LPs. 

If you think about it, it’s like creating a whole just-in-time (JIT) AMM tailored to the trade at hand. 

Maximum flexibility and maximum efficiency. 

But to make all of this work, there needs to be some sort of checks and balances. This is achieved by the health score, which directly correlates to positions being liquidated or not.

Health Score

Clone’s CLS warrants the provision of collateral in order to take a comet position. This method enables the risk of liquidation should the comet position become under-collateralized. To manage positions against liquidations, the Clone protocol used the concept of Health Scoring, a 0-100 mechanism that serves as a watchdog over comets, ensuring that they are safely collateralized irrespective of the market condition. 

The Health score takes into consideration these three factors: 

  • The value of the position 
  • The size of the position 
  • The current level of impermanent loss

The health score is calculated using the formula: 

H = 100 — 1 + P / Veff 

If the health score reaches zero (0), the comet position will be liquidated, and the health will increase. But how does the liquidation process work? 

Liquidation 

Liquidations bring balance to the CLS, maintaining a stable system and collateralization. 

A liquidation event on Clone’s CLS occurs when a comet is at risk of becoming undercollateralized, usually signalled by the health score dropping to zero. The liquidation event is carried out by liquidators, who are incentivized to do so. 

How does it work? 

After identifying an almost undercollateralized comet and selecting the liquidity position they intend to liquidate, the liquidator can use either method to execute the liquidation process:

The first is the collateral impermanent loss debt, wherein the comet’s liquidity position debt is brought back to a delta using the comet’s collateral. In this method, the liquidator does not carry out the liquidation procedure using their funds or repaying the debt with their assets. Instead, they proceed to use the collateral (excess USDC) deposited by the LP to adjust the position.  

Or...

Using the clAssets impermanent loss debt wherein the liquidator utilizes clAssets as a deterrent against the debt. This is carried out by contributing a portion of the debt amount to improve the comet's health score. 

Regardless of the aforementioned liquidation methods, the comet's liquidity position is ultimately reduced to zero post-event to avert potential future liquidation. Meanwhile, the liquidator is entitled to compensation equal to the impermanent loss they incurred (specifically related to the clAssets impermanent loss method) and an extra reward from the collateral, determined by the Clone DAO based on the addressed debt.

Clone protocol also goes further to include an Insurance fund as a form of protection against delayed undercollateralized comets. The insurance fund restores the balance to the CLS by paying the debt. 

Peg maintenance

The Clone protocol’s clAssets maintain their peg in a unique way. Unlike the examples given in the first few paragraphs of this article, i.e., the debt pool situation, clAssets pegs are maintained using a model referred to as the Hybrid collateral model

The hybrid collateral model facilitates a balanced swap between bridged assets and cloned assets (clAssets) on a 1:1 basis such that for every one (1) bridged asset into Solana, a corresponding clone asset can be minted on a 1:1 basis. 

Let’s use a bridged $OP token as an example. If the amount of $OP bridged is equivalent to 1000 units, the hybrid collateral model allows for an equivalent form of $OP minted as clOP (cloned optimism) on a 1:1 basis. 

The Hybrid collateral model (HCM) does more than facilitate the swapping of assets from bridged non-native to Clone; it also plays a role in peg maintenance, allowing for arbitrage opportunities in a situation where the price of the bridged asset shifts slightly from the cloned asset. For example, if the $clOP token deviates from the $OP token in price, arbitrageurs can conveniently buy the cheaper $clOP token and use the AMM to swap it for the underlying OP token and then proceed to sell the OP token. This opportunity will help the $clOP token find the peg. 

clAsset Deprecation

Another important thing to consider with clAssets is that there might come a time when there’s a need for such assets to be deprecated; for example, let’s say a protocol decides to migrate its non-native asset to which there exists a clone version (clAsset) on Solana, to an omnichain token. In a situation where this occurs, what are the steps to ensure that users don’t lose their funds? 

In such a situation, Clone presents three steps to redemption: 

  • Extraction: This process will restrict specific actions such as swapping, adding liquidity, swapping clAsset for underlying, and borrowing more clAsset in order for comet position holders to withdraw liquidity, paying off the impermanent loss debt (ILD). Likewise, borrowers will be able to close their positions. 
  • Liquidation: The next step will be the liquidation process wherein those who fail to withdraw their liquidity and pay their ILD and borrowers with open positions will be liquidated to ensure that liquidity is totally removed from the pool. 
  • Deprecation: Lastly, the deprecation process will commence such that those who still hold the clAssets will be able to swap to the bridged underlying asset. 

The goal is to ensure that users are not left holding a valueless deprecated clAsset. 

Closing Thoughts

Cloned assets open the door to not just a wave of liquidity inflow to Solana, but they do it in such a way that users can now hold non-native assets on Solana, taking advantage of the fees and latency without fear of being in an illiquid market. 

What adds further intrigue is the Clone Protocol's potential to address on-chain liquidity fragmentation and capital inefficiency. Given the widespread liquidity across cloned assets achieved through the single-side LPing and cross-margin approach in deploying capital to fuel such markets, this potential extends to serving as a foundational liquidity layer for various derivative markets.

The vision of the protocol is clear as day: to build an efficient, scalable, and universally accessible one-stop shop for non-native tokens, thereby unlocking a new wave of liquidity inflow into the Solana chain. 

It’s a no-brainer, really, because the more attention Solana garners, the more folks are convinced to bridge over, and at that point, Clone protocol stands in the gap, offering two options to its sophisticated and efficient solution I.e: the comet liquidity system for yield seekers and a capital efficient, steep trading platform to exchange non-native assets for cloned ones. 

The cool part is that this is still the early stages for the Clone protocol, as it is still on testnet and will be available to whitelisted users pretty soon. To get on the whitelist, feel free to participate in the ongoing campaign on Zealy

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