Defrost Finance: Thawing Liquidity, Minting H2O Stablecoin and Providing Leveraged Yield

What is Defrost Finance

Friends, imagine you have some money, such as digital assets (in the blockchain world, we call them “tokens”), and you don’t want to sell them for now, but you wish they could bring you more value. Defrost Finance (abbreviated as H2O) is like a “pawn shop” or “bank” in the digital world, allowing you to use these digital assets as collateral and borrow a stablecoin called H2O. H2O is a digital currency pegged to the US dollar, aiming to maintain a value of $1, just as stable as the cash we use every day.

This project was originally built on the Avalanche blockchain network, and its name “Defrost” is quite interesting—it means “to thaw.” What it wants to do is “thaw” those assets “frozen” in various liquidity pools (think of them as reservoirs of digital assets), making them more flexible and able to generate more returns.

Simply put, Defrost Finance mainly offers two ways to play:

• Borrowing the stablecoin H2O: You can use some valuable digital assets you hold (such as liquidity provider tokens, which are certificates you get after providing liquidity on a decentralized exchange, or some interest-bearing tokens) as collateral to Defrost, and then mint H2O stablecoins. This way, you keep your original assets and also get stablecoins you can freely use.
• Leveraged trading or yield: Defrost Finance’s V2 version goes further, allowing users to engage in leveraged trading or earn leveraged yields. It’s like using a small amount of capital to leverage a larger investment, potentially amplifying your returns. It can even turn these leveraged positions into tradable tokens, such as “AVAXBULL 3x,” meaning if the AVAX token you hold rises by 1%, this leveraged token can rise by 3%.

Core scenario: Increase the utilization of your digital assets, so you can obtain liquidity or pursue higher returns without selling your assets.

Project Vision and Value Proposition

Defrost Finance’s vision is to make digital assets more efficiently utilized, like waking up dormant funds and letting them flow in the digital economy. The core problem it aims to solve is that many digital assets, while valuable, cannot generate extra returns if they just sit idle. Defrost allows users to use these assets as collateral, thereby unlocking their liquidity and creating new earning opportunities.

One notable difference from similar projects is its focus on using various liquidity pool tokens (LP tokens) and interest-bearing tokens as collateral to mint H2O stablecoins. Additionally, Defrost Finance emphasized being a “fair launch” project at its inception, meaning it did not conduct a presale, did not accept venture capital (VC) funding, and did not pre-allocate a large number of tokens to team members. The team’s incentives are tied to the growth of the project’s total value locked (TVL), aiming to build a community-driven project.

Technical Features

Defrost Finance has some noteworthy technical aspects:

• Diversity of collateral: It accepts various types of digital assets as collateral, including liquidity provider tokens (LP tokens) from decentralized exchanges and some interest-bearing tokens.
• H2O stablecoin: H2O is a stablecoin pegged to the US dollar, and its value is fully backed by collateral, rather than maintained by complex algorithms. It’s like banknotes issued with gold reserves behind them—H2O is backed by sufficient digital assets.
• Stability mechanism: To keep H2O stable, Defrost Finance uses some monetary policy tools, such as “stability fees” and “savings rates.” These parameters can be adjusted according to H2O’s supply and demand, which is somewhat similar to the mechanism of MakerDAO (another well-known stablecoin project).
• Leveraged tokenization (V2 version): Defrost V2 introduces the ability to tokenize leveraged positions. This means you can buy an ERC-20 token representing a specific leveraged strategy, for example, an “AVAXBULL 3x” token represents a 3x bullish leveraged position on AVAX price. These leveraged tokens are fully collateralized by underlying crypto assets, and the code is open source, increasing transparency.
• No liquidation risk (in certain cases): In some designs of Defrost V2, automatic compounding yields can help the value of collateral grow, thereby lowering the collateralization ratio and potentially avoiding liquidation.

Tokenomics

The Defrost Finance ecosystem has two main tokens: H2O (stablecoin) and MELT (governance token).

MELT Token

• Token symbol: MELT
• Issuing chain: Avalanche blockchain.
• Total supply: The total supply of MELT is fixed at 100 million.
• Circulation: Regarding current circulating supply, different sources vary. CoinMarketCap once showed a self-reported circulating supply of 0 MELT, while TokenInsight showed 15,196,482.00 MELT.
• Token utility:
  • Governance: MELT token holders have voting rights and can vote on key parameters of the Defrost Finance protocol, such as which assets to accept as collateral, stability fee rates, H2O savings rates, and liquidity mining incentives.
  • Incentives: MELT is used as an incentive, rewarding users who provide liquidity to Super Vaults and those participating in leveraged trading (e.g., fee reimbursement or discounts).
  • Staking rewards: Users who stake MELT tokens can receive a share of protocol revenue, which comes from fees charged for leveraged trading and compounding yields in Super Vaults.
• Distribution and unlocking: MELT token distribution is mainly through liquidity mining, with a decreasing inflation mechanism. The project claims no presale, no venture capital, and no pre-allocation to team members, with only a small amount of airdrops for community and marketing activities.

H2O Stablecoin

• Token symbol: H2O
• Nature: A stablecoin soft-pegged to the US dollar, aiming to maintain a value of $1.
• Minting mechanism: Users mint H2O by collateralizing liquidity pool tokens or other interest-bearing tokens.
• Circulation: Self-reported circulating supply is 31,242,961 H2O.

Team, Governance, and Funding

• Core members and team characteristics: The Defrost Finance team chooses to remain anonymous and has not conducted KYC (Know Your Customer) procedures. This is not uncommon in the blockchain space, but it means users cannot directly know the background and identity of team members.
• Governance mechanism: The project adopts a decentralized governance model, with MELT token holders voting to decide the protocol’s future development and key parameter adjustments.
• Funding: Defrost Finance claims to be a “fair launch” project, meaning it did not raise funds through traditional presale or venture capital. The team’s incentives are linked to the protocol’s total value locked (TVL) growth. The project is incubated by Avatar and Wanlabs.

Roadmap

Below are some important milestones and future plans for the Defrost Finance project:

Historical milestones:

• 2021: Project launched as the first native DeFi stablecoin protocol on Avalanche.
• November 2021: Released project overview, explaining its mechanism for minting H2O stablecoins using LP tokens and interest-bearing assets, and planning deeper integration with other DeFi platforms in the Avalanche ecosystem.
• June 2022: Announced the launch of Defrost V2, introducing decentralized leveraged tokens and decentralized leverage tools, aiming to provide more efficient leveraged trading and yield opportunities.
• December 2022: Suffered two major security incidents, losing over $12 million. Security firms and the community widely suspected this was a “rug pull” or “exit scam,” but the Defrost team denied these allegations. Subsequently, the stolen funds were reportedly returned by the hacker, and the project team announced a refund plan for affected V1 users.

Future plans (as of November 2021):

• Expanding collateral scope: Plans to whitelist more interest-bearing assets (such as qiETH, qiAVAX, qiWBTC on Benqi) and trading pairs on Trader Joe for H2O minting.
• Cross-chain integration: The ultimate goal is to accept collateral from other blockchains, such as Uniswap and Curve LP tokens on Ethereum, and Pancakeswap LP tokens on BSC, to increase H2O liquidity and diversify risk.
• Expanding DeFi derivatives: Once H2O liquidity is sufficient, plans to expand into DeFi derivatives, including leveraged tokens, leveraged mining, and options, to increase H2O use cases. (Note: Some leveraged token features have already been implemented in V2.)

Common Risk Reminders

Investing in any blockchain project comes with risks, and Defrost Finance is no exception. Here are some risks to pay special attention to:

• Technical and security risks:
  • Smart contract vulnerabilities: Even if the project is audited, there may still be undiscovered vulnerabilities in smart contracts that could be exploited, leading to loss of funds. Defrost Finance suffered two attacks in December 2022, losing over $12 million, one involving the theft of the V1 protocol’s private key.
  • Flash loan attacks: Flash loans allow borrowing large amounts of funds without collateral, and attackers may use flash loans combined with other vulnerabilities for price manipulation to steal funds. Defrost V2 has suffered flash loan attacks.
  • Oracle risk: Oracles bring off-chain data on-chain; if oracle data is manipulated, the protocol may wrongly liquidate users or cause other losses. In the 2022 attack, analysis indicated the attacker used fake collateral tokens and malicious price oracles.
• Economic risks:
  • Collateral price volatility: Although H2O is a stablecoin, its collateral (such as LP tokens, interest-bearing tokens) can be highly volatile. If collateral value drops sharply, it may lead to insufficient collateralization and liquidation risk.
  • Stablecoin depegging risk: Although H2O aims to be pegged to the US dollar, in extreme market conditions or if the protocol encounters issues, its price may fail to maintain the $1 peg.
  • Liquidity risk: If there is insufficient market demand for H2O or its collateral, users may find it difficult to trade or redeem assets at expected prices.
• Compliance and operational risks:
  • Team anonymity: The Defrost Finance team remains anonymous, which means accountability and communication may be more difficult if problems arise.
  • Regulatory uncertainty: Decentralized finance (DeFi) is still in a regulatory gray area globally, and future policy changes may negatively impact project operations and token value.
  • “Rug pull” suspicions: The 2022 security incidents were suspected by some security firms and community members to be a “rug pull” or “exit scam” by the team, although the team denied it. Such negative events can severely damage the project’s reputation and user trust.

Please remember, the above information is not investment advice. Any investment decision should be based on your own independent research and risk assessment.

Verification Checklist

• Block explorer contract address: The contract address for the MELT token is 0x47E...1241D. You can check its transactions and holdings via the Avalanche block explorer.
• GitHub activity: DefrostFinance has some repositories on GitHub, including audit reports. However, some repositories’ latest updates are from late 2021 or early 2022, and activity seems low. It is recommended to check their GitHub page for the latest code activity.
• Audit reports: There are repositories for audit reports on GitHub; it is recommended to carefully review the latest audit reports to understand the security status of their smart contracts.
• Official website and social media: Visit the project’s official website (if still active) and social media channels (such as Medium, Twitter) for the latest announcements and community discussions.

Project Summary

Defrost Finance is a DeFi protocol launched on the Avalanche blockchain, with its core goal to improve the capital efficiency of digital assets by allowing users to collateralize various interest-bearing tokens and liquidity provider tokens to mint the US dollar-pegged stablecoin H2O, and provide leveraged trading and yield opportunities. The project once attracted attention for its “fair launch” and community-driven philosophy.

However, the project suffered two severe hacking incidents in December 2022, with losses exceeding $12 million. Although the project team denied the “rug pull” or “exit scam” allegations raised by security firms and the community, and stated that the stolen funds were returned by the hacker and a refund plan was initiated, these events undoubtedly dealt a heavy blow to the project’s reputation and user trust. The team’s anonymity also adds to potential risks and uncertainty.

From a technical perspective, Defrost Finance demonstrates some innovation in stablecoin minting and leveraged tokenization. But in terms of project operation and security, its history reminds us that the high risk in the DeFi sector cannot be ignored. For Defrost Finance’s future development, close attention should be paid to its performance in security recovery, community rebuilding, and subsequent product iterations.

Please note, the above content is only an objective introduction and analysis of the Defrost Finance project and does not constitute any investment advice. Be sure to conduct thorough personal research and risk assessment before making any investment decisions.