BTCShield - Backstop Protection Implementation

A professional implementation of the BTCShield backstop protection system using reversible call options adapted for Mezo Network's BTC lending ecosystem.

🎯 Overview

BTCShield implements a three-phase backstop mechanism to mitigate DeFi liquidations through reversible call options, specifically designed for Mezo Network's BTC/MUSD lending environment. The design draws on the academic foundation of reversible call options for liquidation mitigation.

🔑 Key Features

• Three-Phase System: Initialization → Pre-Maturity → Maturity

• Premium (φ): Supporters deposit λ × C_t0
  λ = (Expected Liquidation Loss + Safety Margin)/C_t0

• λ* Calculation :

  λ* = (p_t0 e^(–r_f T) N(d1) – K e^(–I_l T) N(d2)) / (C_t0 · p_t0)
  

  Where:

  • λ* = optimal λ
  • p_t0 = spot exchange rate
  • K = liquidation (strike) price
  • T = time to maturity (in years)
  • r_f = risk‑free/foreign rate
  • I_l = protocol borrowing interest (effective interest on outstanding debt)
  • N(d1), N(d2) = standard normal cumulative distribution

  Note on λ*: We adapt Black–Scholes to estimate λ* as an approximation.

• Early Termination: k_re factor for borrower termination prior to maturity

• Real-time Analytics: Forward liquidation risk, health indices, and simulations

📚 BTCShield Backstop Implementation

Lifecycle Phases

1. Initialization
   • Trigger: health factor < 1.53 (position becomes unhealthy)
   • Action: supporters can deposit λ × C_t0
2. Pre‑Maturity
   • Borrower may “terminate” by paying C_re=λ⋅C_t0⋅(1+I_L)⋅k_re (0 < k_re < 1)
   • (0 < IL < 1 is the interest rate which B agreed to pay for its loan when initiating the position P)
3. Maturity
   • Supporter either exercises (takes position) or defaults and loses the premium φ
   • If exercised: supporter assumes position;

🏗️ Architecture

Core Modules

Head over to : (https://github.com/MananSinghal123/musd)

Data Flow

🚀 Getting Started

Prerequisites

• Node.js 18+
• npm or yarn

Installation

npm install
npm run dev

Navigate to http://localhost:3000

📊 Key Metrics

Risk Analytics

• λ vs λ Comparison: Pricing alignment check

🔧 API / Engine Examples

Backstop Manager / RCO Manager (examples)

Pricing Engine (λ* calculation)

Simulation Engine (sketch)

🎨 UI Components

• Dashboard: Current Position and Borrow operations
• Support: Create Support Option and Manage them
• Marketplace: Lists Support Options

📈 Simulation & Analysis

(To be included)

• Health Factor Recovery: Trajectory with support
• Supporter Profitability: ROI distributions

🧭 Future Implementations

🧾 Order Book–Driven Backstop Allocation

Introducing an order book–like mechanism can make BTCShield more efficient, fair, and market-driven — especially when multiple supporters compete to back a position.

1️⃣ Why an Order Book?

Without it:

• All supporters are treated equally.
• Early supporters may be overcompensated, while late ones get little or nothing.
• λ is just split evenly, which doesn’t reflect individual risk/reward preferences.

With an order book:

• Supporters can bid for their share of backing by specifying:
  • Amount of collateral they’re willing to lock
  • Minimum expected payoff (option premium)
  • Time duration of support
• The protocol then allocates support efficiently, similar to a market auction.

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2️⃣ How It Works

Borrower creates a position, specifying:

• Collateral ( C_{t0} )
• Desired backstop coverage
• Liquidation threshold

Supporters submit bids, indicating:

• λ or fraction of collateral they can support
• Expected return or premium

Protocol allocates support:

• Sort bids based on price/risk efficiency (highest expected payoff per risk unit).
• Accept bids until total required coverage is reached.
• Excess bids are either rejected or queued for the next backstop round.

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3️⃣ Advantages

• Dynamic pricing: λ becomes market-driven rather than fixed.
• Capital efficiency: Only required collateral is locked.
• Fair rewards: Supporters are compensated according to actual risk exposure.
• Scalable: Handles 1 or 100+ supporters without manual tuning.

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4️⃣ Variants

• Continuous auction: Supporters can join/leave dynamically, λ adjusts in real time.
• Discrete rounds: New backstop rounds open periodically, λ recalculated each round.
• Priority-based: Early supporters get priority but λ scales inversely with participant count.

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✅ Summary

An order book–like mechanism makes λ market-driven, fair, and dynamically adaptive in multi-supporter scenarios.

It effectively turns backstopping into a micro-market, perfectly aligning incentives among borrowers and supporters.

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📅 Roadmap Position

Planned for Phase 2 of BTCShield, once the single-supporter and λ calibration layers are validated in production.

📑 References

• Qin, K., Ernstberger, J., Zhou, L., Jovanovic, P., Gervais, A. “Mitigating Decentralized Finance Liquidations with Reversible Call Options.” 2023. arXiv:2303.15162

🤝 Contributing

1. Fork the repository
2. Create a feature branch
3. Implement features aligned with reversible‑call backstops
4. Add tests
5. Submit a pull request

📄 License

MIT License - see LICENSE file for details.

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BTCShield - Professional Backstop Protection for Mezo Network