Shell Finance: Advanced Applications of DLC in Lending Machines

Discreet Log Contracts (DLC) are an advanced smart contract technology based on Bitcoin Layer 1, enabling Bitcoin to interact securely and efficiently with off-chain data. This innovative approach allows for the creation of financial contracts that depend on external events, which is crucial for implementing complex DeFi functionalities directly on the Bitcoin blockchain.
DLC ensures the verifiability and executability of contract outcomes through the use of adapter signatures, provided that specific conditions set by oracles are met. In Shell Finance, this powerful technology forms the core of the lending protocol's liquidation module.

What is DLC?

DLC is a cryptographic technique that uses adapter signatures to create programmable financial contracts on Bitcoin. The core functionality of DLC is to allow Bitcoin to securely utilize off-chain data provided by oracles, which are trusted entities that provide external information (such as market prices, weather data, or sports scores). This integration enables Bitcoin to perform complex operations that typically require a more flexible execution environment (like Ethereum).

Application of DLC in Shell Finance

In Shell Finance, DLC is used as the core technology for the lending protocol's liquidation mechanism. This application ensures that the management of loans is transparent and secure, utilizing off-chain data to determine the status of each lending position. Here’s how DLC is used in practice:

1. Loan Initiation: When a user initiates a loan by collateralizing Bitcoin inscribed assets (such as Ordinals, Runes, Atomicals, and Stamps), Shell Finance calculates the loan amount based on the collateral value and the current market price provided by the oracle. A DLC contract is then set up, initializing a secret value for future liquidation scenarios.
   

2. Loan Adjustment: During the loan's lifecycle, users can adjust their collateral or debt amounts. Each adjustment recalculates the collateral ratio using real-time data from the oracle, ensuring that the loan is always appropriately collateralized. The DLC updates accordingly to reflect any changes.

3. Liquidation: The most critical application of DLC in Shell Finance occurs during the liquidation process. If the collateral value falls below the required minimum collateral ratio (MCR), DLC allows for the automatic liquidation of positions. The specific operation is as follows:

4. Price updates from the oracle indicate that the collateral value has fallen below the liquidation threshold.

5. This triggers the disclosure of the secret value within the DLC, allowing the protocol to execute the liquidation.

6. The assets are then auctioned off in a Dutch auction, with the proceeds used to repay the debt, and any excess added to Shell Finance's insurance fund.
   

Practical Operation

In a practical scenario, suppose a user collateralizes 100 $ORDI to borrow $BTCX. The following steps outline the DLC-driven liquidation process:

1. Monitoring: The oracle continuously monitors the market price of $ORDI.
2. Triggering Liquidation: If the price drops below 225,000 SATS/ORDI, the oracle signals the protocol.
3. Executing Liquidation: The secret value is disclosed, completing the DLC signatures required for liquidation.
4. Auction: The collateral is auctioned off, with the proceeds used to repay the debt and any liquidation penalties.

By combining DLC with oracle technology, Shell Finance ensures a trustless and automated liquidation process, enhancing the security and efficiency of its lending operations. This innovative application of Bitcoin Layer 1 functionality sets a new standard for DeFi protocols, bringing complex financial services directly to the Bitcoin network.