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Accessing funds and expanding financial opportunities through decentralized borrowing
Borrowings can only be made when there are assets available to be borrowed. The borrow interest rate is a variable factor that is dependent on the utilization rate i.e. demand and supply, with all borrowings secured in an over-collateralized manner.
In order to borrow assets, users must lock up some other assets as collateral. Otherwise, users can just flee with the borrowed assets without returning them, resulting in bad debt.
A simple analogy on how this works is that to borrow money from the bank, you may need to pledge your car or house as collateral.
For capital efficiency, Carbon follows a Collateralized Debt Position (CDP) system such that assets being lent out can also be used as collateral for borrowing, creating room for “double usage”. The collateral collected therefore do not simply sit in a vault but also actively earn a yield via lending APR.
This means that assets deposited in the CDP module will return a receipt, which:
The dual usage of collaterals as both collateral and assets for lending is safe as the borrowed collateral will also be recursively secured by other collateral from a new borrower.
Since a single user can lend out multiple types of assets at once, it follows that a user can also use multiple assets as collateral to back their borrowings. Given one or more collateral assets, users can borrow one or more types of assets at the same time (multiple borrowings).
When a collateralized borrow happens, the user is said to enter a Collateralized Debt Position (CDP), as they have adopted debt (i.e. they have borrowed with an obligation to return) that is collaterized by assets they have pledged (i.e. the collateral will be seized if the position is no longer viable). In TradFi, collateralized debt is more commonly known as “secured debt”.
For the CDP system to work properly, the total value of all the locked collateral needs to be more than the total value of the borrowed assets. Otherwise, the borrower can simply sell the borrowed assets and pocket the difference in value as profits.
However, even if this condition was being met when the user opened the loan, it may quickly not hold true as the value of the borrowed or collateralized assets changes with its market price.
For example, a user borrows 1 BTC with 20,000 USDC when BTC was at $20,000. If the market price of BTC drops to $19,000, his loan will now become under-collateralized.
In order to avoid this situation, the initial required collateral (i.e. “initial margin”) must always be somewhat more than the amount that is being borrowed. This is also known as the Loan-To-Value (LTV).
On Carbon, each asset is given a LTV based on how volatile it is estimated to be. Assets that are more volatile need lower LTVs so that there is a larger buffer against potentially greater price fluctuations.
The value of the loan that can still be taken out for a given collateralized position is also known as its “Borrowing Power”.
For example, a user borrows 1,000 USDC with 1 BTC when BTC is at $20,000. BTC has a LTV of 50%. His remaining borrowing power is $9,000.
If market prices continue to move against the lender, (i.e. collateral value drops more than loan value OR loan value increases to more than collateral value), the same issue will eventually occur (i.e. user’s borrowings become under-collateralized).
In TradFi, this is normally triggered by a “margin call”, where the borrower is issued a call to deliver more collateral to the lender. If the borrower does not meet this call within the pre-agreed timeframe, they are considered to be in default, and the collateral is liquidated by the lender so that they are made whole. The lender can also use legal means to attempt further clawback of assets if the liquidated collateral’s value turns out to still be short (”deficit”) of the borrowed value.
The liquidation level, normally expressed as a percentage, is the point that, if reached, will initiate the automatic closure of existing positions.
E.g. Borrowing Information for ATOM on Carbonscan
- 1.Click on 'Borrowable Assets' under the 'Assets' toggle.
- 2.Click on a specific asset e.g. ATOM and you will be directed to 'The Borrowable Asset Details' page for the asset.