Comment on page
Empowering borrowers and earning passive income through decentralized lending
Users can lend (i.e. “supply”) multiple assets at once, to earn an interest on each of them. As this is non-custodian, users can withdraw their lent amount at any point in time.
The liquidity of the money market is measured by the availability of assets for basic market operations such as borrowing assets backed by collateral and claiming supplied assets along with accrued yield.
A lack of liquidity will block operations. At any point in time, the liquidity of the protocol can be assessed through the utilization ratio (i.e. the share of the reserve that is currently borrowed vs. the supply of each asset).
The Interest Rate Model is central in the management of liquidity risk. As utilization rate rises, borrowing rises as well (due to higher price of capital).
The interest earned is determined by a simple linear curve (i.e. two straight lines), which is meant to incentivize the utilization rate (i.e.
borrowed amount / lent amount), to hit a ratio that has been determined to be optimal via basic supply & demand forces.
E.g. Interest Rate Model for ATOM on Carbonscan
In an ideal world, a utilization rate of 100% would be optimal (such that there is no idle capital for lending that is sitting unused).
The Carbon protocol sets the target utilization rate for individual assets to be less than 100% to allow for rapid recall of loans by lenders; If there are no assets left for borrowing, lenders will NOT be able to withdraw until borrowers repay their loans.
Setting utilization rate <100% is especially important during periods of market volatility where more lenders may seek to withdraw their volatile assets at the same time (either due to perceived system risk, or, to sell and remove market risk), resulting in what is commonly referred to as a “bank run”.
A “bank run” refers to the economic phenomenon where a “withdrawal queue” builds as lenders (more commonly termed as “creditors” in this situation) are unable to withdraw their assets.
BELOW Target Utilization Rate
- Interest rate drops linearly to 0, incentivizing borrowing due to cheaper rates, thereby increasing the utilization rate.
- The interest rate at the pivot point is estimated and set by the protocol based on a few factors, such as the USD interest rates, perpetual market funding rate and futures premium rates. If no such factor is available, it will be estimated by using correlated assets or by class-based asset categorization.
ABOVE Target Utilization Rate
- As the utilization rate goes above the target point, the borrow interest rate increases rapidly, incentivizing borrowers to quickly repay their debt (and avoid opening new loans), thereby lowering the utilization rate.
Assets that are more volatile require a lower target utilization rate to establish good protocol resilience against market forces.
Intuitively, one should be able to see that the lending APR is simply equal to
(borrowInterestRate)% x (1-Interest Fee)% x current Utilization Rate.
This is because all interest (after fees) that is paid by borrowers is shared equally among lenders.
The current utilization rate gives the ratio of assets that are not earning interest (as they are not being borrowed) to total assets, diluting the earnings of lenders by that factor.
E.g. Lending 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.