2 Types of Operating Lending Model

June 20, 2022 - Around 6 mins mins to read

Currently, on the market, there are two ways of operating lending platforms, one side operates in a way that bears the same risk, and the other side separates risks for each separate pool. Both methods have certain advantages and disadvantages that I will explain in this analysis.

Lending/Borrowing Operation

In the previous analysis, I presented the general model under which Lending Platforms work, you may want to refer to that article here.

Now, let’s focus on analyzing how the Lending Platform works. We have two ways: (1) pooling all assets into one pool and (2) each pool is a certain pair of assets for lending/borrowing, also known as Isolate.

In general, both models have the same way of working, specifically:

Lender asset volume = Lender’s asset volume
Borrowing asset volume = Lending asset volume * µ
The collateral volume is kept unchanged and ready for liquidation if any.

Where: µ is the collateral ratio, determined based on volatility risk from assets

Normal Lending Model

This model is developed by MakerDAO in the form of a partial contribution, meaning that they will be Lender for lending activities, users will only go to the platform to borrow DAI (Stablecoin) minted at the rate of µ. In addition, other platforms such as Aave and Compound have extended the above model, allowing users to participate in the protocol as a Lender.

The advantage of this model is high liquidity, and there is no asset fragmentation. In turn, the risk of default from one asset will affect all other assets. Therefore, Platforms of this type often control risk through interest rates between individual assets and control the overall risk of the Platform, otherwise, a chain default will easily take place.

Isolate Lending Model

The isolate Lending Model was pioneered by Sushiswap under the name Kashi and operated to this day. Basically, this model is a combination of many Normal Lending Models, but each Pool contains only a single pair of assets, for example, Pool1 only contains ETH (collateral) and USDC (Lending and Lending Assets) pairs of loan assets).

The advantage of this model is that the risk of each asset pool is segregated, that is, if one pool is at risk of default, only that pool will suffer without affecting the entire protocol. Risk control is also much simpler. In turn, liquidity in borrowing/lending is fragmented because the pools are not interconnected, resulting, in the same assets being contained in many different pools.

Compare Lending Platforms

MarkerDAO

Maker is an Over-Collateral system that creates and keeps stable prices for the stablecoin DAI.
Simply, for every $40 worth of Crypto assets that a user deposits into MakerDAO, the user can Mint about 15 – 20 DAI, the more Minted, the higher the risk of being liquidated.

The main feature of the whole Maker system is that there is only one:

Deposit collateral to Maker Vault and Generate CDP to get DAI Token.
The rest of the features are mostly additional mechanisms to make MakerDAO’s operation smooth and efficient and keep the price of DAI stable at around $1.
MarkerDAo uses the Normal Lending Model

Compound

The compound is a Money Market Protocol. It consists of groups of assets with floating interest rates that are algorithmically calculated based on the supply and demand for that asset. The compound is considered a pioneer project in this field, it can be compared to Uniswap in the AMM array.

Some key features of the Compound:

Lenders (Depositors) Deposit Crypto Assets into the Pool to receive floating interest rates.
Borrowers (loan takers) mortgage Crypto Asset into the Pool to borrow an amount and pay interest based on the amount they borrow, basically, the borrower is also a Lenders because according to Compound’s mechanism, they have to Deposit first before they can borrow.
cToken represents a user’s balance each time he interacts with Compound’s Liquidity Pools.
The compound uses the Normal Lending Model

Interest in Compound is not distributed directly. Instead, cTokens accrue interest through their exchange rate over time. So just holding cTokens, users will earn interest.

Each Underlying asset will have its own cToken as a representative (DAI – cDAI, ETH – cETH, USDC – cUSD, etc.), it allows you to earn interest and can be used as collateral to borrow in the compound.

cToken works similarly to an ERC20 so it can be traded or used to build other products.

For example:

Let’s say the user Deposit 1,000 DAI for the Compound, when the exchange rate is 0.020070 cDAI/DAI then the user will get 49,825.61 cDAI (1,000 / 0.020070).

A few months later, the User decided it was time to withdraw his DAI from Compound, the exchange rate is now 0.021591.

User’s 49,825.61 cDAI now equals 1.075.78 DAI (49,825.61 * 0.021591)

Aave

Aave is a Money Market Protocol. The main function of Aave is similar to Compound.

Although behind competitors, Aave has always been active in research & development to integrate useful features into the platform to attract new users and retain old users.

Lenders (Depositors) Deposit Crypto Assets into the Pool to receive floating interest rates.
Borrowers (loan takers) take out an over-mortgage loan and pay interest based on how much they borrow.
Integration with Swap rate allows Depositors & Borrowers to swap between fixed and floating rates.
Flash loan support.
aToken represents a user’s balance each time he interacts with Aave’s liquidity pools. aTokens are pegged 1:1 to the value of the collateral sent in the Aave protocol. Similar to cToken, aToken can be freely stored, transferred, and traded.
Profits in Aave are distributed directly through the increment of aToken, they are accumulated in real-time, and users can watch their balance grow with each block of Ethereum.
Aave uses the Normal Lending Model.

For example:

Let’s say the user Deposit 1,000 DAI into Aave, the user gets 1,000 aDAI.

A few months later, the user decided it was time to withdraw his DAI from Aave, the amount

The user’s aDAI now is 1,071.21 aDAI equivalent to 1,071.21 DAI.

Kashi

Kashi is an isolated lending pair solution. You can create a trading pair similar to how a brother creates a Sushi pair. Some lending markets are very stable and safe, while others are quite volatile (volatile prices and illiquid assets).

In addition, using Kashi funds are generating incremental returns through flash loans for unused capital (e.g. collateral) and is risk-free.

Lenders deposit the paired asset into the pool
Borrowers choose the paired asset they want to mortgage and borrow.
Lenders will receive interest for depositing their assets into the pool and Borrowers have to pay interest after the loan is finished.
Interest difference will be profit for the Kashi platform
Kashi uses Isolate Lending Model

Verdict

Above is the analysis of 2 current operating models and their representatives. We’ve also learned the pros and cons of each operating model, and they depend on the platform’s goals. Hopefully, the analysis will help everyone have a clearer view of the Lending Category

If you have any questions, comments, suggestions, or ideas about the project, please email ventures@coincu.com.

DISCLAIMER: The Information on this website is provided as general market commentary and does not constitute investment advice. We encourage you to do your research before investing.

Marcus

Coincu Ventures

Analysis, DeFi

2 Types of Operating Lending Model