Liquidity Risk

Overview

As a cryptocurrency-based lending protocol, users can deposit or borrow ETH, WBTC, USDC, earn or pay interest on DEFED.

In order to improve the efficiency of lending, DEFED uses a peer to pool mechanism, where depositors deposit funds into a lending pool for borrowers to borrow at any time as they need.

In this process, a key indicator emerges, namely liquidity, which refers to the current reserve balance available for borrowing, and is related to the ability of the protocol to coordinate and operate itself. Typically, lending protocols choose the utilization rate to assess the current liquidity situation. And liquidity is regulated through an interest rate model that changes around the utilization rate.

This is achieved by simultaneously lowering the deposit and borrowing rates to encourage borrowing when liquidity is sufficient. When liquidity is not enough, a punitively high interest rate is used to discourage demand for borrowing while encouraging depositors to provide more available funds for the protocol to avoid running out of liquidity.

The equation of the interest model

$$if \ U < U_{optimal}:R_t=R_o+U_t/U_{optimal}∗R_{slope1}$$

$$if\ U \ge U_{optimal}: R_t = R_o + R_{slope1} + (U - U_{optimal}) / (1 - U_{optimal}) ∗R_{slope2}$$

Parameter Description

$$U$$	Current funds utilization rate
$$U_{optimal}$$	Pre-determined funding rate threshold
$$R_t$$	Final Interest Rate
$$R_o$$	Base Rate
$$R_{slope1}$$	First-stage interest rate
$$R_{slope2}$$	Second-stage interest rate (punitive)

Current Parameter

$$U_{optimal}$$	65%
$$R_o$$	0
$$R_{slope1}$$	8%
$$R_{slope2}$$	100%

Current Interest