Research Summary
The report delves into the complex landscape of lending protocols within the Web3 ecosystem, examining the intricacies of interest rate mechanisms and pricing models. It contrasts APR and APY, explores various pricing strategies such as orderbook, utilization-based, and model-based pricing, and discusses the challenges and innovations in the sector, including the use of NFTs as collateral and the introduction of new protocols like Term Finance and Tazz.
Key Takeaways
Interest Rate Fundamentals
- APR vs. APY: The report distinguishes between APR, which does not account for compounding, and APY, which does, noting that APY is more commonly used in Web3 lending due to continuous compounding.
- Fixed Term Lending: Protocols like Pendle and Notional offer fixed-term loans, typically quoting interest rates in APR to address orderbook trading challenges.
Pricing Mechanisms in Lending Protocols
- Orderbook Pricing: Despite its commonality, orderbook pricing faces issues such as unsophisticated user pricing, active management needs, and non-fungible default risks.
- Utilization-Based Pricing: Aave and other protocols use this model, where interest rates increase with utilization, balancing borrower demand with lender supply.
- Model-Based and Governance-Led Pricing: Some protocols employ complex models or governance decisions to set interest rates, which can be less responsive but less prone to manipulation.
Innovations and Challenges
- NFTs as Collateral: Platforms like Blur and Arcade.xyz are enhancing user experience by allowing NFT collections to be used as collateral, representing a subcategory of orderbook pricing.
- Market Fragmentation: The report highlights the fragmented market and the complicated trading experience as significant challenges for pricing in lending protocols.
New Protocols and Approaches
- Term Finance and Auctions: Term Finance introduces an auction-based mechanism for matching lenders and borrowers, aiming to reduce capital inefficiency.
- Tazz’s Novel Pricing Primitive: Tazz is set to introduce a new pricing mechanism where the debt token’s price determines the interest rate, enabling efficient peer-to-pool lending.
Collateralized Debt Positions (CDPs)
- CDP Stablecoins: The report discusses CDP stablecoins like DAI and GHO, which function as loans with manual pricing subject to governance, highlighting the trade-offs between speed and susceptibility to manipulation.
Actionable Insights
- Assess Interest Rate Models: Lenders and borrowers should evaluate the differences between APR and APY to understand the compounding effects on their investments or loans.
- Explore Fixed-Term Lending: For those seeking predictability, investigating fixed-term lending options with APR quotes could provide a more stable financial planning environment.
- Consider Utilization-Based Protocols: Utilization-based pricing models like Aave’s may offer a balanced approach for those looking to engage in liquid and fungible asset lending.
- Investigate NFT Collateralization: The use of NFTs as collateral is an emerging trend that could offer new opportunities for asset-backed lending in the Web3 space.
- Monitor New Protocol Developments: Keeping an eye on innovative protocols such as Term Finance and Tazz can provide insights into evolving lending practices and potential efficiencies in the market.
