How does Borrow work?
Last updated
Last updated
All borrowings on Native are secured in an over-collateralized manner to ensure the repayment of debts. The borrow interest rate is variable, influenced by the utilization rate, which reflects supply and demand dynamics.
The Interest Rate Model plays a crucial role in managing liquidity risk within the Native platform. It operates by adjusting borrowing rates based on the utilization rate of assets, which is determined by the ratio of borrowed assets to lent assets.
The model aims to incentivize optimal utilization through a dynamic interest rate mechanism.
The utilization rate, 𝑈, is a critical parameter as it reflects the availability of assets in the market.
It is defined as:
As the utilization rate approaches 100%, assets become scarce, making borrowing difficult and potentially preventing suppliers from withdrawing their liquidity.
While a utilization rate of 100% might seem ideal, Native sets target utilization rates below 100% to allow for the rapid recall of loans by lenders. This precaution is especially important during periods of market volatility to prevent a "," where a surge in withdrawal requests leads to a liquidity crisis.
The target setpoint is the desired utilization rate for each market, balancing the needs of both lenders and borrowers.
When the current utilization rate is near the target, borrow rates are adjusted gradually.
When the utilization rate deviates significantly from the target, borrow rates are adjusted more radically.
Below target setpoint: When the utilization rate is below the target, the interest rate drops linearly towards zero. This incentivizes borrowing by offering cheaper rates, thereby increasing the utilization rate.
Above target setpoint: When the utilization rate exceeds the target, the borrow interest rate increases rapidly. This incentivizes borrowers to repay their debt quickly and discourages new loans, thereby lowering the utilization rate.
This formula shows that all interest (after fees) paid by borrowers is shared among lenders.
The current utilization rate dilutes the earnings of lenders proportionally to the assets not being borrowed.
Native employs a to enhance capital efficiency. Under this system, users can lend multiple types of assets simultaneously and use various assets as collateral for their borrowings. This flexibility allows users to maximize their borrowing potential by using a diversified portfolio of collateral assets.
For the CDP system to function properly, the total value of all locked collateral must exceed the total value of the borrowed assets. This ensures that borrowers cannot simply sell the borrowed assets and profit from the difference. However, even if this condition is met when the loan is opened, market price fluctuations can quickly change the value of the borrowed or collateralized assets, potentially leading to under-collateralization.
Example A user borrows 1 BTC using 20,000 USDC as collateral when BTC is priced at $20,000. If the price of BTC drops to $19,000, the loan becomes under-collateralized.
The value of the loan that can still be taken out for a given collateralized position is known as its “Borrowing Power”.
Example A user borrows 1,000 USDC using 1 BTC as collateral when BTC is priced at $20,000. With BTC having a Loan-To-Value (LTV) ratio of 50%, the user's remaining borrowing power is $9,000. This means the user can still borrow up to $9,000 more before reaching the maximum allowable loan based on the collateral provided.
If market prices move against the borrower (i.e., the collateral value drops or the loan value increases), the . In the Native ecosystem, borrowers must monitor their own liquidation levels. The Health Factor indicates the safety of a borrower's position. The liquidation level, expressed as a percentage, is the threshold at which the system will automatically close existing positions to prevent under-collateralization.
To borrow assets, users must lock up other assets as collateral. This prevents borrowers from absconding with the borrowed assets, which would otherwise result in bad debt.
A simple analogy on how this works is that borrowing from a bank often requires pledging assets like a car or house as collateral.
Collateral assets can be volatile. It is the borrower’s responsibility to ensure that the value of their collateral remains sufficient to cover their debt. The fluctuating nature of asset prices means that borrowers must actively monitor and manage their collateral, or Health Factor, to maintain a healthy position.
To avoid liquidation, borrowers must:
Monitor health factor: Keep track of the of their collateral assets and debt.
Add more collateral: Deposit additional collateral if the value of existing collateral declines.
Repay part of the debt: Reduce the debt to improve the Health Factor.
The lending Annual Percentage Rate (APR) can be derived as follows:
