Fuse Explained

Understanding Rari Capital’s breakout product

Justin Yu
Rari Capital

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As of September 14th, the Rari Capital ecosystem holds over $260M in TVL, largely due to the increasing success of Fuse, which contributes $240M alone. This piece will serve to explain what Fuse is, how it works, and how to participate in the consistently growing product.

What is Fuse?

Firstly, Fuse is a protocol that supports isolated interest rate pools. More plainly put, Fuse allows “pool creators” to spin up customized, isolated pools for lending and borrowing assets of their choice. Pool creators can choose all the unique parameters they want: interest rate curves, oracles, collateral factors, etc.

Furthermore, since each pool is isolated, pool creators may customize their pools according to their appetites for risk without compromising or affecting the safety of other pools. For individual users, this means that if someone had a position in one pool they deemed acceptable risk-wise, that position would not be jeopardized by the potential flaws of another pool. These potential flaws can be understood with deeper insight into the actual functions of Fuse.

How does Fuse work?

At its core, Fuse allows users to enter and exit lending and borrowing positions using unique assets and settings. If you’re familiar with protocols such as Compound or Aave, Fuse pools operate similarly, however, they introduce a new element of customization and present more options.

In essence, each pool has a specific set of assets that can be “supplied” to earn lending interest and/or be used as collateral. By enabling supplied assets to be used as collateral, users can borrow from the same set of assets *with some exceptions that will be covered later. Pool creators not only build these sets of assets, but they also choose certain parameters such as asset collateral factors (also represented as LTV: Loan to Value ratio). This ratio defines the maximum amount of tokens in the pool that can be borrowed with specific collateral. For example, if the LTV is 85% on RGT in a pool, for every 1 RGT worth of collateral, borrowers can borrow .85 RGT worth of other tokens in the pool. If the price of a user’s supplied asset decreases to lower their collateral amount or if the borrowed asset increases to make the borrowed amount exceed the LTV limit, a user’s position will be liquidated. Essentially, their collateral will be sold to repay enough of the user’s loan until their borrow amount no longer exceeds their supplied collateral. This makes it critical to carefully monitor one’s borrow limit and borrow carefully within the limit.

If a supplied token is also being borrowed by other users in the pool, supplying positions earn interest from borrower payments. The rate at which users earn and repay interest is determined by the asset interest rate curve selected by the pool creator for that asset and the utilization of that asset.

Utilization is the ratio of how much a certain asset is being borrowed relative to the amount supplied (if 80 ETH is being borrowed out of 100 ETH supplied, utilization is 80%). Interest rate curves are functions that essentially plot interest rates along the y-axis according to utilization percentage along the x-axis. Meaning that each point of utilization gives a specific interest rate for supplying and borrowing.

To target a healthy utilization percentage, curves have a kink at around 80% where the curve begins to rise more sharply at each step for utilization (the slope increases). Essentially, as utilization goes beyond about 80%, interest rates for lending and borrowing increase more dramatically. This is done to prevent “bank runs,” scenarios where high utilization prevents users from exiting supply positions because there is not enough liquidity remaining. Thus, higher supply rates incentivize more supplied liquidity while higher borrow rates incentivize repaying loans, both acting to keep utilization in check.

When interacting with a pool, you may notice that supply rates are displayed in APY while borrow rates are displayed in APR, this translates to how interest on supplied liquidity compounds while interest on borrow positions are flat and do not compound. However, both are subject to changes in rates according to the interest rate curve.

Having covered the basics of how Fuse works, it’s important to understand how pools may be dangerously customized, whether intentionally nefarious or not. While the currently supported pools have been created with the help or direct oversight of the Rari Capital team, some future pools may have intentionally unsafe assets designed to allow users to exploit pools. For example, if a pool creator adds an unknown asset with little liquidity, they may be able to manipulate the price of that asset to return a large supply position for a bloated collateral amount and use that to borrow funds with no intention of repaying the loan, since the supplied position was in a manipulated asset. Similarly, pools may be constructed riskier concerning the collateral factors assigned to assets, as volatile assets should normally have more restricted LTV ratios. As mentioned earlier, because these pools are isolated, there are no risks to other Fuse pools from a poorly or nefariously constructed pool. Our automatically calculated Rari Safety Scores are displayed on the pool discovery page to help provide a metric for comparison between pools, however, individual research should also be conducted before entering a position.

How do I become a user of Fuse?

Now equipped with a better understanding of how Fuse works, you can learn or teach others how to participate in Fuse and the budding Rari Capital community. The most simple form of participation can be achieved by simply browsing Fuse pools for high supply interest rates (usually on stablecoins) and supplying whichever asset is in highest demand by connecting your wallet and selecting to supply that asset in the individual pool screen.

A more intricate form of use might involve finding a suitable Fuse pool and supplying an asset (that you intend on holding) as collateral and borrowing an asset from the same pool. You could try borrowing an asset to short it or you could borrow a stablecoin at a rate that you can outperform elsewhere (whether in another pool on Fuse), by market buying a third asset (predicting a price increase of the asset), or through some other function elsewhere. Once you’ve established a borrow position, it’s important to monitor the “health” of your borrow limit and how close you are to exceeding it. It is recommended for newer users to stay relatively conservative with their positions, especially when supplying more volatile assets.

With either a newly founded or newly enhanced knowledge of Fuse, hopefully, you can join the community and even teach others how to participate. Thanks for reading.

-Justin Yu (Twitter: @JustinTylerYu)

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