In our previous article, we compared some aspects of Traditional Finance (TradFi) and Decentralized Finance (DeFi). In this article, we will delve deeper into DeFi lending platforms and what they have to offer.
Managing your money and being faced with an endless amount of attractive options can easily be overwhelming. Even looking for reliable information can be problematic and lead to avoidable and expensive mistakes.
This article will help you make sense of the information and break down the basics.
What is a Lending Market?
As mentioned in our previous article, lending markets are comparable to the banks of DeFi.
Their main goal is to provide various options to utilize your money without the need to sell your long term assets.
Apart from simple depositing and borrowing, most lending markets provide additional features such as revenue share for LP (liquidity pool) staking, looping, rewards in the form of various tokens, the ability to deposit revenue generating assets (also known as vaults), and more.
Confused? Let’s have a look and start with our own platform, UwU Lend.
UwU Lend’s Origin
In DeFi, forking contracts is a common practice. When a contract is “forked”, it is first copied and then often expanded upon. This has the advantage of saving time, but also provides an already field tested base code. The main disadvantage is that potential errors or vulnerabilities that have not been found in the base code would inheritably affect all protocols that use the code.
UwU Lend is a decentralized lending market forked from a well-known protocol called AAVE. This means that most of the original smart contracts were replicated from the base protocol. Fortunately, AAVE has been audited and is battle tested. This means that by default, UwU Lend inherits those qualities. However, to ensure UwU Lend’s security, additional audits were performed, ensuring any new feature added or change in code was also audited.
UwU Lend launched in September 2022 and has not been affected by any of the hacks or vulnerabilities that have impacted AAVE and other similar platforms. Our team is experienced, working together on multiple ecosystem protocols. The utmost caution is exercised, especially when rolling out new features and collateral types. User security is always the highest priority.
UwU Lend differentiates itself with its tokenomics and distinctive features, such as sharing 100% of its revenue, unique collateral options, and modifications to increase security. UwU Lend is non-custodial, meaning no one has control over your funds but you. All operations are automated via smart contracts, working autonomously and transparently on the blockchain. The team can add or remove markets, adjust rates and parameters and take emergency steps when needed. Everything is secured via a multisig, meaning more than one signature is required to execute operational changes.
Understanding the Options, Terms and Associated Risks
Deposit
Lending markets allow you to supply assets to earn yield. Deposited assets then become available for other users to borrow. In exchange for lending out your assets, you receive part of the accrued interest.
When depositing on UwU Lend, you will receive “uTokens” in return. uTokens are a receipt of the asset deposited at UwU, earning interest and other rewards that come from depositing the asset. To redeem your assets, simply withdraw from the dashboard at any time.
Deposits are not locked and can be used as collateral to borrow against unless specifically excluded on the dashboard. This means that you will always need to have assets deposited to borrow. Your deposited asset will still receive interest and meanwhile you can free up capital to use elsewhere to generate profits.
The return is displayed as APY (Annual Percentage Yield) and APR (Annual Percentage Return). The APY accrued is automatically added to your deposited position, so your uTokens will increase at the rate of the APY.
Borrow
Borrowing is the act of taking a loan. Your collective deposited assets (collateral) value is used to determine how much you can borrow. There are several things to consider when borrowing, such as the volatility (price changes) in the collateral. We will explore this topic in depth at a later point in our series.
Users can leave the borrowed positions open indefinitely but need to consider that the interest paid is variable and it is always good practice to keep an eye on your positions to avoid defaulting on your loan and getting liquidated by accumulating too much interest.
You can always check the current interest rates by checking the APY on the dashboard. The borrow APY shows how much interest occurs over the course of a year. You will notice as well the displayed APR. This is the reward in UwU tokens you will accumulate on your borrow position over the course of a year.
Liquidation
Liquidation is the mechanism which will allow wallets to repay your debt and seize the appropriate amount of collateral plus liquidation fee. A liquidation can only occur when the Health Factor (HF) drops below 1 to repay underwater debt positions. Smart contracts ensure that no healthy positions can be liquidated.
The HF, visible at all times on your dashboard, is simply a number to symbolize the health of your current borrow position, including accrued interest, vs. your deposited collateral value.
Keeping an eye on your Health Factor to take action to avoid liquidations is good practice. Adding more collateral or repaying your loan fully or partially will raise your health factor. Withdrawing assets will lower your HF.
LTV (Loan to Value)
How much you can borrow against your deposited collateral depends on the loan to value (LTV) percentage that the protocol allows. The LTV is usually decided per asset and based on multiple factors such as the liquidity, safety and volatility of the asset. It is important for the user to know that every loan is overcollateralized due to the LTV. This means that you cannot borrow more than you have deposited.
Example: Alice deposits 1000 DAI. The LTV is 90% so the maximum she can borrow against that deposit is $900.
Looping
Looping is the act of depositing and borrowing the same collateral multiple times in order to collect additional rewards. This would normally result in paying a higher amount of interest on your loan in order to accumulate a higher amount of reward (UwU tokens for UwU Lend).
As there is no cross collateral involved, meaning it is the same asset being borrowed and deposited, liquidation risk is only present if the borrowing interest over a long period of time is left unmanaged. It is considered a fairly low risk way of earning UwU tokens.
You can see the expected return and costs in the looping section of the dashboard. While looping multiple times can be done automatically, be mindful that the process to unloop (pay off the position) has to be done manually over several transactions.
LP Staking
LP staking can be a very lucrative way to earn yield passively. UwU Lend distributes all revenue back to LP stakers, something not commonly done even in DeFi. But what does that mean exactly?
Every token needs what is called “liquidity” to allow users to buy or sell them. This usually means the protocol issuing the token will create a liquidity pool (LP) with “two sides”: on one side their own token, and on the other side, a stable coin or highly liquid token such as ETH, AVAX etc. This is normally done on a Decentralized Exchange (DEX) or a Market-Making protocol, such as Uniswap, Sushiswap etc. Once an LP has been created, anybody can add to it by providing the two assets at the set ratio.
Example: Alice deposits 1 ETH and 250 UwU in the LP on Sushiswap. On most pools, the deposited token pair needs to be of equivalent value. This means that the price of 1 ETH equals 250 UwU at the time of deposit. In return, Alice will receive a receipt token called “SLP” that reflects her LP position. This SLP token can be staked on UwU Lend under the “Stake” tab.
At UwU Lend, doing this will lock up your SLP tokens for eight weeks. This means that during this period of time you will not be able to retrieve your SLP tokens. After eight weeks you can unstake, or leave your position staked and continue to receive rewards. Doing so gives you a share of the revenue of UwU Lend proportional to the size of the amount you have staked.
Example: UwU Lend has a total of 2500 SLP staked. Alice staked 250 SLP tokens, therefore she will receive 10% of the revenue shared. Revenue depends on users repaying their loans and exiting early. This is often called “real yield”, meaning it is generated from real revenue and not paid out in dilutive protocol tokens.
However, before providing liquidity anywhere and hoping for large returns, there is one thing to consider.
Impermanent Loss (IL)
Impermanent Loss is when you provide cryptocurrency to a liquidity pool, and the price of your deposited tokens changes over time after you have deposited them. IL is a risk that can occur when providing liquidity to a DeFi market-making protocol, also known as an Automated Market Maker (AMM). It is called “impermanent” because it is not a permanent loss of capital, but rather a temporary loss that can be recovered if the liquidity provider continues to hold their position.
Due to the fixed value ratio within the liquidity pool it is possible that, when withdrawing liquidity, Alice will likely have different amounts of ETH and UwU tokens. This rebalancing happens automatically and can lead to a loss in $ value compared to simply holding the asset. Usually high APR makes up for potential IL, but that is not always the case for low APR options sometimes offered by protocols, or highly volatile assets.
It is important to consider your initial position and earned interest to make sure you will not incur an overall loss before withdrawing liquidity. Impermanent loss is a complex topic and we recommend asking on our social media channels for more information.
The Road Ahead
Although we have covered a lot of ground in this article, not every topic has gotten the attention and details required for them to be fully understandable. However, we hope this information offers you a good base understanding of the options available on UwU Lend.
We will dive deeper into these various topics over the course of the next articles. See you then!
