Dharma Markets #3: Interest Rates in Lending Protocols

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Interest rates are a core a tent of any well functioning capital market — they enable long term holders to trade the time value of their money, leading to more efficient capital allocation. In this way, interest rates are a prerequisite for any valuable form of money.

As we’ve previously written, a number of trust-minimized debt markets have emerged in which passive holders can lend out their excess crypto assets to willing borrowers. Given these platforms are both nascent and built with distinct design choices, interest rates within these platforms vary widely. For example, an investor interested in borrowing a stablecoin today could do so for either 0.1%, 1%, and 8.6% APR on Dharma Lever, MakerDAO, and Compound respectively.*

While interest rates in an efficient market should ideally converge on, or at least move close to, an agreed upon ‘market rate,’ the mechanisms by which decentralized lending protocols set interest rates are unique. To better understand the use cases that each lending protocol is best suited for, it’s important to know how interest rates are set across various platforms and the mechanisms by which they fluctuate.

Market-based rates in Dharma Lever

In Dharma Lever, interest rates are decided in an open, P2P market — borrowers and lenders are free to propose interest rates on the Dharma Credit Market and Lever will find the best available offer(s) to match. Assuming borrowers and lenders are able to transact in a free market, supply and demand for loans in Dharma Lever should converge on an agreed upon interest rate.

Loans in Dharma Lever are fixed term, meaning each lending agreement has a fixed duration during which a borrower must pay back their debt. Borrowers don’t necessarily have to wait till the end of the loan term — they’re able to pay off their debt at any point in the duration.

Fixed rate crypto loans are preferable for large volume orders because, unlike other models, interest rates don’t change relative to the size of the loan. In this paradigm, investors can borrow large amounts of crypto assets at affordable, fixed interest rates if there are willing lenders. This is similar to how OTC lending agreements work: an investor can borrow a large amount of crypto assets if they’re willing to accept the desk’s terms.

Dharma Lever’s trust-minimized, fixed-term loan offering makes it particularly useful for hedge funds, market makers, and crypto exchanges who want to margin borrow/lend in high volume at affordable interest rates.

Algorithmic floating rates in Compound

Compound’s money markets employ a variable interest rate model in which rates fluctuate relative to the supply and demand within each money market. If there are more lenders than there are borrowers, meaning demand to borrow is low, interest rates decrease. If there is strong demand to borrow and the liquidity in the money market is low, interest rates rise.

Unlike the peer to peer model, users of compound don’t need to negotiate maturity dates, interest rates, or collateralization requirements with counterparties — they are free to borrow and lend from the money markets as long as they’re willing to accept the protocol’s offered terms.

Compound’s greatest advantage is that they can offer borrowers and lenders instant liquidity — they don’t have to wait for a loan to mature before getting access to their capital. This makes it particularly good for short-term borrowing and lending use cases. For example, a user that needs a token to access a decentralized application but doesn’t want to take on the risk of holding the asset or a custodial wallet that wants to use a sweep account to earn a small amount of interest on their float.

MakerDAO stakeholder governance

Maker is a bit more unique in that the stability fee — also interpreted as the system’s interest rate — is decided through community governance. Holders of MKR, the network’s intrinsic token, periodically vote on whether or not to raise or lower the stability fee. The primary motivation for changing the stability fee is to keep demand for CDPs in line with demand for DAI.

CDP holders pay the stability fee to compensate MKR holders for the credit risk they take on by being the recapitalization resource for the system. Maker is different from other lending platforms in that there are no fixed terms — borrowers can pay off their debt at any time, with the stability fee compounding continuously. It was interestingly noted that MakerDAO’s stability fee exists completely outside of the fed funds rate, essentially creating a parallel economy with a new ‘price of money.’

Given the fact that borrowing DAI doesn’t require a counterparty, Maker is most suited for use cases which mandate a higher level of trust-minimization. To date, demand for DAI has primarily been a function of demand for permissionless leverage. Borrowers were extremely motivated in Q4 2018 because of the .5% stability fee.

*The 0.1% APR interest rate on Dharma Lever is only available during the Alpha phase and is subject to change based on market demand

ETH Locked in #DeFi: 02/04/2019–02/17/2019

The total number of ETH locked in DeFi breached 2,100,000 these past two weeks. The largest gainer was Uniswap, which saw record volume within the MKR liquidity pool. Compound, dy/dx, and Augur saw little movement as markets remained relatively calm. It is interesting to see the fall in the dy/dx’s total ETH after one of their sETH positions was margin called.

Looking closer at Uniswap, the on-chain decentralized exchange now holds over 10,000 ETH and is quickly becoming the go-to source for dApp liquidity.

DeFi News

💎 Dharma unveils new visual experience and waitlist for Lever

We recently unveiled a completely new visual experience for Dharma Lever. Our goal with this new design is to make borrowing and lending beautiful and easily accessible. When borrowing and lending through Dharma Lever, users will enjoy the same ease of use they get from today’s most successful fintech products, but with the magic and speed of an upgraded, programmable financial system.

Dharma Lever is also centered around the idea of dynamic crypto finance. The main way users interact with crypto today is buy, hold, and forget about it — we want to change that. Why not put those assets to work in a globally accessible credit market and watch them grow in real time?

If you’d like to experience Dharma Lever for yourself, you can reserve a spot on the alpha waitlist here: https://www.dharmalever.com/

🦄 Uniswap becomes most liquid MKR exchange

Uniswap saw a large uptick in volume as prospective MKR buyers finally got a chance to purchase the asset in a liquid market. Uniswap quickly became the most liquid avenue to purchase MKR, with over $500,000 USD worth of MKR available in the pool.

Uniswap’s growth to date has been remarkable and it’s on a launch trajectory similar to MakerDAO. A lot of this growth came as a result of Kyber Network making Uniswap one of their primary liquidity sources. We expect more projects to follow suit.

💵 InstaDapp is now responsible for .5% of all DAI creation

InstaDapp recently announced that it’s platform has been responsible for .5% of all Dai minting. At the time of the announcement, $379, 493 USD worth of debt was issued on their platform, backed by 8,911 ETH as collateral.

What Team Dharma is reading

DeFi: Constructing the Foundation of a New Microeconomy

Digital Asset Lending via Open Protocols 2018

Dai in Numbers

Understanding Uniswap Returns

Superfluid Collateral in Open Finance

Rehypothecation: BTC’s path to becoming king of collateral

On-chain activity under the microscope: Uniswap leads ETH/MKR market, difficulty bomb dampens Ethereum issuance

Understanding Plasma, Part 1: The ‘Basics’

Moloch DAO Whitepaper

Politics, Power & Protocols


Last week, we unveiled a brand new Dharma Lever experience. Our design pattern was influenced by our core belief that usability is paramount to bringing new users onto the decentralized financial system. With Lever, users can seamlessly borrow and lend crypto assets the same way they interact with their favorite fintech products today.

The feedback so far has been deafening — over 1,200 people signed up within the first few days of launch, and we’ve already garnered a ton of valuable feedback. If you’d like to be one of the early few users of Dharma Lever, you can sign up for the waitlist here: https://www.dharmalever.com/

As always, team Dharma is hiring! Join us in changing the way financial markets look and feel:

Lead Product Designer

Blockchain Engineer

Full Stack Web3 Developer