Curve's Stablecoin and Lending Market

Curve is the largest DEX by TVL and ranks second in daily trading volume on Ethereum. It has become one of the most efficient DEXs through the creation of its novel AMM designs that provide traders and LPs with a better user experience. The protocol has performed well since the start of the year and is actively launching the major upgrades discussed in our Q1 report.

On May 17, Curve officially launched its stablecoin and lending market, marking the evolution of the protocol beyond just a DEX. Among many benefits, the expansion increases protocol revenue potential and improves the outlook for the health of CRV.

The Current State of DeFi Lending

Lending protocols began to see meaningful traction during DeFi Summer in 2020, with two lending models proving to be scalable. Aave and Compound popularized the peer-to-pool model, where suppliers provide pooled liquidity to fund overcollateralized loans for borrowers. The majority of interest paid by borrowers flows to suppliers, given their capital is required to make markets. In contrast, MakerDAO uses a peer-to-protocol model that improves protocol profitability by replacing the suppliers with the protocol itself. Borrowers still deposit collateral to open overcollateralized loans, but the debt asset must be the protocol’s stablecoin, so all interest paid by borrowers flows to the protocol.

In all overcollateralized DeFi lending mechanisms, volatile collateral poses a risk to the solvency of the protocol and must be managed. Most existing protocols use “hard liquidations'' where a borrower’s collateral is sold at a discount to repay the outstanding loan if the value of their collateral drops below a certain threshold. The threshold is often determined by a “health factor” that measures the amount of collateral relative to the outstanding debt for each borrower. The collateral value is generally decreased by a risk discount (liquidation threshold or collateral factor) based on the market cap, liquidity, and volatility of the collateral asset. Borrowers are subject to hard liquidation when their health factor falls below 1.0, meaning the loan has become undercollateralized.

Hard liquidations with tight risk parameters have effectively protected protocols from bad debt. However, the design forces the borrower to realize losses as their collateral cannot be recovered post-liquidation, even if the value of the collateral recovers. Additionally, each loan is treated individually, so arbitrageurs must execute liquidations in separate transactions. For example, if 1,000 loans have a health factor below 1.0, it takes 1,000 liquidation transactions to protect the protocol from carrying bad debt.

LLAMMA: Curve’s Lending Market