The money market of USDFI employs a Peer-to-Pool lending mechanism, which has gained significant traction among various DeFi lending protocols. In order to explicate the functioning of this methodology, it is helpful to understand the more conventional Peer-to-Peer lending approach first.
In Peer-to-Peer lending, a lender and a borrower are matched with one another to create a specific loan. This method of lending is often facilitated through online platforms that directly connect borrowers and lenders. The aim of Peer-to-Peer lending is to eliminate the need for intermediary institutions, such as banks, which can reduce costs and enable lenders to earn higher interest rates on their loans while borrowers can access lower interest rates.
Peer-to-Pool Money Markets
In Peer-to-Pool Money Markets, lenders contribute tokens as liquidity to a shared pool of assets, while borrowers draw from that same pool by borrowing liquidity in the form of tokens. Rather than dealing directly with each other, both parties engage with the communal pool. These pools, which are governed by smart contracts on EVM compatible blockchains, use algorithms to dynamically calculate the interest rates that lenders earn and borrowers pay. This automated process eliminates the need for intermediary parties and significantly reduces associated costs. The Money Markets (MMs) established by the Compound protocol embody this concept, where users enter and exit the market as lenders or borrowers in response to the rates quoted by the Market.
In USDFI's Peer-to-Pool Money Markets, the lending process is based on the over-collateralization mechanism. This entails that to secure a loan from one Money Market, a borrower must first deposit tokens of higher value into another Money Market as collateral. Furthermore, the borrower is obligated to maintain an adequate amount of collateral throughout the entire loan duration. This approach is prevalent in DeFi lending because users are typically anonymous when interacting with smart contracts. This means that traditional identity-based methods of enforcing loan repayment are not feasible in the DeFi context.