The Two-Market Model
The two-market model, while a new DeFi construct, has been battle-tested, and is used heavily in traditional finance. Catalysing this model in DeFi is not without its challenges however. The underlying assumption with the Two-Market model is that there is an almost unlimited amount of participants on either side of both lending and borrowing, each with their own desire or risk appetite to participate in such a market.
To catalyze this market and address the issue of going from zero-to-one, we look to the Liquidity Provider model to create off-the-shelf demand. A portion of protocol revenues will be shared with the LPs in exchange for the risks that they take.
The share of revenues are a function of the overall size of the Reference Market vs the Subscription Market, the fee structure, and the absolute level of interest rates.
- Subscription Market Size: $100mm
- LP Size: $10mm
- Fees: 10% of the prevailing Reference Interest Rate (for illustration)
- Reference Interest Rate: 5%
The interest rate that Lenders would receive would be 4.5%, i.e. reference rate (5%) minus the fee (5% x 10% = 0.5%), and similarly the interest rate that Borrowers would pay would be 5.5%, i.e. the reference rate (5%) plus the fee (5% x 10% = 0.5%). So the absolute fee revenue is $0.5mm (i.e. $100mm x 0.50%) from Lenders plus $0.5mm (i.e. $100mm x 0.50%) from Borrowers respectively.
Sharing these fees across LPs then equates to:
- Lender LPs: $0.5mm fee income on $10mm = 5% Fee Income
- Borrower LPs: $0.5mm fee income on $10mm = 5% Fee Income
Note in addition that the Lender LP may be accruing interest on a portion of their loaned assets, and that we may not evenly divide protocol revenue into the Lender LP, and Borrower LP positions evenly. We will monitor this process, and allocate fees where we feel it drives the most depth, and health for the system, and ecosystem as well.