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BTC DeFi Hub

Interlay v2 features a set of financial tools, offering Bitcoin users decentralized access to trading, borrowing, lending and other primitives.

Liquidity Protocol

Interlay v2 introduces support for borrowing and lending of iBTC and other assets through a pool-based liquidity protocol, based on the design of Compound v2.

Lending Pools

Assets supplied by lenders into a lending pool are represented by a fungible "qToken" balance. Subject to the supply of the pool exceeding the borrowed amount, qTokens can be redeemed for the underlying assets. As the protocol accrues interest, subject to borrowing demand, the amount of the underlying asset redeemable by each qToken increases. Thereby, generated interest is distributed among lenders of each pool on a pro-rata basis.

To borrow assets, users must deposit qTokens as collateral. Borrowing contracts are open-ended while rates follow the models encoded in the protocol. Each loan must be backed by collateral at a loan-to-value (LTV) ration below 1.0 to ensure that borrowers have an economic incentive to repay their loans. The interest accrued by a loan, payable in the underling asset, continuously increases the LTV ratio.

Each asset that can be supplied into lending pools must be whitelisted by Interlay network governance. Assets (qToken representations) that can be used as collateral for borrowing require a separate vote. This is to ensure high quality of assets and proper risk management.

Subject to proper risk assessment by community governance, qTokens may also be used as Vault collateral in the BTC bridge. This allows Vaults to lend out their bridge collateral as an additional revenue stream, significantly improving the capital efficiency of the collateralized bridge model.

Liquidations

If the LTV ratio of a position exceeds the borrowing capacity, as configured by network governance on a per-asset basis, all or part of the outstanding loan may be liquidated. During a liquidation, an arbitrageur repays (parts of) the outstanding loan in return for the borrower's qToken collateral at the current market price minus a liquidation discount. This process can be executed by any user and repeated until a healthy LTV ratio is restored.

Interest Rate Model

The Interlay liquidity protocol utilizes an interest rate model to balance lending supply and borrowing demand, and incentivize liquidity. High demand for an asset leads to a decline in liquidity of that asset. The protocol reacts by increasing interest rates, which makes borrowing more expensive and incentivizes supply (and vice-versa).

Decentralized Exchange

To unlock easy access to trading for BTC holders, Interlay v2 introduces a decentralized exchange (DEX). The DEX serves as capital source for liquidations on in the liquidity protocol. Further, the combination of lending / borrowing with trading transactions unlocks a variety of financial products for Bitcoin, including leverage and hedging. In the first iteration, the goal of the DEX is to create deep iBTC liquidity, pairing all major listed assets with iBTC: trades between any two assets should be able to be routed via iBTC.

The DEX supports the following automated market maker (AMM) functions:

  1. Constant product AMM($XY=K$), following the Uniswap v2 design, which allows pairing iBTC with any other crypto asset.

  2. Curve StableSwap AMM for low-slippage swaps between assets which are expected to trade at the same value, e.g., iBTC and wBTC.

Liquidity positions in the DEX are represented through "LP-tokens", which can be transferred and potentially traded themselves. Subject to proper risk assessment by community governance, LP-tokens may also be used as Vault collateral in the BTC bridge.

DeFi Hub Math

Liquidity Protocol Interest Rate Model

At launch, the Interlay liquidity protocol will feature an interest model inspired by Compound v2 - a model that is well tested in practice. Improvements and optimizations are expected in future versions of the protocol.

Utilization Rate

The utilization rate displays which percentage of the total supply is currently borrowed and is a central parameter in determining the supply rate.

$$UtilizationRate = \frac{TotalAmountBorrowed}{TotalCash + TotalAmountBorrowed-TotalReserves}$$ where $\mathit{TotalCash}$ is the amount of supply that is currently not lend out, $\mathit{TotalAmountBorrowed}$ is the total outstanding debt, $\mathit{TotalReserves}$ is the amount of unharvested reserves which accrued in the pool.

Internal Exchange Rate

When a supplier adds tokens to the lending pool, they get credited qToken based on the initial exchange rate. Since the qTokens accrue interest as the TotalAmountBorrowed continually increases, the amount of tokens they will receive at redemption will change based on the internal exchange rate. This can be represented as: $$InternalExchangeRate= \frac{TotalCash+TotalAmountBorrowed-TotalReserves}{TotalSupply}$$ where $\mathit{TotalCash}$ is the unborrowed supply and $\mathit{TotalSupply}$ is the total available supply in the pool.

Borrowing Rate

The function below describes the borrowing rate depending on the demand and supply for that token, represented as the utilization rate U. $$r_{borrow} = \frac{BaseRate + U*(JumpRate - BaseRate)}{U_{target}} \vert U \leq target$$ $$r_{borrow} = \frac{JumpRate + (U - U_{target})*(FullRate-JumpRate)}{1-U_{target}} \vert U >target$$ where $\mathit{BaseRate}$ is the intercept (when utilization is zero), $\mathit{JumpRate}$ is the borrow rate when $U = U_{\mathit{target}}$ and $\mathit{FullRate}$ corresponds to the rate when $U = 100%$.

Supply Rate

The relationship between the supply rate and the borrow rate can then be described as below. Note that the supply rate supply rate is reduced by the fees that are attributable to the protocol. $$SupplyRate = \frac{\mathit{BorrowRate} * \mathit{TotalAmountBorrowed}}{\mathit{TotalSupply}}*(1-\mathit{DAOFee})$$ where $\mathit{DAOFee}$ is the percentage fee that is collected by the protocol.

AMM Curves

Non-stable Pools

Exchange prices on the DEX are determined by the constant function market maker. For non-stable pools, prices are determined via a constant product function in the form of $$K = x * y$$ where K is a constant, x and y are the supplies of tokens X and Y, respectively.

Stable Pools

For stable pools, the DEX determines the exchange price of an asset using the stable swap invariant first proposed by Curve $$An^n \sum{x_i} + D = ADn^n + \frac{D^{n+1}}{n^n \prod{x_i}}$$ where $\mathit{A}$ is the amplification coefficient that determines the liquidity concentration towards the middle of the curve, $\mathit{D}$ is the constant (determined as the product of the amount of tokens and is comparable to the constant K in the constant product function), $\mathit{n}$ is the number of coins in the pool and $\mathit{x_i}$ is the respective token. When a trade is being executed on such a pool, the above equation must hold. This requires to find a solution for either $\mathit{D}$ or $\mathit{x}$, when all other variables are known, via iterative convergence.