A brief discussion on the feasibility of liquidation-free lending protocols: Can DeFi have both high returns and flexibility?

6 months ago
This article is approximately 1002 words,and reading the entire article takes about 2 minutes
Liquidation-free lending protocols offer a new alternative that is simple and effective.

Original title: Insightful Examination of the No-Liquidation Lending Protocol

Original author: SCapital

Original compilation: Qianwen, ChainCatcher

Current lending protocols face many challenges because the main players in the DeFi lending ecosystem (platforms such as Aave and Compound) adopt the following basic mechanisms:

Overcollateralization: Primarily requires borrowers to deposit an amount of an asset (such as ETH) that is much higher than the amount they wish to borrow, usually in the form of a stablecoin.

Interest rate fluctuations: Interest rates change dynamically in response to supply and demand. As more borrowers tap into available liquidity pools, interest rates tend to rise quickly to encourage repayments or additional deposits.

Collateral liquidation: If the market price of the collateral is below a critical ratio (taking into account the borrowed amount and interest), the collateral will be sold to pay off the users debt.

However, this popular model has an inherent flaw - when market prices drop sharply, it triggers a cascade of liquidations. This can lead to rising interest rates and market panic. The recent decline in CRV is a case in point. The market is worried that CRV will be liquidated, causing its price to plummet. At the same time, the market is worried that stablecoins on lending platforms may have bad debts. This sentiment will also affect the entire DeFi industry. Borrowers fear of a sudden market drop often results in less capital efficiency, with them saving more money than necessary in the hope of avoiding liquidation. Under this model, it is difficult to simultaneously meet the requirements of capital efficiency, capital pool liquidity, and effective liquidation.

Innovative solution: liquidation-free lending agreement

This new approach proposes a lending protocol with predetermined terms using Ethereum as primary collateral. Its beauty lies in its simplicity: Borrowers determine a clearing price when they originate a loan, and as long as they repay by the set deadline, their collateral is safe.

Mechanism explanation

Borrower’s perspective: They mortgage ETH, obtain a stablecoin loan (like USDC) with no periodic interest, and lock in the liquidation price. So even if the market price of ETH plummets below this price, the collateral will only be threatened when the loan closes.

Lender’s perspective: They provide the stablecoin required for lending. The ETH pledged by the borrower generates pledge income, from which the lender can profit. If the market price of ETH falls below the level set by liquidation, they can effectively acquire ETH at the pre-agreed liquidation price.

At the heart of the system is the concept of stablecoin (USDC) pools. These coin pools have clear expiration dates and liquidation price caps. Borrowers interact with these pools, set their preferred liquidation price (making sure it is below the pool’s cap), and then derive the amount of USDC they are eligible to borrow based on the collateral.

During the loan term, the borrower can repay the loan early and withdraw ETH. Lenders liquidity is backed by unlent USDC; if all USDC has been lent, they cannot withdraw money early.

Lets take two borrowers A and B as an example:

Borrower A puts forward 10 ETH as collateral and specifies the liquidation price as 1,600 USDC. Based on these criteria, the borrower would be entitled to a loan of 16,000 USDC. The crux of the matter is that if the price of ETH falls to 1,600 USDC, or falls to a lower point at the end of the loan, the 10 ETH he deposited will be forfeited, unless he chooses to settle the loan early.

Borrower B uses a similar procedure, but the specific amounts are different: the borrower chooses 5 ETH as collateral and 1,200 USDC as the liquidation value, which is equivalent to obtaining a loan of 6,000 USDC.

Strategic advantages compared to traditional systems

This agreement gives borrowers more room to set liquidation prices, providing a buffer against hasty liquidations that platforms such as Aave may trigger. On the other hand, lenders can enjoy potential returns higher than deposit rates on traditional platforms such as Aave, especially if the ETH market price is favorable to them.

In-depth comparison

Let us assume that the market price of ETH is 2000 USDC

Use new protocol:

When the borrower obtains 1 ETH and chooses the liquidation price of 1600 USDC, 1200 USDC or 800 USDC

The amount this borrower can lend is 1600, 1200 or 800 USDC respectively.

Using AAVE:

Use 1 ETH as collateral to borrow 1600 USDC, 1200 USDC or 800 USDC.

The system will automatically set the ETH liquidation prices to 1927 USDC, 1445 USDC and 963 USDC respectively. Compared with the liquidation price under the new agreement, these points are significantly higher and may pose greater risks to borrowers.

Evaluate rate of return:

Lido’s stETH annual interest rate is 4.2%. If we then take into account the 70% pool utilization and compare that to AAVE’s USDC deposit rate of 2.1%:

Lenders operating under the new protocol are expected to have actual returns of 4.31%, 5.53% and 7.98% respectively when the above-mentioned liquidation values ​​are 1600 USDC, 1200 USDC and 800 USDC. Obviously, these benefits are more generous than Aaves deposit interest rate.

Overall, this new protocol provides a more flexible and secure environment for borrowers, while also delivering more attractive returns for lenders compared to existing platforms such as AAVE.

Improvement factors that can be considered in the future:

A potential improvement for lenders could be real-time liquidation on top of previously agreed prices during the active loan period. This approach may allow lenders to obtain ETH at a cost-effective price, but it also requires borrowers to keep an eye on the price fluctuations of ETH.


There are some popular lending models in the DeFi field (represented by platforms such as Aave and Compound), which bring some inherent challenges, leading to market volatility and unplanned liquidations. Liquidation-free lending protocols offer a new alternative that is simple and effective. In this model, the borrower deposits ETH, determines the liquidation price by himself, and can recover the collateral as long as the loan is settled before the maturity date. This model provides greater flexibility and potentially higher returns for both borrowers and lenders respectively.

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