The project aims to:
Explore the optimal design of decentralized lending/borrowing protocols on blockchain
Identify and address the financial issues associated with implementing such protocols

In traditional finance, lending/borrowing markets are among the largest markets in the world in terms of total outstanding amounts. Recent developments in the decentralized finance industry (or DeFi) suggest that lending/borrowing markets on blockchain could also become very large in the coming years.

DeFi refers to a set of decentralized and autonomous protocols, built on blockchain infrastructure, that replicate the functions of traditional finance while also enabling new developments by leveraging the underlying blockchain properties. Alongside decentralized exchange protocols (DEX), lending protocols are the two most widely used types of DeFi protocols today.

The idea behind most current lending protocols is to create a liquidity pool in which:
— Liquidity providers can deposit crypto-assets in the form of tokens,
— Liquidity borrowers can borrow the tokens deposited by liquidity providers in exchange for collateral in the form of other crypto-assets (positions are generally over-collateralized).

The borrowing rate, usually variable (though fixed rates are possible), is calculated to maintain an optimal utilization level of the liquidity deposited by liquidity providers, with different parameters depending on the risk of the underlying assets. The revenues generated by the liquidity pool are then shared among liquidity providers in the form of a variable rate.

In principle, the protocol allows liquidity providers and borrowers to borrow/lend/repay/withdraw their liquidity at any time. Liquidity is generally ensured through a mechanism that liquidates positions whose collateralization ratio falls below a certain threshold.

This brief description of lending protocols corresponds to protocols such as Aave or Compound, which belong to the first generation of lending protocols. But these protocols suffer from a number of limitations. First, since resources are pooled together, liquidity providers share the revenues generated by liquidity borrowers, creating a spread between the borrowing rate and the lending rate that depends on the level of liquidity utilization. This spread may appear inefficient, as it does not correspond to transaction fees captured by an intermediary but instead results from the fundamental idea of gathering all lenders and borrowers of a given market into a single pool. Second, lenders cannot choose which type of collateral will be used to borrow their crypto-assets. Typically, the types of collateral accepted by liquidity pools are defined at the protocol governance level, leaving lenders exposed to the collateral risk chosen by borrowers.

The purpose of this research program is to continue exploring the limitations of existing protocols, beyond those already identified, to investigate the possibilities for optimal design of lending/borrowing protocols, and to address the concrete issues and challenges arising in the context of these explorations.

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