The second iteration of DeFi lending markets can be characterized simply as modular lending markets with externalized risk management. Modularity is beneficial for creating flexible market structures while externalizing risk management provides scalability and security to lenders. Lending protocols must adopt a modular architecture to be flexible enough to address new metas (asset types, collateral types) while not compromising the overall security and solvency of the base protocol. That being said, as modularity becomes commoditized, the Sentiment team is taking several initiatives to differentiate the modular lending architecture for users.

DeFi lending market success has been predicated on 2 key aspects

1. Scalable collateral assets

2. Scalable borrowing activity

Take Aave and Compound as a simple example, in DeFi summer 2020, Aave and Compound scaled to 10B+ TVL, mainly due to the demand for borrowing stablecoins against ETH and wBTC. Users borrowed Stablecoins against these assets to farm DeFi pools for the yield delivered by inflationary tokens. This solidified both protocols as dominant lending markets since they identified; ETH and wBTC as scalable collateral assets while “DeFi yield farms” became the scalable borrowing activity.

For Sentiment, we plan to focus on yield-bearing assets as the scalable collateral assets with leveraged yield being the scalable borrowing activity. The specific types of yield we believe are scalable are:

• Market-Making activities → Providing liquidity to perp and spot dexes

• Carry Trades → borrowing capital cheaply and deploying it for a large spread on rates

• Leveraged yield → Leveraging into yield products such as Pendle, Ethena, and vault products

• Bespoke Yield Strategies → Sentiment’s flexible infrastructure facilitates building strategies that can’t be done with current markets such as delta-neutral Market Making and Basis rate arbitrage

We plan to make big bets in these categories and dominate them as they develop into large-scale strategies.

An implicit function of modular lending markets is externalized risk management. While this is an incredibly attractive offering for Lenders, for the base protocol this creates a competitive dynamic for defensibility namely:

1. Incentives for attracting and retaining risk managers

2. A moat around bespoke risk management

3. Dependency on 3rd party actors without significant lock-in

In short, all lending protocols will rely on risk managers, but ultimately risk managers will focus on markets with the largest incentives and scalability. Additionally, risk managers could set up markets and abandon them if there are better incentives elsewhere, in this case, lenders lose out. For Sentiment, we plan to attract and retain risk managers via 2 mechanisms

1. Oracle Extractable Value → Capturing liquidation fees and passing them to Risk managers and lenders

2. Being Borrower Centric → Focusing on strong and scalable borrowing strategies and assets that will produce high-interest income

The only way to ensure defensibility concerning risk managers is to have incentive mechanisms that align them long-term. Since risk managers are compensated via fees; high-interest fees and redistribution of liquidation fees, are competitive ways to instill risk manager lock-in.

For lending to go down the permissionless path, different considerations must be taken as compared to spot DEXes. Lending requires 2 things that DEXes do not

1. Risk Management

2. Brand equity

To create a lending market at scale you must consider risk management at a local and global scale, and you have to build brand equity by consistently delivering quality risk-adjusted returns. Due to these factors, a purely hands-off approach to lending markets will be insufficient. If a market blows up on a protocol, lenders will blame the protocol, not the market itself. Sentiment plans to build brand equity by prioritizing security. Internally, Security is the “North Star” that is optimized for, everything else is secondary.

Modularity is a means to maintain flexibility, but if everyone has it, you must iterate on another modality. Sentiment v2 is a bespoke lending market with a core focus on Security. Users will be able to identify the Sentiment protocol via our focus on:

• Incentive mechanisms

• Liquidity base

• Hyperfocus on niche ecosystems and assets that can get REALLY big

We care the most about giving the borrowers the best and most efficient access to capital and giving lenders the best risk-adjusted yields.