We have presented in previous posts its advantages. To mention a few, it provides lenders with interest rate-bearing limit orders and borrowers with stop-loss and take profit orders. It reduces liquidation penalties and enables high leverage. In addition to these benefits, the protocol is natively protected against the risks of bad debt and can operate with minimal governance. In this post, we explain in more detail the operation of lending.

The diagram presents the double queue organization of a central limit order book to which a lending functionality is attached.

On the left-hand side, lenders place buy orders at the limit price they deem appropriate. Borrowers can borrow the assets deposited in the buy orders in exchange for an interest rate. Rectangles' height indicate the amount of assets lenders have deposited in the different pools of orders. The orange rectangles represent the assets which are borrowable from the pool of buy orders. On the right-hand side, borrowers place their collateral as sell orders.

To concentrate liquidity, lenders are permitted to deposit assets within a restricted set of limit prices. A pool of limit orders groups all assets deposited at the same limit price. Allowing users to deposit and borrow from the pools, rather than from individual orders enables capital efficiency and scalability. Lenders can withdraw their orders whenever they wish, unless the pool is fully borrowed, in which case the interest rate will be high.

Example

Let's illustrate how a lending operation works in the simplest scenario of two actors and two orders. Market price is 3100.

Alice posts a buy order of 9000 USDC at limit price 3000. This order is placed in Pool₃₀₀₀. Its capital is added to the liquidity provided by all other buy orders posted at the same limit price.

Bob is willing to borrow USDC from the Pool₃₀₀₀. He deposits 2 ETH in sell order at limit price 3300 in the Pool₃₃₀₀ or any other pool of orders with a limit price greater than market price. With the collateral, Bob can borrow from the Pool₃₀₀₀ up to 6000 USDC (=2✕3000).

What happens if the price decreases below 3000?

A taker swaps some of the non-borrowed USDC from Pool₃₀₀₀ which triggers the liquidation of the borrowing positions from Pool₃₀₀₀ including Bob’s position. Bob keeps the borrowed USDC and his 2 ETH of collateral are transferred to the lenders of the Pool₃₀₀₀. Alice’s buy order is filled and Alice receives 3 ETH from takers and/or borrowers.

Nothing changes for Alice compared to a classical buy order. Importantly, Bob's assets are not sold in the market but directly transferred to lenders in Pool₃₀₀₀ who are repaid with the collateral. This way, the protocol ensures that any position borrowing from a pool of orders can be liquidated when remaining assets in the pool are taken. The alignment of the two events, the liquidation of Bob and the filling of Alice’s order, greatly streamlines the settlement process for all parties.

Now what happens if, instead, the price increases to 3300?

Bob's limit order, with 2 ETH serving as collateral, is filled. His borrowing position is automatically closed out, as illustrated in the next diagram.

Why does the filling of borrowers’ sell orders trigger the repayment of their debt?

For three reasons. First, closing the borrowing position guarantees that the type of assets serving as collateral always matches the type needed in case of liquidation. Second, by posting collateral at a limit price of their choice, borrowers expect the price to fall back after crossing the limit price. Given these expectations, there is no reason to maintain a long position in this scenario. Third, borrowers have the option to program the closing of their long in advance based on a price scenario. This way, they know from the start the price at which their position will be liquidated if the price decreases or closed for a profit if the price increases.

This post is part of a series aimed at explaining the various aspects of the protocol. Make sure to follow our X account and join the Discord for updates!

If you want to learn more about LendBook, check out the white paper or the documentation!

CLOBs, despite their transparency and flexibility rely on high volume to narrow the bid-ask spread, limit price slippage and provide continuous pricing. However, none of those limitations really matter for CLOBs used as lending pools and liquidation engine. The large bid-ask spread for instance becomes a feature, not a flaw.

In this context, could CLOBs make a resounding comeback as a better on-chain base layer for lending?

We believe so and this is why we are building LendBook, the first CLOB-based lending protocol (see post for an introduction). To explain the advantages of CLOB-based lending compared to AMM-based lending and maybe dissipate a few misconceptions about CLOBs, let’s answer a number of important questions.

1/ In AMMs, LP soft liquidate borrowers by continuously buying the collateral when its price is decreasing. What about CLOBs?

A similar mechanism exists in CLOBs: makers (those who place limit orders), by posting buy orders at the limit price of their choice, buy borrowers’ collateral when the price crosses the limit price. This unlocks unparalleled benefits for lenders and borrowers:

• high loan-to-value (up to 98% for correlated assets)

• high leverage (more than 20x)

• low liquidation fees (starting at 1% for pegged assets and 4% for volatile asset pairs)

• no risk of bad debt

• no need for off-chain risk management

and other CLOB-specific advantages that AMMs cannot reproduce:

• borrowing programmability (borrowers decide at which price their positions are liquidated if the price decrease, or closed for a profit if it increases)

• lending programmability (lenders choose at which price they accept to buy the collateral and at which price they are willing to sell the collateral and repost the received assets on the lending side)

• liquidation fees: earned by lenders (not bots)

• leveraged limit orders (makers can leverage their bet that the price will bounce back starting from a chosen limit price).

2/ AMMs are peer-to-pool markets, contrary to CLOBs which are peer-to-peer. How a lending protocol built on a CLOBs can scale?

The CLOB on which LendBook is built is also peer-to-pool. This is a major innovation which avoids liquidity fragmentation. In practice, users deposit and borrow in a few pools of orders which limit prices are spaced so that two or three pools are active at the same time. For instance, limit prices for volatile pairs like ETH/USDC is spaced by a multiplicative step of 10%. For a market price of 2300 and a pool of buy orders at 2200, lending and borrowing are enabled at limit prices 2200, 2200/1.1 = 2000, 2000/1.1 = 1818 and so on.

3/ Liquidity providers (LP) make losses if the price diverge but their losses are transitory (impermanent) if it returns to its initial value. What about makers in CLOBs?

Makers also take the risk of losses, similar to what LP experience, when the price diverges (called inventory risk) but, contrary to LP, they profit when the price returns to its initial state. Let’s illustrate by an example. Price is 2300. Makers place a buy order at a limit price of 2000. If the price falls below this limit and bounces back to 2300, LPs wipe out their losses entirely while makers earn a positive return rate proportional to the price spread, which in the example is 2300/2000 – 1 = 15%. Makers in LendBook are the counter-party to much less transactions than LP in AMMs due to the spacing of authorized limit prices, but they earn an order of magnitude more every time they buy at low price and sell at a higher price.

4/ LPs expect to compensate IL by earning trading fees, what about makers in CLOB?

As shown in the previous illustration, makers are compensated for inventory risk by betting on price volatility, as do LP. They can automate their buy-the-bottom/sell-the-top strategy by reposting filled limit orders on the other side of the order book, similar to what market makers do in CLOBs. LendBook offers lenders and borrowers this possibility by automatically replacing filled orders at the limit price of their choice. Lenders compensate inventory risk by earning the price spread, akin to trade fees in AMMs, liquidation fees and a lending interest rate.

5/ In Uniswap V3-type AMMs as well as in most AMM-based lending, LPs can manage their risk by choosing a price range over which they offer liquidity. What about makers in CLOBs?

Makers benefit from the superior flexibility offered by order books. They not only choose the limit prices at which they are willing to exchange, but they also choose how much they accept to trade for every limit price at which they lend. They can withdraw their liquidity before the price crosses the limit price, unless the pool is fully utilized, in which case they earn a compensating interest rate close to 100%, similar to what Aave’s lenders earn in the same scenario.

This post is part of a series aimed at explaining the various aspects of the protocol. Make sure to follow our X account and join the Discord for updates!

If you want to learn more about LendBook, check out the white paper or the documentation!

Let's delve into a simple example in which Alice deposits a buy order.

The ETH market price is 2600. Alice holds part of her wealth in stablecoins, anticipating that the ETH price may fall below 2500. However, since ETH is a top-tier asset in the long term, she is confident that the price will eventually rise well above 2500. To back up her confidence with action, she deposits 25,000 USDC in a buy order at a limit price of 2500. As the price falls below 2500, a trader fills Alice’s order. She receives 25,000 / 2500 = 10 ETH against her USDC. She’s now prepared for the price to bounce back.

The remarkable thing about limit orders is that one can append a lending functionality to them at no extra cost.

Bob is interested in borrowing USDC from Alice's buy order. He deposits 8 ETH as collateral in a sell order at a limit price of 2700 (or any price above the market price of 2600). He borrows 8 x 2500 = 20,000 USDC from Alice. As the price falls below 2500, a trader fills Alice's order for 5000 USDC (the non-borrowed assets of Alice's order), triggering the liquidation of Bob's position. Alice receives 5000/2500 = 2 ETH from the trader and 8 ETH from Bob's collateral.

Nothing has changed for Alice in comparison to the first scenario, except she now earns an interest rate. The result is a new type of lending facility based on a streamlined liquidation process.

Improving capital efficiency and addressing a market gap

Adding a lending functionality to an order book enhances capital efficiency and provides a superior solution for the two parties.

Alice benefits from a buy order with unchanged characteristics and earns an interest rate (and, though not illustrated in the example, potential liquidation fees) on top. Meanwhile, Bob enjoys a high loan-to-value (LTV) ratio: he can borrow 20,000 USDC by setting aside 8 ETH as collateral, which, at market price, is worth 8 * 2600 = 20,800 USDC. His LTV is 20,000/20,800 = 96%, which is significantly higher than what other lending protocols offer.

LendBook, by enabling assets deposited in an order book to be borrowed, fills a market gap.

Alice, by placing a buy order, is betting that the market price will initially fall below 2500 before eventually bouncing back. Conversely, Bob expects the price to rise without dipping below 2500 first. He borrows USDC from Alice and sells them for more ETH. He's willing to take the risk of being liquidated at 2500 if Alice's prediction proves correct.

Until now, Alice and Bob could not trade on opposite expectations: Alice place orders in an order book whereas Bob borrows in a lending protocol. LendBook is the first protocol where Alice and Bob can meet and take those opposite bets. In traditional lending protocols without limit orders, Alice, by holding USDC, would merely bet that the price can only go down.

This post is part of a series aimed at explaining the various aspects of the protocol. Make sure to follow our X account and join the Discord for updates!

If you want to learn more about LendBook, check out the white paper or the documentation!

Place limit orders, earn

LendBook rethinks lending and borrowing from the ground up by enabling users to lend and borrow assets in limit orders. Order books are long recognized to be an efficient design for trading assets in financial markets. They turn out to be also a great base layer to build a lending protocol. Lenders deposit quote assets in buy orders. Borrowers deposit collateral assets in sell orders and borrow quote assets. Borrowings are liquidated at the same price as the limit orders are filled. The alignment of the two events streamlines the settlement process for all parties and represents a fundamental shift in how lending and borrowing are approached.

A simple example:

Let’s illustrate with a USDC/ETH market and a current price of 2100. Alice wants to lend USDC. She first decides the limit price at which her USDC may be filled. Perhaps she plans to exchange her assets against ETH at 2000. Or she expects to buy the bottom at 1800, or prefers to keep her USDC and set a very conservative price of 1650.

Bob wants to borrow USDC. He first deposits ETH in a sell order at e.g. 2300. He can then borrow USDC at the limit price of his choice which is also the price at which he will be liquidated. The closer the limit price to the current price, the higher his maximum loan-to-value (LTV). If he borrows from limit orders at 2000 his maximum LTV is 93%. If the price crosses 2000, Bob’s collateral is transferred to lenders at this price. If instead he borrows USDC from lenders at 1800, his maximum LTV will be 84% and his probability of liquidation will be lower.

Conversely, if the price increases and Bob’s sell order is filled at 2300, the USDC he receives are used to pay back his debt first and only the difference is sent to him.

What differences does it make?

It makes a huge difference compared to existing lending protocols.

First of all, there is no need to incentivize liquidation bots or to rely on a deeply liquid external AMM to sell the collateral back. There is no concept of bad debt that might need to be absorbed by a DAO treasury / insurance fund or socialized across lenders. There is also no need to pay expensive third-party risk agencies to oversee hundreds of risk parameters and a DAO to vote every week on technical proposals that most users do not understand. This is a big improvement over existing designs and opens a credible path to full decentralization.

Second, the numerous borrowing limitations enforced by lending protocols to protect against the risk of bad debt can be lifted. This includes the removal of lending or borrowing caps, the reduction of liquidation costs to as low as 1%. Maximum LTV can be as high as 98% and leverage up to 50.

Third, debt management of borrowers’ positions is now simple and transparent. Well specified stop price exists at which positions are closed at a loss (the limit price from which the position borrows) and for a profit (the limit price at which collateral is placed). Liquidations can be executed gradually across multiple limit prices, and similarly, take profit prices can be diversified by placing collateral at various limit prices.

As for lenders, aside from earning an interest rate, they can easily rebalance their portfolio following price movements, implement buy-low/sell-high strategies and earn liquidation costs in case of conversion.

Lendbook is the first product built by Breaking Labs.  If you want to learn more about it, check out our white paper.

Make sure to follow our X account and join our telegram group for updates!