DeFi lending markets face a significant unspoken issue often hinted at by the question: "Where does the yield come from?" This question seeks to uncover whether DeFi lending can deliver scalable and sustainable yield without relying on incentives. It's easy to inflate yields with short-term incentives, but providing sustainable yield at scale without taking on massive risks (e.g., Luna/Terra) is far more challenging. The solution is straightforward: Focus obsessively on the borrower.
As Sentiment v2 prepares for launch, it's useful to explore what makes Sentiment appealing and how the team envisions the product beyond its basic protocol.
Obsessing Over the Borrower
Most lending markets today prioritize lender safety and risk monitoring. While this is critical for attracting capital, as the market becomes more competitive, security alone won't be enough to retain and expand capital. Capital retention and expansion require scalable, risk-adjusted yields independent of incentives. To achieve this, lending markets must focus on borrowers' needs and behaviors, as they are the core customers. Borrowers drive demand and set prices in lending markets, not lenders, making it essential to address borrowers’ needs. Ignoring this risks creating an imbalance where there's abundant supply but little demand. This supply-demand imbalance is one of the primary challenges facing most incumbent DeFi protocols today.
Modularity allows newer markets to better address borrowers' needs over time.
Operating Like a Credit Fund
Sentiment v2 can easily function like a skeuomorphic credit fund, and we encourage this approach for two reasons:
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Flexibility in Borrowing Initiatives: The Sentiment team can explore high-potential borrowing initiatives without introducing excessive system risk.
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Responsive External Risk Managers: External risk managers can quickly respond to market demands without cumbersome governance processes.
Credit funds add value to economies by taking underutilized assets and allocating them to initiatives where they can drive productive growth. Sentiment will perform a similar role for the on-chain economy.
A modular lending system offers many benefits, the most significant being its ability to list collateral assets seamlessly, allowing borrowers to access liquidity efficiently. The key advantage of Sentiment v2 over other lending markets is that borrowers are not limited to overcollateralized loans. The Sentiment Position Manager enables a range of expressive borrowing activities, creating an “on-chain credit card” experience. To truly be borrower-centric, the core protocol must provide the flexibility for borrowers to pursue actions beyond basic leverage. In time, we anticipate that even entire chains and apps will become significant borrowers on Sentiment, using our liquidity to fuel their own on-chain economies.
Scaling the On-Chain Economy
While passive lenders are vital to DeFi, the real force driving growth in the on-chain economy will be borrowers. In any local or global economy, credit growth—whether through mortgages, car loans, or education financing—is a key indicator of development. The same holds true for crypto, where liquidity is the metric we are all optimizing for. A lending market that wants to maintain and grow liquidity must always stay ahead of borrower demand.
Sentiment’s initial focus will be on supporting market-making activities, which currently demand the most liquidity in DeFi. In the medium term, it's reasonable to expect that borrowers will shift from individual DeFi users to protocols, DAOs and chains themselves, borrowing capital to stimulate their on-chain economies. The ultimate goal is to blur the lines between the on-chain and real-world economies.
Borrowers Are All You Need
A borrower-centric philosophy focuses on serving the “buyers” of liquidity. By maintaining close relationships with borrowers, a lending protocol can always provide an answer to the question, "Where does the yield come from?" With a modular stack, a sharp focus on borrowers, and a flexible architecture that enables on-chain capital growth, Sentiment, with the support of its borrowers, will help expand the on-chain economy.