Risks
Overview of risks for borrowers/LPs using MYSO v1
Risks for LPs
Collateral price risk: LPs are exposed to collateral price risk, i.e., if during the lifetime of a loan the associated pledged collateral becomes worth less than the owed repayment amount, a borrower will not have to repay and LPs will not earn the repayment amount but instead receive the depreciated collateral asset. Moreover, when a LP adds liquidity to a pool, it may happen that during the liquidity provisioning time the collateral price falls below the
maxLoanPerCollUnpredictability of yield: the yield a LP can earn by adding liquidity to a pool cannot be known in advance. This is because, depending on how the collateral price changes, borrowers will repay or not, either yielding the repayment amount or the depreciated collateral. Secondly, the effective interest rate at which loans are given to borrowers is dynamic and changes depending on liquidity supply and demand - though, there is a lower bound rate r2 that defines the guaranteed lower bound at which LP's capital is lent to borrowers
Pool dilution: if other LPs add liquidity into a pool, previous LPs get diluted. This means that older LPs will fund new incoming loans at a lower pro-rata share, and, as a result, will also only be entitled to a lower pro-rata share of the associated loan proceeds. In case of large liquidity injections, dilution can be significant and potentially even cause claimable amounts to become negligible and prone to truncation errors.
Minimum liquidity provisioning period: LPs must wait for a minimum liquidity provisioning period of 120 seconds before they can remove liquidity. During this time their capital is locked up.
Overhead and costs of claiming: The process of claiming can come along with significant transaction overhead and gas costs, especially if the LP is trying to claim proceeds from a larger number of loans. While the aggregation mechanism can help make claiming more efficient, it cannot be guaranteed that the LP will be able to take advantage of the full aggregation benefits. This is because the eligibility to claim from buckets depends on the time that the LP added liquidity. Some claiming functions might allow LPs to overwrite certain claiming settings, which can lead to an irrevocable loss of entitled loan proceeds. Hence, LPs should call claiming related functions with great caution, especially when doing this programmatically or directly through Etherscan.
Non-transferability of LP position: in MYSO v1, LP positions are non-fungible and nontransferable, meaning that the only way to recoup a liquidity contribution is by removing any unused liquidity and claiming from all entitled loan proceeds. In particular, there’s no secondary market through which a LP could convert their LP position into cash.
Opportunity costs: if a LP adds liquidity into a pool it cannot be known in advance when the next borrower will arrive and when the LP’s liquidity contribution can be utilized to fund the next loan. Hence, LPs can incur opportunity costs when there’s little borrower activity in the pool. Moreover, once a loan has been settled, the corresponding loan proceeds aren’t automatically reinvested but instead the LP needs to first actively claim them and reinvest if desired. Hence, unclaimed loan proceeds may sit idle in the pool and cause opportunity costs for LPs.
Risks for borrowers
Fixed repayment amounts: when a borrower takes out a ZLL, they lock in a fixed repayment amount. This means that if the pool’s borrow rates fall afterwards, the borrower will still have to pay the previously locked-in repayment amount. Moreover, borrowers should be aware that early repayment doesn’t lead to a lower APR, i.e., the repayment amount is constant and independent of how long the borrow position was open.
Opportunity costs: when a borrower pledges collateral into a pool, any associated rewards aren’t automatically harvested for them (e.g., airdrops or the like).
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