Pricing Loans

How fair loan terms are determined for ZLLs on MYSO

ZLLs can essentially be seen as a swap in which a collateral token is swapped for a combination of a loan token amount and a call option on the collateral token. In this swap, a lender sells a call option to the borrower that accepts their given loan quote which gives the borrower the right, but not the obligation, to reclaim their collateral prior to some expiry date.

We can then price the embedded call option leg to derive a fair APR.

Since the lender is implicitly selling a simple option, borrowers do not have to deal with the complexities of option knock-out levels (liquidation thresholds) found on conventional lending protocols. However, there now exists a risk that the value of the pledged collateral becomes less than that of the loaned amount and borrowers might choose to then not repay the loan prior to expiry.

If this situation occurs, the lender bears the downside risk and ends up retaining the borrower’s pledged collateral. To make things fair for both sides, the lender should be compensated for this in the form of an adequate, risk-adjusted yield.

We can thus figure out the payoffs and subsequent fair APRs for any counterparty taking on a Zero-Liquidation Loan based on the parameters of the loan and the chosen pricing model (typically Black-Scholes) used to price the embedded call option. To learn more about loan pricing on MYSO and figuring out fair APRs, check out this video guide we've put together: