The smooth flow of capital between borrowers and lenders is a key aspect of a vibrant economy. Anyone with additional assets can borrow them to use their spare capital, while people who need them to grow their business or cover operating expenses can easily access them.

- Advertisement -

Money markets are platforms where borrowers and lenders can meet. Throughout history, money markets have been generators of economic activity. Although the structure of money markets has changed over time, their role has remained unchanged.

How does the money market work?

- Advertisement -

Traditionally, money markets have been centralized structures that facilitate transactions between lenders and borrowers. Borrowers will turn to the money markets to obtain short-term credit (up to a year) that can be secured. If borrowers cannot repay their loans, lenders can sell collateral to repay the borrowed funds. When the loan is repaid, the deposit is returned.

- Advertisement -

Borrowers are required to pay interest to lenders (for providing them with working capital) and money market fees (for facilitating the transaction). The interest rate provides adequate liquidity for borrowers as well as lenders. The fee paid to the money market helps them cover their operating expenses.

However, there is a problem with the centralized structure. It simply puts too much power and influence over user tools in the hands of one organization, which can arbitrarily change the terms for other stakeholders. Worse, they may even siphon funds from their guardianship income. The decentralized structure provides a robust alternative to centralized money markets.

What is a decentralized money market?

A decentralized money market running on top of a blockchain is a self-propelled structure driven by a smart contract, software. Once a smart contract is running, it cannot be tampered with, making it free from human bias.

Driven by a global community of stakeholders through a highly decentralized network of nodes, the market eliminates any role of intermediaries. In popular jargon, the money market belongs to the realm of decentralized finance (DeFi).

The DeFi stack: stablecoins, exchanges, synthetics, money markets and insurance

Let’s understand the functioning of the decentralized money market with an example. Fringe Finance ($FRIN) is a decentralized money market that opens dormant capital in cryptocurrency assets of all levels through the issuance of secured loans. The platform facilitates decentralized lending and borrowing. Fringe Finance is the main lending platform where anyone can lend additional funds and earn interest or provide altcoin collateral to take out a stablecoin loan.

As mentioned, decentralized financial lenders and borrowers operate through on-chain software code controlled by decentralized nodes, thereby ending one person’s monopoly of control and reducing points of failure. Here are a few benefits that decentralized money markets bring:

without permission

In a decentralized environment, users do not need to ask permission from a central authority before engaging in any money market activity. Any online user can freely receive interest on their capital and / or borrow funds for their needs. Decentralized protocols have an internal censorship-resistant structure.

non-custodial

In centralized money markets, user funds are in the care of a central gatekeeper. However, DeFi protocols such as money markets do not involve custody, and funds are under the direct control of borrowers and lenders. On-chain smart contracts running on predefined logic ensure that funds cannot be compromised as long as users have full control over them.

overwealthy

Centralized financial markets typically functioned under underfunded and fractional reserve conditions. These markets, under peer pressure to get more business, allow borrowers to withdraw more funds than they put in as collateral. Decentralized money markets follow over-collateralization, ensuring system stability. The smart contract simply liquidates the collateral of borrowers who cannot repay their debts.

Composability

Composability is a design principle that allows the components of a system to interact with each other. Various applications and protocols can interact seamlessly without permission. DeFi applications can be composed to create a blank canvas with endless possibilities for new mechanisms such as yield extraction and complex derivatives.

How the coming decentralized money markets are entering uncharted territory

In the early days of DeFi, money market protocols leaned in favor of more established cryptocurrencies with large market caps and high liquidity. However, the upcoming money markets want to try out new models. Fringe Finance, for example, focuses on altcoins with smaller market caps and lower liquidity. Most DeFi money market protocols do not support altcoins, and this is where Fringe Finance comes to the rescue.

What is an altcoin? A Beginner’s Guide to Cryptocurrencies Beyond Bitcoin

Since altcoins are a niche use case, they tend to be more speculative than large-cap digital coins. However, since few decentralized financial lenders and borrowers serviced such altcoins, the capital locked up in them remained untapped. Regardless, Fringe Finance has changed that scenario. Keep in mind that altcoins are inherently more volatile, which entails some associated stability risks that potential gains can offset.

How does the altcoin money market maintain financial stability?

To neutralize the volatility of altcoins, the money market protocol uses a variety of borrowing parameters and related mechanisms. Let’s continue with the Fringe Finance example to better understand it. Options applied by Fringe Finance includes platform-wide maximum credit for each collateral asset and automatic calculation of LVR (Loan to Value Ratio). For adequate implementation of these mechanisms, the system takes into account the available liquidity of the asset, historical volatility and other non-subjective indicators.

The platform offers a sustainable economic incentive model for all participants such as lenders, borrowers, altcoin projects, stablecoin holders, stakers and liquidators. For example, it is implementing liquidator incentives to help stabilize the platform, such as allowing native $FRIN token holders to stake on the coins to earn commission rewards. To expand its operating base, the DeFi money market could include cross-chain collateral, NFT-backed lending, fixed-rate loans, embedded insurance, and a decentralized user interface as the platform grows.

The Future of Decentralized Money Markets

With people becoming wary of self-serving bias in centralized money markets, DeFi protocols provided them with a profitable option. The latter usually grants governance rights to anyone who owns native coins and represents a blockchain-based ecosystem in its true decentralized spirit.

Similar to money markets, which used to be focused on popular cryptocurrency projects with significant market caps, new projects are now focused on altcoins. unlocking the value stored there. Going forward, future DeFi money market protocols can be expected to explore previously untouched territories.