When exploring yield opportunities, recognition of the unique risks and rewards involved is a strong starting point. In the world of DeFi, where the majority of users are solely responsible for the custody and deployment of their funds, it’s vital for protocols to provide a transparent and accurate assessment of the risks undertaken by users. In that spirit, this article will expand on the risk assessment given in Sturdy’s documentation, as well as compare the tradeoffs between Sturdy and other prominent DeFi lending platforms. Read on to see exactly why Sturdy yields are being recognized as one of the top risk/reward opportunities available.
The Core Difference between Sturdy and Other Lending Platforms
To set up this discussion of risks and rewards, let’s review what sets Sturdy apart from a typical DeFi lending platform. Most DeFi lending platforms function as a marketplace, aggregating liquidity from lenders into a pool that borrowers can access by depositing collateral to secure a loan.
On most major platforms, interest rates are algorithmically assessed for borrowers based on the utilization level of the pool. This interest becomes the yield earned by lenders, so when utilization is high, they earn more yield, and borrowing gets more expensive. This mechanism certainly works, as proven by the success of protocols like Aave and Compound, but it puts lenders and borrowers in an adversarial position. Lenders rely on borrower demand to generate suitable levels of yield, but higher interest rates are unattractive to borrowers. There is a limited amount of upside between the two parties, and when one is winning, the other is losing.
Sturdy’s innovation is aligning both sides’ incentives in a system where lenders and borrowers can both benefit simultaneously. This works by shifting the lenders’ yield source from interest to a share of yield farming earnings generated off of borrower’s collateral. Lenders still supply their assets to pools similar to other platforms, but borrowers’ deposits are deployed to whitelisted staking protocols such as Lido and Convex on Ethereum, and Yearn on Fantom. Since the yield earned in these protocols gets partially paid to lenders, the borrowers are able to take out interest-free loans, and lenders get higher yields that aren’t subject to the limitations of algorithmic interest rates.
Risks of Any DeFi Lending Platform
Before getting into the risk/reward differences between Sturdy and other platforms, let’s look at the risks that are present across the board. Since all on-chain lending platforms operate on smart contracts, depositing incurs a risk typical to any sort of on-chain interaction, Smart Contract Risk. If the protocol’s code has any bugs, or is otherwise exploited, then deposited funds are at risk. Since code is written by humans, there’s no way to entirely eliminate Smart Contract risk. Sturdy has worked to mitigate the chances of any exploits through multiple audits, as well as a $100,000 bug bounty program.
Unique Risks and Mitigation
Since Sturdy also integrates several other protocols into its structure via farming and collateral staking strategies, there are third-party Smart Contract Risks to consider. With this in mind, Sturdy thoroughly vets each protocol, currently incorporating trusted and tested platforms such as Convex, Yearn, and Lido.
Beyond Smart Contract Risk, Liquidation Risk is the other main consideration when it comes to lending protocols. Sturdy takes a unique approach here, as borrowers’ collateral is not lent out to other users, rather it is staked with protocols like Convex and Lido to earn yield. This is different from most lending protocols where collateral gets loaned out to other users. While Sturdy borrowers can still be liquidated if the health factor of their position declines below 1, the fact that collateral is not loaned out has benefits when it comes to protocol solvency when large price moves occur.
Consider this scenario with a traditional DeFi lending platform:
A volatile asset like ETH is widely borrowed with stablecoin collateral, and ETH price melts up causing loan health to drop below liquidation levels. It may be the case that there is not sufficient stablecoin collateral left in the protocol to liquidate, as that collateral is being loaned out to other users.
Alternatively, on Sturdy, collateral is easily retrievable from protocols used for staking, ensuring solvency in this type of scenario. Additionally, the yield earned off of this collateral is partially paid out to lenders in lieu of interest payments, a positive for both lenders and borrowers.
Summing up the risks, Sturdy is generally similar to other prominent lending protocols, as smart contract risk and liquidation risk are both present for users. While the incorporation of third-party smart contracts is another factor to consider, each integration has passed through extensive review and is widely trusted among the DeFi community. Sturdy also mitigates insolvency risk by not lending out collateral funds, instead opting to stake them in Convex and Lido for smooth retrieval during liquidations.
With Risk Comes Reward
Now for the other side of the equation, reward. Given Sturdy’s innovative approach to lending and borrowing, the yield for both parties is consistently above what can be found on the most prominent platforms like Aave and Compound.
Removing the constraints put in place by algorithmic interest rates allows both lenders and borrowers on Sturdy to enjoy above-average yields, changing the lending market dynamic from PvP to a win-win result. Interest rates aren’t entirely absent from Sturdy, though. When a given asset’s utilization rate eclipses 80%, interest kicks in for borrowers. This boosts lending yield significantly, incentivizing more liquidity into the protocol and ultimately balancing utilization back to a more sustainable rate.
For borrowers, the rewards are dependent on which farming strategies are utilized and the amount of leverage they apply. The levels of complexity and/or degeneracy a borrower wishes to employ when farming are completely up to their discretion, as long as a healthy collateral ratio is maintained. These ratios and corresponding liquidation penalties vary by asset and can all be found within our docs. No matter your level of yield farming expertise or what strategy youchoose to employ, the zero-fee borrowing Sturdy offers makes the borrowing experience second to none.
You can check out all the lending and borrowing options for yourself in the app, and take a look at key metrics such as historical yields over on our new Dune dashboard! Don’t forget to join us over on Discord to chat with the community about risk management practices, yield strategies, and any other questions you may have.
