On Primex, Lenders deposit their assets into Credit Buckets, which Traders can borrow to amplify their potential gains via margin trading on DEXs.
But where does Lenders' yield interest come from on Primex? Spoiler alert: It is not printed out of thin air but backed directly by margin trading fees.
Let’s see an example scenario to understand how Lenders earn interest and how Primex utilizes liquidity throughout the ecosystem.
Suppose you are a Lender, and you’d like to put your digital assets to work on Primex by lending them out to Traders. So after connecting your wallet, you deposit 1,000 USDC to the Primex USDC Bucket, expecting to earn yield at a 3% interest rate.
Soon after you have supplied liquidity to the Credit Bucket, a Trader borrows 1,000 USDC from the same Bucket at a 5% borrowing rate. By going long (buying) wBTC at a 5x leverage, he makes a decent profit through margin trading.After closing his position, the Trader repays his debt to the Bucket, including the 1,000 USDC he borrowed and the interest.
In an alternative scenario, the Trader’s position becomes unprofitable, with the value of his assets falling below the maintenance margin. As a result, his position poses risks for Lenders. To protect your funds, Keepers automatically liquidate the Trader’s assets, repaying all his debt to the Bucket.
As you can see, Lenders’ yield on Primex is fully backed by Traders’ borrowing fees. In the above example, the Trader borrowed assets from the Bucket at a 5% Borrowing Rate, and you, the Lender, received interest payments at a 3% Interest Rate. The difference in rates is caused by the reserve fee and potential liquidity underutilization.
When liquidity is not utilized fully on Primex (or on any other DeFi protocols that offer lending and borrowing), Lenders earn less interest on the funds they supply to Credit Buckets. For example, suppose Traders only borrow 500,000 USDC out of a Bucket with 1 million USDC. As liquidity utilization becomes only 50%, Lenders only earn half the Interest Rate (e.g., 5%) of the Borrowing Rate Traders pay (e.g., 10%).
For a deep dive into the topic, kindly refer to our blog post article Primex Basics: Explaining Liquidity Utilization and the Source of Lending Interest and the Lenders' interest and Traders' fees section of the Yellow Paper.