Interest Protocol

Interest Protocol is a borrow/lend protocol that is highly capital-efficient thanks to its unique combination of fractional reserves and over-collateralization. Depositors may mint USDi, which is a stablecoin pegged 1-1 with USDC that automatically pays interest to holders via rebasing.

What are the main pieces?

Every lending protocol has four key components:

1. Users depositing capital
2. Users posting collateral & borrowing capital
3. Maintaining the peg with an interest rate system.
4. Preventing a depeg with a liquidation system.

Interest Protocol improves upon each component to create an efficent and decentralized credit market.

• Depositors can deposit capital (USDC) and receive a liquidity provider (LP) token (USDi) representing their loan to the protocol. USDi is a stablecoin that is redeemable one-to-one for the reserve asset (USDC). While holding USDi, interest automatically accrues to the holder through a positive rebasing system. This innovation eliminates the depositor's need to stake capital and sacrifice liquidity.

• Borrowers can post collateral assets after opening a vault. Each borrower has their own vault to deposit their collateral in. The collateral is used to cross-margin the user and increase their borrowing power. When a vault holds governance tokens as collateral, the vault owner can delegate the votes to another wallet. This allows the borrower to continue participating in protocol governance while borrowing against the governance tokens.

• Interest Protocol's interest rate system ensures that USDi holders can redeem their USDi for USDC and thus maintains USDi's peg. When the protocol has a low reserve of USDC, both the borrow rate and the deposit rate of USDi automatically increase. This induces users to repay their USDi loans or deposit USDC to mint USDi, increasing the reserve ratio.

• The liquidation system allows Interest Protocol to extend loans to borrowers while protecting depositors. Liquidations occur whenever a vault's borrowing power drops below its liability. Liquidators are incentivized through a discount on the price of collateral assets to purchase those assets. Governance configures the discount for each asset. Unlike most protocols, Interest Protocol's liquidation system protects the borrower from unnecessary liquidations: liquidators can only liquidate a vault until the vault's liability is equal to its borrowing power. To efficiently process large liquidations, the protocol allows liquidators to liquidate any amount as long as it does not exceed the maximum amount.

USDi Token

• USDi is a stablecoin pegged to $1 that automatically earns interest. Anyone can mint USDi by depositing an equal amount of USDC into the protocol, and anyone can redeem their USDi for an equal amount of USDC held by the protocol. USDi is also minted when users borrow from the protocol. Borrowers can post collateral and take out loans denominated in USDi. The protocol mints USDi to generate loans and burns USDi when they are repaid.

Fractional Reserve

• New USDi is created only when an equivalent amount of USDC is deposited into the protocol, a borrower takes out an over-collateralized loan from the protocol, or when interest accrues to existing loans. Hence USDi is fully backed by USDC and loans. At the same time, whenever there are outstanding USDi loans, the amount of USDC held by the protocol is smaller than the amount of circulating USDi. This is why we say that Interest Protocol implements fractional reserves.

Compounding Yield

• USDi holders accrue interest from interest paid by borrowers, net of a protocol fee. The interest is distributed pro-rata to all USDi holders in the form of additional USDi. Interest Protocol implements this distribution by scaling up the balance of USDi tokens in all addresses so that the value of each USDi remains pegged to 1 USDC. This means that USDi is a liquidity provider (LP) token that is liquid. USDi is an LP token that earns yield generated from protocol operations, and USDi is liquid because it is pegged to $1.
• Therefore, USDi holders can earn compounding yield without staking. This improves gas efficiency because there is no need to switch back and forth between the LP token and the stablecoin, and is especially beneficial to small users who spend a higher percentage of their trades on gas fees. DeFi users no longer have to choose between liquidity and yield; USDi provides both.

Sources:

• https://interestprotocol.io/book/docs/intro/index.html
• https://defillama.com/protocol/interest-protocol