Lending Pool

A lending pool is a smart contract that gathers deposits of a crypto asset from many lenders into a single shared fund, which borrowers can then draw on by locking up collateral. Instead of matching each lender with a particular borrower, the pool acts as a common reserve: lenders earn interest from all borrowers together, and borrowers pay a rate that the protocol adjusts automatically according to how much of the pool is in use.

Lending pools are the core building block of DeFi lending protocols such as Aave and Compound. They are related to, but different from, the liquidity pools used by decentralised exchanges, which hold pairs of tokens for trading rather than single assets for lending.

Picture a community savings jar. Neighbours drop money in, and anyone who needs to borrow can take some out, as long as they leave something valuable in a locked box as security, worth more than they borrowed. Borrowers pay a fee for using the money, and that fee is shared among everyone who put money in the jar.

When the jar is nearly empty because lots of people are borrowing, the fee goes up. That encourages more neighbours to add money and some borrowers to pay back. When the jar is full and few people are borrowing, the fee drops. Nobody runs the jar by hand; a computer program follows the rules automatically.

1. Deposits. Lenders supply an asset, such as a stablecoin or ether, and receive a receipt token that tracks their share of the pool plus accrued interest.
2. Collateral. Borrowers deposit other assets as collateral. Each asset has a collateral factor that limits how much can be borrowed against it, so loans are overcollateralised.
3. Borrowing. Borrowers withdraw from the pool up to their limit and owe interest that accrues block by block.
4. Repayment or liquidation. Borrowers repay to recover their collateral. If the collateral's value falls too far, anyone can repay part of the debt and claim collateral at a discount, a process covered under forced liquidation.

Prices for collateral come from an oracle, and the receipt tokens can themselves be traded or used elsewhere in DeFi.

Pools are usually governed by a community that votes on which assets to list, their collateral factors and the shape of each rate curve. Some protocols isolate riskier assets in separate pools, so that a collapse in one token cannot drain lenders in the main market, while others run one large shared market for all supported assets. Each choice trades capital efficiency against contagion risk.

Most pools set rates from the utilisation rate, the share of deposits currently lent out:

The borrow rate rises with $U$, usually gently at first and then steeply above a target level, often around 80% to 90%, to keep some cash in the pool for withdrawals. Lenders receive the borrowers' interest, less a reserve share kept by the protocol:

• $r_{\text{supply}}$ is the rate earned by lenders.
• $r_{\text{borrow}}$ is the rate paid by borrowers.
• $U$ is utilisation and $R$ is the reserve factor, both as decimals.

For example, if a pool holds 10 million dollars of a stablecoin and 7 million is borrowed, utilisation is 0.7. If the borrow rate at that level is 6% and the reserve factor is 10%, lenders earn 6% × 0.7 × 0.9 = 3.78% a year.

• Earning yield. Holders of idle assets deposit them to earn interest without choosing a borrower.
• Borrowing without selling. Users borrow stablecoins against crypto they want to keep, for spending or to avoid a taxable sale where rules make that relevant.
• Leverage and shorting. Traders borrow assets to increase exposure or to sell an asset they expect to fall.
• Flash loans. Some pools lend their funds for the length of a single transaction, as described under flash loans on Aave.

Lending pools concentrate risk in code. Bugs in the contracts, faulty or manipulated price oracles and governance attacks have caused large losses. If collateral prices crash faster than liquidators can act, the pool can be left with bad debt that lenders share. At very high utilisation, lenders may be unable to withdraw until borrowers repay or new deposits arrive. Pools that accept volatile or thinly traded tokens as collateral are especially exposed. Regulators are still deciding how lending pools fit into rules for crypto lending, which in several jurisdictions has been treated as a regulated activity when run by an identifiable company.

• Aave documentation
• Compound documentation