While decentralized finance is quite a revolution with its permissionless ethos, composability and global liquidity, it has been observed that ability to move money at the click of a button quite often results into draining of liquidity from a protocol as soon as the liquidity mining incentives are withdrawn.
For variable interest protocols that typically lend against security of collateral, this is not a problem as both their loans and liquidity pools are short term in nature. This however results in economic imbalances like extremely low APR, lower than treasury yields and excessive liquidations resulting in less than optimal ecosmic user experience for the borrowers.
Despite these economic absurdities that appear from time to time on pure lending platforms, the short term lending and short term borrowing does not create any risk for the protocol itself.However, most of the RWA focused defi lending protocols provide loans of maturity running into months and years. In such a case, if the liquidity is of ultra short term in nature, the DeFi protocols face the risk of asset liability mismatch which may create a liquidity crisis or bank run on the protocol. In the TradFi world, LTCM and Silicon Valley bank (SVB) bankruptcies are prime examples of risk arising from asset-liability mismatch. The solution to avoid such asset-liability mismatch is to ensure that liquidity is locked up for a period that is equivalent to tenure of the loan given. Bonds provide an effective solution to manage duration risk and asset-liability mismatches. By matching the duration of bonds with the expected cash outflows, bonds can reduce the risk of default, improve financial stability, and ensure long-term profitability. Hence, Brú Finance is introducing Fixed Income Asset-backed bonds that match market demand and supply tenure to tenure, providing a better solution for asset-liability mismatch and protecting the protocol from liquidity problems and the risk of collapse. Further, such RWA backed bonds offer a more stable income source for liquidity providers in the DeFi ecosystem. Let us take a look at the Bonds mechanism of Brú protocol at more detail!
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