Decentralized Money Markets
What is a Money Market?
Borrowers use money markets to take out a short-term loan (typically under a year) to borrow a single currency (i.e USD), while at the same time putting up another currency (i.e. Euros) or an asset (i.e. real estate) as collateral. This collateral is required to help ensure the borrower’s debts are repaid in full; if the borrower fails to pay back their debts the collateral is sold to make the lender whole. Otherwise, the collateral is returned when the borrower pays off the loan plus interest.
In exchange for the ability to borrow working capital from lenders, borrowers are required to pay a fee, usually in the form of an annual interest rate (i.e. 7% a year), which generates yield for lenders and incentives deposits. This interest rate is typically a function of supply and demand to ensure that sufficient liquidity is available for both borrowers and lenders. A high supply and low demand of an asset lead to lower interest rates, while a low supply and high demand lead to higher interest rates. Various money markets compete based on the interest rates they offer and other parameters such as how much collateral is required for loans.
While traditional money markets have been a net positive for the global economy over the centuries by enabling businesses to expand and allowing citizens to save their money, the money markets of today are typically operated by a centralized institution, granting a significant amount of power and influence over user funds to a single entity. This design increases costs for borrowers/lenders and requires a high degree of trust in a single party.
What is a Decentralized Money Market?
In response to the limitations seen in traditional money markets, developers are now utilizing blockchain-based smart contracts to create decentralized money markets that operate as code on a highly decentralized network of nodes worldwide. Instead of being controlled by a centralized institution, decentralized money markets like Umee are operated through on-chain programmatic code that is upgraded and managed by a global community of stakeholders, decentralizing control and reducing points of failure.