The Process of Borrowing Tokens on Ola Finance
Borrowing is the act of taking a loan from any of the lending networks. Contrary to lending which has users supplying tokens to a pool of assets, borrowing is the act of taking tokens out of the pool of assets.
In order to borrow tokens, a user must first supply tokens as collateral (ie. become a lender). This is because Ola's Lending Networks rely on over-collateralized loans (Read more: Over-Collateralized Lending). It's important to mention that a user can still lend tokens and earn interest without borrowing tokens.
After depositing your tokens and enabling them as collateral (click the button labeled "Collateral" next to your token in the app), you can borrow any of the available tokens from that same lending network. You can even borrow the same token you deposited as collateral!
Note: Any interest you earn from depositing funds helps offset the interest you accumulate by borrowing.
The max amount that a user can borrow depends on the amount of collateral deposited and the token's Collateral Factor. The Collateral Factor - expressed as a percentage - is a multiplier used against your supplied assets.
Let's say you supply $1000 WBTC as collateral, and WBTC has a collateral factor of 70%. This means that you can borrow up to $700 of any token ($1000 x 70%). Each token in a lending network (WBTC, ETH, etc.) will have its own collateral factor as determined by the creator of the lending network.
Note: The amount you can borrow is based on the Collateral Factor of the asset (or assets) you are supplying. In the example above, it doesn't matter what asset a user borrows - they supplied WBTC and it had a Collateral Factor of 70%.
Just like in traditional finance, borrowers are required to pay interest on their loans. This interest goes directly to the lenders/suppliers of that token, minus the Reserve Factor (see tunable-parameters).
The interest that borrowers pay is determined by the APY listed for the token(s) they are borrowing. It is important to note that APYs in Ola's MMs are floating and not fixed. Rates get updated on a per-block basis and can fluctuate significantly within relatively short time spans.
The interest that accrues each block is added to a user's borrow position, meaning their borrow position slowly grows over time in proportion to the APY. To pay back this accrued interest, a user simply pays back a portion of their loan.
In essence, borrowing allows people to access the value of their assets while still holding on to them. For example, assume you have some ETH but need USD to pay for a car. Instead of selling that ETH, you could use it as collateral and borrow USD against it. Then, if ETH goes up in value, you can sell the ETH for more and repay the loan, pocketing the difference. Of course, there are other use-cases, usually of a financial nature:
- Enter a short position on a token
- Leverage a long position on a token
- Borrow a token for a lucrative liquidity mining opportunity, while limiting exposure to the token
After borrowing tokens from a lending network, it's important to continuously monitor your position to ensure you have enough collateral to support your loan. As prices of tokens fluctuate, your position can be in danger of liquidation if not properly managed.
In the next section, we are going to take an in-depth look at liquidations and what that means for you as a borrower. In addition, we will go over safe borrowing practices and how you can avoid being liquidated.