Rehypothecation

Rehypothecation in decentralized finance is the process of using the same collateral deposited by a borrower to issue more loans. While platforms like Aave and Compound employ this by allowing collateral to be borrowed again, MORE Markets adopts a distinct approach, focusing on the utilization of tokenized collateral through MORE vaults, based on the MetaMorpho protocol. As such, rehypothecation in MORE mirrors this functionality in Morpho.

Benefits and Risks for Borrowers

Borrowers in MORE Markets can generate interest on their collateral, potentially offsetting loan costs or yielding a net profit, thus enhancing the financial utility of their assets. This rehypothecation process not only maximizes capital efficiency but also fosters a dynamic lending environment where the financial resources are fully utilized, thereby improving capital efficiency. However, rehypothecation also carries risks primarily associated with liquidity issues; collateral re-used in this manner may not be readily liquidatable in volatile market conditions, leading to a higher probability of defaults. Moreover, any depreciation in the value of MORE vault assets can quickly reduce the collateral value, increasing the risk of sudden liquidation needs and potential financial instability for the borrower.

Risk Management in Rehypothecation

Effective risk management in rehypothecation within MORE Markets hinges on meticulously balancing liquidation timelines and market conditions. The time to safely liquidate an account must consistently exceed the actual liquidation duration, which is influenced by the liquidity of the assets and operational dynamics such as market volatility and liquidation incentives. This strategic balance is critical to avoid the accrual of bad debts and to maintain the resilience and stability of the lending environment against rapid market shifts or downturns.

Operational Guidelines for Rehypothecation

In order to mitigate the inherent risks of rehypothecation, MORE Markets adopts several prudent operational guidelines:

• setting conservative loan-to-value (LTV) ratios to maintain a buffer against market fluctuations,

• capping market sizes to limit exposure during large-scale liquidations,

• continuously monitoring the liquidity of MORE vaults to ensure they can support liquidations under adverse conditions.

These practices are essential for sustaining the platform's health and protecting user interests by preventing scenarios that could lead to financial strain or system collapse.

Practical Application: Using MORE Vault Tokens

In a more detailed example, suppose a user deposits FLOW into a MORE vault and receives moreFLOW tokens that represent their stake in the vault.

These tokens, backed by the deposited FLOW, can then be used as collateral in MORE Markets to secure a loan in a stablecoin like PYUSD. This mechanism allows the original FLOW to be re-lent to other borrowers, effectively putting the asset to work twice within the same ecosystem — first, as a deposited collateral, and second, as a lent asset.

The user benefits from potential interest earnings on both the FLOW and the PYUSD loans. Over time, if the value of FLOW increases, the user could repay the PYUSD loan, reclaim the FLOW, and realize a profit on the increased value of FLOW, minus any interest paid.

This example highlights the layered financial strategies enabled by rehypothecation, enhancing both the user's investment potential and the potential increased capital efficiency of the platform.