Lending Order Books - The next evolution in onchain lending

TLDR: The design space for money markets has been widely explored by teams like Compound, Aave, Silo, Morpho, Euler, and others. We think the next big step for improving capital efficiency and flexibility in lending markets is through fully onchain lending order books.

To make onchain lending order books work, two things are necessary: 1) an order book-like interest rate AMM and 2) liquidity sharing between order books to facilitate efficient quoting and loan renewals. Good news—Tenor is building exactly that!

Variable rate money markets like Aave, Compound and Morpho currently dominate onchain lending markets. After many design iterations and different risk management approaches, money markets have found clear product market fit and offer users a broad set of options from isolated markets, shared collateral frameworks, and everything in between.

While they work well, interest rate spreads between borrow and lend rates in these markets range frequently from 20% to 40%, creating an opportunity for more efficient solutions. Additionally, money market borrow rates can spike when utilization increases above the kink, hindering the UX for more sophisticated borrowers.

Though these problems are not overly prohibitive for most crypto natives, they certainly limit the ability to expand onchain lending markets to more traditional use cases. In order to onboard more lending markets onchain, more efficient market infrastructure is needed. 

We see concentrated liquidity lending AMMs (e.g. lending order books) as the next major breakthrough for onchain lending. By matching lenders and borrowers directly (P2P), lending order books can offer better rates, enhance the borrower UX, and expand on what existing money markets already do well.

This shift from money markets to lending order books or concentrated liquidity lending markets mirrors Uniswap's evolution from V2 to V3. Although V2 remains active, the majority of trading volume is now routed through V3.

1. P2P Matching 

Lending order books enable users to lend and borrow at specific interest rates until a set maturity date. Using tick-based interest rate AMMs, users can set limit orders, deposit liquidity, lend or borrow. This allows for a fully onchain interest rate order book where lenders and borrowers can be matched P2P, eliminating the spread found in utilization-based markets. For instance, a lender could set a limit order to lend 1,000 USDC at 8%, while a borrower could then deposit collateral and borrow that 1,000 USDC at 8%.

This approach also gives users more control and predictability by letting them choose their preferred interest rates and maturities.

2. Fixed Rates as a Means to an End

For lending order books to work they require fixed rates. This is because in order for lenders and borrowers to specify a set interest rate, that rate must be fixed over a set period of time. While multiple protocols have historically focused on enabling fixed rates onchain, Tenor is the first protocol to offer concentrated liquidity lending. Concentrated liquidity is key to solving the inefficiencies and UX issues of fixed rate protocols.

Tenor also facilitates liquidity sharing between the maturities of a given market and simplifies loan renewals. This can be achieved via an optimized collateral framework where loans, limit orders and LP positions in any maturity can be used as collateral against debts in other maturities. 

3. A Money Market Extension

Lending order books can leverage existing money market infrastructure (e.g. Morpho) by being deployed on top of money markets. This means that lending order books can inherit a money market's risk management layer (oracle, max ltvs, liquidation discounts). Lending order books can also benefit from money markets by depositing unused funds (like pending limit orders or passive liquidity) to be yield-bearing.

Building on top of money markets eliminates the need for additional governance and expands the offering of existing money markets which already have broad market adoption.

Tenor builds on top of Morpho as its money market layer. The Tenor protocol builds a lending order book layer on top of Morpho markets through its concentrated liquidity, order book-style Interest Rate AMM.

Tenor’s interest rate AMM is implemented as a Uniswap V4 Hook, allowing users to effectively lend using Uniswap. 

The Tenor Team is participating in the current batch of the Atrium Academy Uniswap Hook Incubator. If you want to see a demo of the protocol feel free to reach out on X or at contact@tenor.finance.