Providing Liquidity
What is providing liquidity
When you provide liquidity on Notional you mint nTokens. nTokens are ERC20 tokens that represent your share of the liquidity in Notional's fixed rate liquidity pools.
nTokens earn returns from three sources:
Interest accrual.
Transaction fees from fixed rate lenders and borrowers.
NOTE incentives.
nTokens can also have a small amount of IL as fixed rates change due to interest rate risk. nToken IL is much less than ETH/USDC Uniswap V2 LP tokens, but a bit more than stablecoin LP tokens on Curve.
Who is providing liquidity for
Providing liquidity is for DeFi users who want a passive return but also have some experience using different DeFi products and are familiar with concepts like IL. Providing liquidity offers a passive variable rate yield and it is a great way to earn NOTE, but it's also a bit more advanced than fixed rate lending.
Where does the yield come from
nToken yield comes from variable rate interest, transaction fees, and NOTE incentives. When you put your capital into Notional's liquidity pools it will automatically be converted to cTokens and start earning Notional's variable lending rate.
In addition to the interest you earn, you will get transaction fees paid by fixed rate lenders and borrowers + NOTE incentives paid by Notional.
What are the risks
When you provide liquidity you have three main risks:
Smart contract risk. A hack of Notional’s smart contracts or the smart contracts of any protocol where Notional holds funds could result in loss.
Bad debt risk. All borrowing on Notional is over-collateralized. If the value of a borrower's collateral falls and liquidators don’t purchase the collateral quickly enough, Notional could be left with bad debt.
Interest rate risk. The value of fCash changes as interest rates change, and nTokens hold fCash. Moves in interest rates could cause an increase or decrease in the value of nTokens by causing their fCash assets to change in value.
Redemption risk. nTokens can always be redeemed for a proportional share of their prime cash and fCash assets. But during times of high utilization, users can temporarily be unable to redeem nTokens 100% to prime cash.
Transaction cost
There is no fee to mint nTokens, but there is a cost for redeeming nTokens.
If users want to redeem 100% to prime cash (because they want to withdraw immediately), they will pay a fee that depends on the on the utilization of Notional's liquidity pools. The larger the nTokens's fCash position, the larger the fee.
Collateral - nTokens are collateral on Notional. That means you can provide liquidity and borrow against it!