Providing Liquidity
What is providing liquidity
When you provide liquidity on Notional you deposit underlying and receive nTokens in return. 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 impermanent loss due to changing fixed interest rates. 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 or variable rate lending.
How does it work
When you provide liquidity, the nToken account takes your funds and routes them to the individual fixed rate liquidity pools.
The funds are held as Prime Cash and fCash in the fixed rate liquidity pools. This means that they are earning interest while they are providing liquidity for users who want to borrow or lend at fixed rates.
Where does the yield come from
nToken yield comes from interest accrual on the Prime Cash and fCash held in the nToken account, transaction fees, and NOTE incentives.
Transaction fees are paid any time a user borrows or lends fixed and NOTE incentives are streamed continuously.
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.
Impermanent loss risk. As fixed interest rates move, nTokens can become fixed rate borrowers or lenders. Changes in the nToken's borrowing and lending positions can affect the nToken price.
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.
Redemption
nTokens are always redeemable for the underlying except when utilization on Notional's lending markets is very high. When utilization is too high, nTokens can be redeemed for a proportional share of the prime cash and fCash held in the nToken account.
Transaction cost
There is no fee to mint nTokens, but there is a cost for redeeming nTokens if the user redeems to underlying.
The size of the fee depends on the utilization of Notional's liquidity pools. The higher the utilization, the higher the fee.
Collateral - nTokens are collateral on Notional. That means you can provide liquidity and borrow against it!
