Interest Rate / Liquidity Risk

In some scenarios, the utilisation rate on the external lending market may become very high in the liquidity pool(s) (LP) where the lov-Strategy vault maintains its debt position. High LP utilisation of the borrowed token can impact the lov-Strategy vault user in two main ways:

  1. Interest Rate may become very high which if sustained can cause the yield spread to become negative on the leveraged portion of the user’s position. If the LTV crosses the RebalanceUp_AL_Floor threshold, the vault will trigger a RebalanceUp to partially unwind the position which may cause the vault share price to fall.

  2. Swap pool liquidity may become very thin which can cause the collateral token to trade at a discount against the debt token. This situation could precipitate a depegging or occur in the aftermath of such an event. Thin liquidity and/or a depegging may lead to price volatility that could trigger more RebalanceUp transactions which may cause the vault share price to fall.

In a normal, functioning market, rising interest rate in one pool will create arbitrage opportunities which tends to equilibrate and stabilise interest rates across different pools. In most situations, high interest rates in the external pool are transient and will return to the target rate through the normal deleveraging or forced liquidation process.

However, there are market scenarios where the high interest rate fails to reset the liquidity to nominal levels and the pool becomes permanently illiquid. In such scenarios, the Origami vault automatic rebalance mechanism may not function as expected or may not function at all.

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