Detailed Explanation of EigenLayer Cap: How Retail Investors Can "Lend Money" to Big Market Makers Without Fear of Rug Pull?

Eigencloud is exploring the composability potential of Ethereum's Decentralized Finance. Recently, they launched a Cap AVS, which is quite interesting, attempting to pump some large institutions into participating. Previously, on-chain lending did not have enough security in the eyes of some institutions, making them hesitant to engage. The Cap that Eigen is working on may change the situation.

A big institution has come this time, called Flow Traders. It is one of the world's large market makers and a company listed on European exchanges. Market makers have high liquidity and often need to borrow money to make markets, thereby earning greater profits. Now it can borrow money directly on the Ethereum blockchain. So, here comes the question, who dares to lend it money?

At this time, Eigen's Cap can play its role, which can be simply understood as “on-chain bank of Ethereum.” The money that users deposit into the pool (for example, USDC) is often the money that retail investors/funds/institutions/DeFi projects want to earn more interest on. Therefore, when the returns are in place and there is insurance, they are willing to lend to Flow Traders.

If Flow Trades market makers can provide returns on idle funds, then guarantors (like YieldNest, which is also operated by Eigen) provide insurance. YieldNests are willing to pledge their own ETH as collateral. If Flow Traders fail to repay their loans or behave recklessly (spending borrowed money indiscriminately/exceeding collateralization ratio), then lenders can seize the ETH pledged by YieldNesT through the contract and receive compensation.

So, what are the benefits for the guarantors of YieldNest? Aren't they afraid of risks? The guarantors can also make money, and the risks are relatively controllable. The fees mainly come from the guarantee fee (insurance fee), for example, if Flow Traders borrows 100 million USDC, it is willing to pay an extra “insurance fee/guarantee fee” to the guarantor (assuming the borrowing interest is 5%, now willing to pay 8%, the extra 3% is the pure profit for the guarantors of YieldNest). For YieldNest, by collateralizing their own ETH, they can earn millions or even tens of millions of dollars in guarantee fees each year (depending on the scale of lending). Originally, this part of ETH was already staked in Eigenlayer, and providing guarantees is equivalent to earning an additional high guarantee fee.

In terms of risk, YieldNest will consider the qualifications of Flow Traders (a regulated European listed company) and will lend out corresponding amounts of collateral based on on-chain credit limits, without providing collateral for all structures; furthermore, in the event of default, early warnings will be received first, and forced liquidation will be automatically triggered if LTV exceeds the limit. When Flow Traders borrows money, a whitelist is strictly enforced, and transfers to other account addresses are not allowed (any outflow will trigger an alert); the counterpart is required to collateralize their assets in the Cap protocol, which cannot exceed the agreed LTV collateral rate; data must be reported as required, etc.