Protocol net profit is equal to the sum of fees generated by Borrowers (through interest, borrow fees and liquidations) minus the losses they incur to the protocol (through unprofitable liquidations). Borrowers in the highest tiered vaults pose the greatest risk to profitability, since liquidations there may lead to the accumulation of toxic debt in the system (i.e. debt which is not recoverable by liquidating the underlying collateral).
To manage and optimize profitability, the ARCx Credit system provides a number of unique control parameters. Through understanding, monitoring and fine-tuning these parameters, ARCx Credit will deliver sustainable net profit across its loan book.
The design of ARCx Credit and the DeFi Credit Score aim to incentivize responsible borrowing behavior. This is based on two unique factors:
- 1.The time and effort required to build to a high DeFi Credit Score (which would be a sunk cost if a wallet is abandoned after liquidation)
- 2.The quantifiable benefit that a borrower receives from continued access to higher-tiered vaults (i.e. the capital efficiency gained)
Since the growth of the DeFi Credit Score is explicitly tied to responsible borrowing behavior, users who want access to improved capital efficiency will be incentivized to borrow responsibly. Conversely, if the expected benefits of continued access to improved capital efficiency exceed the penalty for liquidation and the time and effort required to rebuild a Score, then borrowers will be incentivized to avoid liquidation.