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Introducing the Two Market Model (TMM)

Jun 9, 2023


  • The Two Market Model (TMM) is an even notional/principal matching mechanic for lending and borrowing protocols.
  • TMM consists of a Subscription market; and a Reference market, where a 1:1 ratio ensures that the Subscription market has no deadweight loss baked into the mechanics.
  • TMM is modeled after TradFi institutional markets facilitating trillions of dollars in lending and borrowing.

In our previous articles, we introduced the concept of Utilisation (part 1, part 2). We highlighted the inefficiencies (deadweight loss / wide bid-offer spread) resulting from the mechanic of uneven notional / principal matching by the existing lending and borrowing protocols (DeFi 1.0), such as Aave and Compound.

These two lending and borrowing protocols have a (roughly) combined $10B in TVL, and we hinted that Infinity could double current TVL to $20B, overnight.

Introducing the Two Market Model.

Two Market Model (TMM)

The Two Market Model (TMM) is an even notional / principal matching mechanic that is going to transform DeFi (2.0) to become a more efficient model for lending and borrowing protocols.

As the name suggests, the TMM consists of two markets:

  1. Subscription market; and
  2. Reference market.

Based on the diagram above,

  • On the left, we have the Reference market with ‘X’ number of lenders willing to lend (Lend LPs or Lend Limit Orders) and ‘Y’ number of borrowers willing to borrow (Borrow LPs or Borrow Limit Orders).
  • On the right, we have the Subscription market with 100 lenders and 100 borrowers, where the notional / principal is evenly matched at a 1:1 ratio.
In short, TMM is a revolutionary paradigm to the existing concept and economics of Utilisation.

Subscription market

The Subscription market has an equal number of lenders and borrowers paying and receiving the Interest rate, respectively.

In the diagram above, we have 100 lenders and 100 borrowers. As compared with DeFi 1.0, the TMM (DeFi 2.0) ensures that lenders and borrowers are notional / principal matched, with the Interest payment from the 100 borrowers being directly received by the 100 lenders (not more, not less) ignoring any protocol fees.

Subscription market consists of an equal amount of Interest paid (by borrowers) and received (by lenders).

Lenders and borrowers in the Subscription market have opted-in to receiving and paying the Interest rate respectively, and if they decide the Interest rate is not for them — they have the option to opt-out and exit the Subscription market.

The Interest rate lenders receive and borrowers pay is a ‘floating’ rate linked to the Reference market (discussed below).

A floating rate is an interest rate that changes periodically, where the rate could move up or down, i.e. it “floats”. To illustrate, the floating rate could be 4% one day, 5% the next, 3% thereafter, and so on.

Reference market

If the Subscription market contains an equal number of lenders and borrowers receiving and paying interest, how does the Interest rate change? The Reference market.

The Reference market could have an equal or unequal number of lenders (X) and borrowers (Y) looking to get into the Subscription market. However, the number of lenders and borrowers in the Subscription market will be equal.

Reference market consists of lenders willing to lend at different interest rates, and borrowers willing to borrow at different interest rates.

Lenders and borrowers in the Reference market wish to be inside the Subscription market. However, they are waiting for their counterpart, i.e. if they are a lender, they are looking for a borrower at their desired Interest rate. Hence the TMM is equal notional / principal matched.

How does the TMM work?

As a recap, we’ve explained that the TMM consists of a Reference and Subscription market, and that in order to enter the Subscription market (where Interest is paid and received by an equal number of lenders and borrowers), lenders and borrowers can only enter from the Reference market.

One of the ways we could illustrate this is to imagine a nightclub (as example). In our nightclub analogy, there is one door and it is the only gateway to enter and exit the nightclub (the orange box in the above diagram). The only way to enter / exit is to be matched, in the case of a lender — a borrower, and vice versa.

As the TMM requires a lender to be matched with a borrower in order to enter the Subscription market (from the Reference market), it ensures there is always an equal number of lenders and borrowers in the Subscription market, and thereby always have an equal notional / principal matched market, or a 1:1 ratio.

The 1:1 ratio ensures that the Subscription market has no deadweight loss baked into the mechanics.

From Reference to Subscription

The TMM mechanic ensures a 1:1 ratio between lenders and borrowers. How does this translate from the Reference to the Subscription market?

In the Reference market, we have 1 Lend LP (a liquidity provider willing to lend at (say) 5%) and 1 Borrow LP (a liquidity provider willing to lend at (say) 5%). Since their quantity and desired Interest rate are the same, they are able to pass through the ‘door’ and enter the Subscription market.

They each become a Lender and Borrower in the Subscription market, increasing the total Subscription market size from 100 lenders and 100 borrowers to 101 (+1) lenders and 101 (+1) borrowers, maintaining the 1:1 ratio.

The above example illustrates new, additional capital entering the Subscription market, increasing the total size from 100 to 101, or enlarging the size by 1 (equally in the quantity of lenders and borrowers).

Leaving the Subscription market

Let’s illustrate the instance a lender or borrower seeks to exit the Subscription market. Based on the above example, the total Subscription market consists of 101 Current Lenders and 101 Current Borrowers.

Recall that the Subscription market retains a 1:1 ratio. For a Current Lender / Borrower to exit the Subscription market, there are two potential scenarios consisting of a Current Lender / Borrower and Potential Lender / Borrower.

In the case of a Current Lender seeking to exit the Subscription market,

  1. A Current Lender is matched with a Current Borrower, where both seek to exit the Subscription market. Since they are notionally / principally matched, 1 Current Lender exits or is ‘matched’ with 1 Current Borrower and the total Subscription market decreases by a quantity of 1.
  2. A Current Lender is matched with a Potential Lender seeking to enter the Subscription market for the same notional / principal as the Current Lender. In this case, 1 Current Lender is swapped with 1 Potential Lender, and the total Subscription market remains unchanged.
Both scenarios apply to lenders and borrowers interchangeably.

A brief introduction only

The above is a brief introduction to Infinity’s Two Market Model, a more efficient even notional / principal matched mechanic than the current lending and borrowing protocols (DeFi 1.0).

In our upcoming articles & videos, we will dive deeper into the mechanics around how Interest rates will move within the TMM. For example, if a potential lender (Lend LP) is willing to lend at 5% and a potential borrower (Borrow LP) is willing to borrow at 4.9%, if the Borrow LP changes their mind and decides to (‘pay up’ and) borrow at 5%, they would match (and ‘take’ the price) with the Lend LP, thereby establishing the ‘Reference Rate’ at 5%.

Is this revolutionary? Yes, for DeFi today, however the TMM is simply modeled after the mechanics in traditional ‘institutional’ finance (TradFi) markets, and specifically, the interbank market, which have been battle tested with trillions of dollars (at any given time) over several decades, subscribing to pay a floating interest rate (which used be called Libor).

TMM is modeled after TradFi institutional markets facilitating trillions of dollars in lending and borrowing.

Stochastic, not Deterministic

The TradFi institutional market is accustomed to paying and receiving the prevailing (floating) interest rate on trillions of dollars (no matter what), and if they are no longer satisfied with paying the prevailing interest rate, they (in the instance of a borrower) could pay back their loan and simply exit the market.

In the TradFi institutional world, everyone is notionally / principally matched where the number of lenders is always equal to the number of borrowers, all the time. While the TMM is nothing new in the context of TradFi, we represent it in the context of DeFi where it is a new, revolutionary paradigm for the inefficient lending and borrowing markets we see today.

The TMM mechanic is stochastic in nature, where we establish a market clearing Interest rate with lenders and borrowers entering and exiting the TMM at different levels of interest rates (i.e. prices) to lend or borrow, and thereby push the (market-cleared) Interest rate ‘up’ or ‘down’ based on the randomness of where lenders and borrowers would be willing to enter / exit the Subscription market (i.e. our hypothetical nightclub).

TMM is stochastic in nature and establishes a market clearing interest rate.

As we highlighted in our previous articles on Utilisation (part 1, part 2), the current ecosystem of lending and borrowing protocols use a deterministic Utilisation based model, which is widely used in DeFi today and demonstrated that:

  1. An uneven notional / principal matched mechanism leads to a wide bid-offer (deadweight loss); and
  2. Utilisation rate determines their interest rate, which means it is deterministic in nature and no different than a bunch of folks in a room drawing lines on a whiteboard and agreeing to what the interest rate would be for any given Utilisation rate.

With Utilisation, whether there are 100 lenders and 80 borrowers, or 100 million lenders and 80 million borrowers, the interest rate is exactly the same each and every time. As such, it’s very easy to predict where the Interest rate would be.

The TMM in contrast, is stochastic in nature and representative of the tried and tested mechanics of TradFi institutional markets which handle trillions of dollars daily.

In a financial market, participants have varying levels or willingness to trade, their views also change rapidly as new information becomes available, as does the sequence or speed at which they change their views. As such, the TMM is a far superior model than that currently used in DeFi today. We are, of course, excited to roll the TMM out in the DeFi space.

Given the parallels to TradFi, as well as the theoretically more efficient exchange mechanics, we believe the TMM will substantially increase the notional amount of TVL, simply because more borrowers and lenders are satisfied at the prevailing interest rate.

Next steps

We will be sharing more in-depth on the TMM in our upcoming Ahead of the Curve series, and introduce the notion of using different types of collateral with Infinity’s TMM.

Still not subscribed? Here is one big reason:

We will discuss the idea of arbitrage and how Infinity’s TMM accelerates this.

Spoiler Alert… This is huge.

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