Detailed Explanation of EigenLayer Cap: How to get retail investors to "lend" money to giant market makers without fear of them running away with the money?

Eigencloud is exploring the composability potential of Ethereum DeFi. Their recent Cap-based AVS is quite interesting, and they're trying to attract large institutions to participate. Previously, on-chain lending was seen as lacking sufficient security by some institutions, preventing them from engaging. Eigen's Cap-based approach might change that.

This time, a major institution called Flow Traders has entered the fray. It's one of the world's largest market makers and a company listed on a European exchange. Market makers, known for their high liquidity, often need to borrow money to make market-making decisions and maximize profits. Now, they can borrow money directly on the Ethereum blockchain. The question is, who dares to lend to them?

This is where Eigen's Cap comes into play, which can be simply understood as an "on-chain bank for Ethereum." The money users deposit into the pool (such as USDC) is often money from retail investors/funds/institutions/DeFi projects who want to earn more interest. Therefore, when the returns are in place and there is insurance, they are willing to lend it to Flow Traders.

If Flow Traders' market makers provide returns for idle funds, and guarantors (such as YieldNest, which is also Eigen's operator) provide insurance, then YieldNest users are willing to pledge their own ETH as collateral. If Flow Traders default on their loans or misuse the funds (spending money recklessly/exceeding the collateral ratio), then lenders can forfeit the pledged ETH in YieldNest through the contract and receive compensation.

So, what are the benefits for guarantors like YieldNest? Aren't they afraid of the risks? Guarantors can also make money, and the risks are relatively controllable. The fees mainly come from collecting guarantee fees (insurance fees). For example, if Flow Traders borrows 100 million USDC, it's willing to pay an extra "insurance/guarantee fee" to the guarantor (assuming the loan interest rate is 5%, now it's willing to pay 8%, the extra 3% is pure profit for guarantors like YieldNest). For YieldNest, by pledging its own ETH, it earns millions or even tens of millions of dollars in guarantee fees annually (depending on the loan size). This portion of ETH was already pledged on Eigenlayer; providing guarantee is equivalent to earning a substantial guarantee fee.

Regarding risks, YieldNest will consider Flow Traders' qualifications (a regulated European listed company) and will lend a corresponding amount of collateral based on on-chain credit limits, without providing guarantees for all structures. Furthermore, in case of default, a warning will be issued first, and automatic forced liquidation will be triggered if the LTV exceeds the limit. Flow Traders uses a hard whitelist when lending money, prohibiting transfers to other account addresses (an alert will be triggered immediately if funds are transferred out); it requires borrowers to pledge their assets in the Cap protocol, and the collateral ratio cannot exceed the agreed LTV; and data must be reported as required.