Learn more about liquidity risk at MoneySwitch.
This is the risk that liquidity providers will not be able to immediately withdraw their assets upon request. This will occur if all of the assets are currently on loan (i.e. 100% utilisation). In this event liquidity providers will have to wait for a borrower to make a repayment to withdraw their assets. When the utilisation is high, the interest rate earned by lenders will be at its most attractive, incentivizing liquidity providers to retain or increase the amount of assets they have in the liquidity pool. Whilst liquidity risk will still exist, this provides a mechanism to incentivize additional liquidity when it is most needed.
Liquidity risk will be greatest initially, when the size of the liquidity pool and the number of borrowers is small. In this event a single borrower could take out a loan representing a large % of the liquidity pool. As the liquidity pool becomes larger, we expect the utilisation of the asset pool to become more stable, and for loan sizes to represent a smaller % of the pool, which will naturally reduce liquidity risk.