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How important is fixed income? Combing DeFi and discovering 4 fixed income models
Summarized by AI
Original title: "Fixed Rate Yields That Outperform ETH Staking"
Original author: Jack Inabinet, Bankless
Original compilation: Jack(0x137), BlockBeats
As we all know, fixed rate returns are uncommon in the crypto market due to its high volatility. This is a huge problem for creditors and debtors looking to match fixed rate liabilities with fixed rate assets. TradFi (traditional finance) entities in particular need access to convenient fixed rate solutions for proper asset and liability management.
The ability to mitigate the risks associated with a given funds, insurance companies, and hedge funds) are critical and are often achieved through derivatives that offer capital-efficient solutions for risk management and are often more favorable than balance sheet restructuring activities accounting and disclosure treatment.
From the perspective of lenders in the financial market, there is no effective hedging of changes in ETH pledge yield Lenders are unable to offer fixed rate products that do not expose them to significant interest rate risk. While over-the-counter OTC desks have developed derivative contracts for ETH collateralized returns, these contracts are inaccessible to many market participants and are off-chain, limiting use cases and aligning the protocol with the composable ecosystem that DeFi offers isolated.
As an analogy, a commercial bank wishing to hedge against rising interest rates might choose to sell U.S. Treasury futures, Instead of selling U.S. Treasuries for cash. In this way, on the one hand, the bank retains the benefit of the sale, and on the other hand, the use of futures contracts avoids the immediate transfer of cash or other assets between counterparties, thereby avoiding taxable events for the seller.
Ordinary individuals (i.e. users who do not operate according to the "Degen Standard") also attach great importance to reduce the volatility of its portfolio. In a bear market, when BTC reaches $69K and ETH exceeds $45K, you will most likely be trading some potential rewards in exchange for protection from the market downside.
Unfortunately, we all seem to be trying to reach the stars, but end up lifting the rocks Smashed his own foot. We all pray for the recovery of the bull market, but in the meantime, you have the opportunity to absorb more knowledge than Tai Lopez sitting in a garage full of books and Lamborghinis Start a business, turn from bankruptcy to become a billionaire).
When the next bull market occurs, you will learn about various fixed income derivatives and products, allowing you to Better manage your portfolio risk for the next cycle yourself.
Fixed Rate Solutions in DeFi
Developers are already working on solutions to curb volatility in the crypto market. Some have turned to all manner of exotic derivatives in search of the next advanced DeFi product. Currently, there are four common solutions for obtaining fixed income:
1. Revenue split
2. Interest rate swap
3. Structured financing and trading
4. Fixed Rate Loans
For these unique methods and their respective The analysis of fixed and variable returns provided by the protocol will allow us to compare future returns between different strategies by adjusting the return on investment (ROI) of the income stream in proportion to the unique risk profile of the underlying asset.
Let's expand and take a closer look.
1. Revenue Split
Revenue Split Protocol, as the name suggests, is to split the yield-generating Token (such as rETH or stETH) into principal and yield components with known maturity dates .
What is the income and principal?
Imagine borrowing $100 at 6% per annum, due at the end of each month Repayment, the loan will be paid off within one year due. Each month, this results in $0.50 in bank interest. On a monthly basis, these interest payments yield about 6.17% to the lender. At the end of the year, the borrower must also repay the principal (or loan amount) of $100.
The loan presented in the above example represents an interest-only repayment structure, That is, the type of debt instrument yield split agreement adopted. Importantly, there must be a definite maturity date in order to price the principal and yield tokens.
Before this, all the income generated by the underlying assets will only belong to the Token holder all. When the contract expires, the holder of the principal token will be able to exchange the principal token for the underlying collateral at a ratio of 1:1. Since the proceeds do not belong to the holder of the principal Token, it will be traded at a price lower than the face value of the underlying object.
The difference between the underlying asset and the principal Token is actually the value of the income Token, Before the contract expires, the income Token will be greater than zero. The formula for determining the value of the principal and income Token can be expressed as:
Income Token Price + Principal Token price = underlying asset price
If the total value of income and principal Token is greater than the underlying asset value, there is an arbitrage opportunity, and the principal and income Token can be minted and sold in the market. And when the price of the underlying asset is greater than the total value of the rate of return and principal Token, there will also be arbitrage opportunities, so that two tokens can be purchased and redeemed to obtain a greater value of the underlying asset. Therefore, the total price of principal and yield tokens will closely reflect the value of the underlying asset.
Principal and income Token valuation is affected by the income generated and the maturity time. Yields fluctuate over time. Therefore, when the yield increases, the willingness to buy yield tokens will increase, and vice versa. Investors will also be less willing to pay for yield tokens as contract expiration approaches, as the total yield to be generated is lower.
The holders and purchasers of principal Token basically fix their returns, because They can hold their security until its maturity and redeem it for a known amount of the underlying asset at that time. There are no interest rate fluctuations, because changes in yield, whether negative or positive, are borne by yielding token holders.
Agreement using the principal/revenue Token structure includes:
Although there is There are subtle differences, but these protocols all divide the yield-generating assets into principal and yield tokens. This structure allows users to engage in leveraged variable interest rate speculation. Users mint principal and income tokens from underlying assets, sell principal tokens, and purchase more underlying assets, repeating the process until the desired variable interest rate exposure is achieved. port, or by purchasing the principal Token to lock in a fixed interest rate.
2. Interest rate swap
Interest rate swaps, while prominent in the TradFi world, have yet to materialize on a large scale in the DeFi market.
It was first published by Voltz Protocol is used in DeFi. The premise of Voltz is simple, the agreement aims to offer a product similar to a traditional interest rate swap: the buyer agrees to pay a fixed rate and receives a variable rate from the seller. In Voltz's terminology, buyers of interest rate swaps are called "Variable Takers," while sellers of swaps are called "Fixed Takers."
Margins are built into the protocol, greatly improving capital efficiency and allowing users to spend less Capitals hedge or expand their exposure to interest rate fluctuations.
Just as the notional derivatives market in TradFi dwarfs the spot market, Voltz's interest rate swap It is also possible that the notional value of the market far exceeds the market value of its underlying asset. If this dynamic is the same as it is in the TradFi market, this is a huge opportunity.
So how does Voltz work?
Fixed rate bearers (swap sellers) in Voltz can fully collateralize their positions, without exposing users to liquidation risk or increasing the risk of potential interest rate changes.
Voltz establishes upper and lower bounds on the expected volatility of interest rates before the maturity of a given pool of funds Modeling to calculate initial and liquidation margin requirements further improves capital efficiency. Oracles provide pools with rate information and determine cash flow allocations to fixed and variable rate bearers, while virtual automated market makers are used for price discovery.
The nature of the swap means that the fixed rate bearer has a known and capped payout . However, variable rate bearers have unlimited upside risk to the variable rate increase offered by the underlying asset. The payoff matrix produced by this phenomenon incentivizes more speculative activity within the variable rate bearer group.
Additionally, liquidity providers provide seamless The ability to trade experience is critical.
Voltz's AMM is modeled on Uniswap and uses the concept of centralized liquidity. Since transactions require only one asset, LPs on Voltz are not subject to impermanent losses. However, they face losses from what the protocol calls "Funding Rate Risk," which occurs when there is an imbalance between fixed and variable rate bearer activity and rates fall outside the LP's liquidity scale.
As a result, LP now holds an out-of-the-money position. Funding rate risk effectively substitutes for the impermanent losses of spot market AMMs. This is a tradeoff that must be considered and balanced against the ability to earn protocol transaction fees.
3. Structured financial instruments and transactions
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Tranching protocols also draw inspiration from traditional financial instruments, including the infamous Collateralized Debt Obligations (CDO), which It was the chief culprit of the 2008 financial crisis. There are different noteholders in a CDO, and each class has a different priority for repayment.
The current DeFi layered protocols are:
2. BarnBridge
What these protocols essentially do is bring liquidity and risks are divided into different pools. Both agreements establish senior (lower risk) and junior pools (higher risk), with the senior pool having priority access to any cash flow income from loans or yield farming activities, secured by credit enhancements on the junior tranche. For example, participants in the junior pool will suffer losses when the underlying securities do not generate sufficient returns to repay the senior pool.
In exchange for providing security to Premium Pool Participants, if the total Junior pools have the ability to generate additional upside if returns exceed those paid to senior pool participants. Participants in the advanced pool receive a fixed interest rate and enter the position at or below the current rate of return generated by the basic rate of return Token.
BarnBridge calculates the rate of return offered to the premium section using the following formula:
Advanced rate of return = moving average rate of return * primary loanable liquidity / total pool liquidity (where "moving average rate of return Rate" is defined as the three-day moving average rate of return generated by the underlying asset)
In contrast , Tranche Finance determines the fixed interest rate provided to all fixed interest rate bearers through governance Token voting, which means that the interest rate is not fixed and may change at any time. Changes in fixed rates may be beneficial or unfavorable to senior sectional participants.
Previous BarnBridge V1 iterations, while designed to protect premium pool participant returns, did not Explicitly guaranteed fixed rates, as senior pool participants face potential declines in returns after significant declines in the variable rates offered by the underlying securities, and thus also fail to offer true fixed rates.
4. Fixed rate loan agreement
Fixed rate loans can have a similar liquidation process as variable rate loan agreements. At the maturity of the loan, the borrower pays the lender a fixed interest rate. Furthermore, the pre-specified term means that the lender cannot access its funds until the loan matures, and the borrower faces the impact of prepaying the loan, unlike in a variable rate agreement where the lender's on-demand withdrawals (if liquidity is available) and the borrower The ability to fully close a position at any time varies.
In a fixed rate loan agreement, the borrower may be liable for default penalties or be forced to loan until Only when the contract expires can the position be closed.
Fixed rate loan agreement includes:
3. HiFi
Better than the benchmark interest rate
At this point, you may be wondering:
“How can I include fixed rate derivatives and lending strategies in my portfolio to exceed the benchmark rate of passive income generation from ETH staking rewards?”
I use this extremely detailed report to block validators analyze reports to establish a benchmark rate for ETH stakers. This analysis was done before the merger, so I adjusted the upper and lower quartile bounds (optimistic and pessimistic return scenarios) proportionally to current ETH staking returns.
Back to the whole "collateralized ethereum can be thought of as a composite bond, the interest rate may one day Cited as the concept of "the spread of ETH's return rate", this rate of return is regarded as the risk-free rate or the minimum rate of return that experienced DeFi investors are willing to accept.
While all of the above protocols allow users to hold fixed rate positions, only a few ( Voltz Protocol, Element Finance, Sense Finance, Notional Finance, and Yield Protocol) offer yield products that I believe are comparable to ETH staking reward rates.
In the graph below we compare the estimated ROI vs. returns offered by fixed rate instruments:
The current variable APY and APR listed for each asset against the yield of the underlying asset, image from Bankless
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Red fixed rates represent strategies with returns below pessimistic estimates. In contrast, fixed rates shown in orange indicate that the strategy met or exceeded pessimistic forecasts, but failed to exceed expected staking returns. Those shaded in light green met or exceeded the expected variable ROI of staking, while those shaded in dark green met or exceeded the most optimistic staking expectations.
Due to the variable rate of return of liquid mortgage derivatives and ETH-stETH stable pool and Ether Fangfang mortgage returns are different, we can assume that they have different risk profiles.
For rETH and stETH, the risk of slashing is lower than independent pledge Ethereum, and the two protocols Both provide slashing insurance to protect user deposits. Additionally, staking with Lido or Rocket Pool is much easier than running your own validator, and users who don’t meet the 32 ETH minimum stake will also have the opportunity to stake. Investors trade marginal returns for these guarantees and conveniences, accepting rates of return below the risk-free rate.
Provide Curve with ETH-stETH liquidity, represented by steCRV principal Token, also Has a different risk profile than simply staking Lido. Enhanced returns represent smart contract risk from Curve, in addition to native smart contract risk and impermanent loss risk inside Lido. While Curve is battle-tested, the high rate of return suggests that investors are less willing to accept returns below the current variable APR. If this were not the case, we expect the rate of return to be close to the current variable ETH staking reward rate. To account for these differences in the risk profiles of various major assets compared to Ethereum staking, the estimated variable ROI resulting from the staking ROI analysis is scaled for risk.
Unfortunately, I must announce that the media attention to Voltz has brought A lot of "smart money". Despite the Degen look of the protocol, the rETH and stETH interest rate swap yields a fixed ROI surprisingly close to the expected ROI of Lido or Rocket Pool. Sorry, no obvious arbitrage opportunities here.
But the Voltz protocol allows speculative market participants to place bets on the direction they think the market is going , and offers sophisticated market participants the only opportunity of any protocol to hedge upside and downside risks with effective interest rates. If you think the staking reward rate will decrease, you can use the fixed rate offered by Voltz, and similarly, users who are bullish on the staking reward rate can take advantage of the variable rate offered by the protocol.
Element's fixed income ETH product performed slightly worse than the expected ROI of staking, but Compared to the variable staking returns offered by principal tokens, the similarity of returns provides risk-averse investors with the ability to hedge against fluctuations in interest rates. Using Element Fixed Income provides an end result similar to using the Voltz protocol, but using a different investment vehicle.
Notional is a bit unusual when it comes to fixed loans. Fixed rate loans issued with earlier and longer maturities both provided fixed returns below pessimistic estimates. In addition, the APR offered by the fixed-rate loan due in September was 111% higher than the APR offered by the December note. If that's not an inverted yield curve, I don't know what is. Is the dreaded market crash imminent? It is possible, but we leave that question to economists.
Yield Protocol also fails to offer a desirable fixed rate for ETH borrowing and lending. The inefficiencies in the fixed-rate loan market may be a direct result of the current market uncertainty and volatility, as lenders must lock their ETH to maturity: flexibility and liquidity are critical to portfolio health in a bear market.
There can also be Alpha in fixed income
While several potential arbitrage opportunities stand out, the most enticing may be using ETH offered by Sense Finance before May 31, 2027 fixed rate of return. The prospect of pegging ETH’s annual return at 7.21% is too good to pass up.
Scaled for stETH's risk profile, this fixed rate exceeds the most optimistic future response rate. While gas fees may increase, temporarily boosting the staking reward rate, it is also plausible that increasing the number of validators would reduce the increase in rewards and thus the yield on ETH.
In addition, the beacon chain withdrawal is currently not enabled, which means that if the Gas fee is further If the number of validators is reduced, the number of validators will remain the same, artificially depressing the staking income, because the number of validators can only respond to the increase of gas fees.
Voltz offers reduced The best solution for interest rate risk. Actual market pricing enables entities to hedge portfolio risk and does not force them to take speculative positions on the direction of interest rates. Instead, it allows variable rate cashflows to be converted from staking to fixed yield at rates competitive with projected ETH staking returns.
The ability to fix interest rates in DeFi is critical for the industry to be adopted by traditional financial institutions. The recently launched Voltz is an important innovation in the decentralized fixed-rate derivatives market, not only because the protocol improves capital efficiency, but also because it provides accurate pricing for interest rate swaps, especially when compared to current alternative fixed-rate derivatives products in comparison.
In addition to the interest rate risk management agreement, compared with pledged ETH, the market for fixed interest rate agreement Inefficiencies provide veteran DeFi users with access to an accessible, low-risk source of return. In addition, these products provide another source of speculation for DeFi users and implement a new "Degen standard of conduct", that is, transaction rates instead of transaction tokens.
As cryptocurrencies become more mainstream, the fixed rate market is likely to increase in importance. While the range of practical use cases for yield derivatives today is relatively limited, the rigidity of the crypto market will bring the demand for fixed rate products in DeFi into line with that observed in the TradFi market.
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