IPOR: The new pulse of DeFi development

23-06-07 15:50
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Original Title: "IPOR: The heartbeat of DeFi"
Original Author: ROUTE 2 FI
Translated by: Kxp, BlockBeats


DeFi is advancing. In the early stages from 2017 to 2022, we saw countless protocols focused on trading, leverage, staking, and maximizing liquidity. We are now entering a phase with more real-world use cases. IPOR is at the forefront of this and is revolutionizing DeFi through its Interest Rate Derivatives (IRD) protocol. One outcome of IRD could be fixed interest rates, which is the primary use case for IPOR. By hedging interest rate risks and creating a fixed interest rate product (or even more complex structured products).


Before we delve into this, let's take a look at the addressable market in the figure below. The crypto market is valued at approximately $1.1 trillion, while the largest index in the US stock market is $36 trillion. Real estate is valued at over $300 trillion, while the target market for interest rate swaps (which is the target market for IPOR) is valued at $450 trillion. In other words, IPOR has entered a market with huge potential in the crypto world.



So why should you care about interest rates and fixed-rate loans? Isn't that something only banks and institutions on Wall Street are concerned about?


Do not jump to conclusions so quickly.


Before we delve into the theory, I want to clarify a situation: I have read countless comments about protocols, many of which are purely theoretical and do not even understand the essence of the product. Therefore, I do not want you to experience the same thing.


Users/Agreements/Whales/DAO use IPOR and Compound for 28-day fixed-rate loans


 A protocol wants to borrow 1 million USDC for a period of 28 days. Currently, they can borrow on Compound at an annualized interest rate of 2.33%, but they do not know whether this rate will increase or decrease in each block over the next 28 days.


Therefore, the agreement decides to borrow on Compound and conduct a fixed-rate interest rate swap with IPOR to lock in a specific rate for 28 days.


They can do it like this:


1. Protocol/Whale/User owns 2 million USD worth of ETH and decides to provide it to Compound to obtain a safer collateral ratio (currently, the collateral ratio for ETH is 82%, so the protocol must deposit at least 1,219,512 ETH to obtain 1 million USD of USDC debt).


2. Then, the protocol/whale/user exchanges fixed-rate payments with IPOR for a notional amount of 1 million USDC. As IPOR allows for a collateral deposit ratio of 1,000 times less than the notional amount, the protocol deposits 1,000 USDC to IPOR (plus fees and clearing deposits). It is worth noting that here, 1,000 times leverage does not mean that you are taking a 1,000 times long position on an exchange. On IPOR, a 0.1% movement does not trigger liquidation. 1,000 times leverage on IPOR is about capital efficiency and not necessarily speculation, but rather reducing the amount of collateral for risk management purposes. We will explain this in more detail later.


3. Assuming you borrow at a rate of 2.5 on Compound, while the IPOR rate is 2.0. If during the borrowing period, the Compound rate is 3.0, while the IPOR rate is 2.5, you will hedge against the same volatility (50 basis points). In this case, the cost you need to pay is the interest rate differential, and if the fixed interest rate differential is 2.1% (IPOR + 10 basis points), then your cost will be 10 basis points plus the fee. Your effective fixed interest rate will be the Compound rate plus the interest rate differential and fee. For simplicity, we can say it is a fixed interest rate of 2.6%.


4. The agreement successfully locked in a fixed interest rate for 28 days for the borrowed 1 million USDC. They should continue to monitor their health factor/collateral ratio on Compound and ensure that they will not be liquidated on IPOR. However, for liquidation to occur on IPOR, the interest rate must drop significantly.


As we saw in the example above, you can use IPOR to lock in a fixed interest rate for the funds you lend on Compound. For example, the DeFi protocol Treasury may need to borrow to fund the development of new products. Or the DAO Treasury may have funds that will not be needed in the next 6 months and is willing to lend them for a fixed term, usually at a premium.


In this example, the interest rate of Compound is not the worst case. But imagine if you do the same operation on AAVE. There, the interest rate for fixed-rate borrowing can reach 12%, so using IPOR to lock in the interest rate will be more efficient.


Fixed-rate lending is crucial for the future of Crypto and DeFi. In the example above, DeFi protocols/whales/users do not know what the actual cost of their financing/borrowing will be, as interest rates can fluctuate at any time.


For institutions and whales in the crypto industry, it may make sense to pay slightly higher interest rates now because they know the rates will not change (for example, locking in rates for 6 months).


Assuming you can lock in a 2% interest rate on a $1 million loan for 6 months. This means that the user/institution will need to pay a total of $10,000 in interest when the 6-month period expires.


Therefore, by using IPOR, you can obtain this fixed interest rate, unlike using Aave/Compound, where the interest rate may fluctuate significantly and cause tension.


Okay, let's take a step back and explain in more detail what IPOR is and how it works.


DeFi Status and Credit Market


The total locked value (TVL) of DeFi is currently about $50 billion, which is a decrease from $200 billion at the end of the bull market in 2022.


According to DeFiLlama's data, lending applications account for about 30% of the total market, second only to decentralized exchanges (dexes). IPOR's TVL is currently $32 million and is increasing, with significant growth since 2023.



When most people think of DeFi, they consider returns and how to maximize them. However, a relatively undeveloped area is the crypto credit market. In the banking industry, this is a huge market ($450 trillion), but due to immaturity and lack of risk management tools, institutions and whales have been reluctant to try the credit market in DeFi.


In the real world, the credit market is very important for enterprises. Interest rates determine market conditions, and you may have noticed that technology stocks have risen sharply when interest rates are low (looking back at 2020 to early 2021). The reason why technology stocks and enterprises perform well in a low interest rate market is that they can borrow at low interest rates and reinvest it to obtain greater profits. In other words, interest rates are the pulse of the financial market. So, what is the pulse of the DeFi credit market?


Enterprises predict future cash flow and profits based on these interest rates. Interest rates are also important for ordinary people like you and me. Suppose you want to buy a house. Generally, it is easier to obtain a loan in a low interest rate environment because banks require less collateral. Higher interest rates will bring more costs to customers, and if the interest rate rises to a high enough level, you may be forced to sell the house.


In other words, interest rates guide the economy. For example, take a look at how important CPI and FOMC events are. During these events, there is always a great deal of volatility in the market because people know they will have a significant impact on asset and commodity prices.


As you may have guessed, this has led to a large number of speculators in the currency market, who bet on the rise or fall of interest rates.


Want to speculate? Get to know derivatives


How to place price bets in a simple way?


Get to know derivatives. Derivatives are contracts whose value is derived from the performance of an underlying entity. This underlying entity can be an asset, an index, or an interest rate, commonly referred to as the "underlying". Primarily, interest rate derivatives are used as risk management tools.


Returning to the example at the beginning, you can obtain a floating interest rate by borrowing and lending in Compound, and then hedge with a fixed interest rate in IPOR.


This is basically an interest rate swap. So, as someone who holds a floating rate loan (you), you pay a fixed rate while the other party pays a floating rate, hoping to gain from an increase in interest rates. You get what you want (the stability of fixed monthly payments), while the risk taker holding the floating rate loan may potentially receive lower interest rates.


The main purpose of interest rate swaps is to hedge risks. This mechanism has existed in traditional finance for a long time, but in the crypto field, interest rate swaps are seen as an important step forward. Please refer to the comparison of the market in the following figure.



If there was a way to bring a huge traditional financial market into DeFi and combine the mature concepts of traditional finance with DeFi best practices, wouldn't that be great?


Let's get to know the innovative DeFi protocol IPOR.


IPOR - The Pulse of DeFi


DeFi is not perfect. Borrowing and lending funds in Crypto have highly unpredictable loan rates, which may make traditional finance hesitant to use DeFi. DeFi also lacks a traditional risk-free yield curve for discounting cash flows. This means that it is difficult to accurately value a specific DeFi opportunity. Fortunately, IPOR has recognized this issue and aims to help mature DeFi money markets by building rate derivative financial instruments, achieving standardization of rates across the entire industry.


The IPOR protocol is built on the following premise: if DeFi is a global disruptive sandbox, then credit will be the catalyst. In order for the DeFi credit market to develop into tomorrow's fixed income market, they must provide the same risk management tools required by traditional financial institutions.


IPOR stands for Inter Protocol Over-block Rate, named after famous traditional financial indices such as the London Interbank Offered Rate (LIBOR) and the Secured Overnight Financing Rate (SOFR), and applicable to DeFi. IPOR is a mid-market rate determined by block-to-block sources, which is the closest approximation to real-time possible on the blockchain. Unlike LIBOR and SOFR, IPOR is not a quoted rate, but a mid-market rate.



The mission of IPOR is to help DeFi establish its own benchmark interest rate, which can serve as a risk-free rate in DeFi. An important difference is that IPOR uses block-to-block instead of overnight rates. This is reasonable because the crypto market is open 24/7, which is why it is called the pulse of DeFi. Like the pulse of the heart, the interest rate is always beating and is always up-to-date.


Imagine this: within 5-10 years, you can purchase a house with a decentralized bank loan. Interest rates are quoted at a premium of IPOR, and interest rate derivatives (IRD) of IPOR are used to hedge interest rate risks, all of which are completely invisible to the end user.



In short, IPOR has a simple mission: to become the foundational layer of the DeFi credit market.


IPOR Labs was founded by senior professionals in the crypto industry, who have extensive backgrounds in derivatives, quantitative finance, exchanges, risk management, venture capital, and enterprise software development. Please see below for the team introduction.


IPOR Labs' powerful team 


For IPOR Labs, it is impossible to develop this protocol without the right combination of talents.


They have 3 quantitative finance experts, two of whom have over 20 years of experience in the fixed income industry, and three with doctoral degrees.


As far as I know, they are the only DeFi protocol that has its own quantified financial database.


You can do what with IPOR?


1. Trading/Providing Liquidity 


By utilizing non-custodial on-chain IPOR derivative tools, you can lock in your interest rate or hedge your risk exposure.


This is similar to the example we gave at the beginning of the text, where we hedged our interest rate risk on Compound by establishing a position with 1,000x leverage on IPOR. Although 1,000x leverage may seem high, your profits accumulate gradually over time, unlike perpetual contracts which are immediate. This truly achieves efficient use of capital (very useful for hedgers). In addition, profits also accumulate over time, for a period of 28 days.



Returning to our example, suppose you borrow a USDC loan of $1 million at a floating interest rate of 2.33% on Compound. If the interest rate rises, you will need to pay more interest.


This is why you need a product. If the interest rate on Compound rises, you can earn interest income from it. In other words, you want to "bullish" the interest rate (you want to "pay fixed interest and receive floating interest").



Liquidity providers (LPs) play a crucial role in providing necessary funding support for derivatives (acting as swap guarantors). The liquidity pool can be seen as a market maker that continuously provides liquidity.



In order to facilitate derivative trading by traders (or buyers) on the other side of the trader's contract, the IPOR protocol reserves funds as collateral from liquidity providers (market makers). When a trader's derivative trade is successful, the funds in the liquidity pool will be used to settle the payment amount to the trader.


When LP provides funding to the pool, it will exchange its stablecoin for liquidity tokens. Each currency has its own specific liquidity token, called "ipToken", such as ipUSDC.


When traders open derivative contracts or withdraw liquidity (fees) and the profits and losses of traders will bring benefits to LP. However, providing liquidity is not without risk. LP is actually the counterparty of traders. Therefore, if a large number of traders make huge profits, LP will face the risk of losses. If traders make profits, the funds in the pool will be used to pay the net payout amount.


2. Ipor Index 


Consider IPOR as the benchmark risk-free interest rate. What is risk-free? In DeFi, we can say that over-collateralized loans are equivalent to risk-free.


Therefore, IPOR can be used to hedge risk-adjusted returns.


If you earn a 6% return in a certain under-collateralized market, and the asset's IPOR is 2%, then your risk premium return is an additional 4%.


This is still a good way for anyone to see how their credit conditions compare to other market participants. This is a transparent on-chain data point where anyone can see if they have received a good or bad transaction.


Switch the currency and view the current IPOR rate. Hover over the line to see the past 30 days' performance. In the application, you can see a more detailed version with details ranging from 24 hours to one year.



Multiple IPOR indices are provided to represent different assets, such as IPOR USDT, IPOR USDC, and IPOR DAI. IPOR indices can serve as suitable substitutes for risk-free (Rf) interest rates.


For each type of asset, a 1M, 3M, 6M, 1Y, and other time-based interest rates will be established to form their own yield curve. This yield curve will promote the development and operation of on-chain interest rate derivatives market.


Therefore, you can use IPOR for interest rate hedging, arbitrage, or speculation.


We have already discussed how to use IPOR to hedge your interest rate (for example, by locking in your interest rate on Compound through IPOR).


Arbitrage 


There are three different stablecoins (USDC, USDT, and DAI) on IPOR. You can see that they have different interest rates on IPOR, which you can take advantage of.


Assuming the interest rate for USDC is 2.5% and the interest rate for USDT is 3.5%, you can borrow USDC and ensure borrowing costs through fixed interest rates, then exchange USDC for USDT. Afterwards, you can lend USDT using a fixed income contract.



Many such tools have announced that they will be put on the chain, so naturally, the trading of interest rate differentials will take place on IPOR. Even if the paradigm is reversed, that is, DeFi rates are higher, this process will also be reversed.


With so many project plans introducing UST interest rates onto the chain, this narrative has become even stronger.


Speculation 




Okay, now let's take a look at the governance token of IPOR.


IPOR Token


IPOR Token is the governance token of IPOR DAO.


It allows holders to vote on various proposals, including future protocol development, fees, and financial matters.



The token allocation is as follows:




· 30.00% DAO Reserve

· 25.00% Liquidity Mining· 13.15% DAO operation· 11.85% investors




Now that we know about IPOR, let's take a look at its collateralized version, called Power IPOR (pwIPOR).




IPOR Labs on Twitter: "Join the #IPOR meme competition and exchange ideas to gain Crew3 experience. Express the power of #PowerIPOR visually. There is one week left. You can earn up to 1000 XP. pwIPOR is a non-transferable token anchored 1:1 with IPOR Token. This means that pwIPOR is generated through revenue sharing, and your IPOR and pwIPOR balances will increase simultaneously.


As an LP, you will receive ipTOKEN, which is essentially an accounting Token with a fluctuating interest rate. After providing USDC, you will receive ipUSDC. In the future, these ipUSDC should be able to exchange for more USDC.


The earnings of ipTOKEN will not be affected by the earnings of pwIPOR.







Actual revenue 



Liquidity providers deposit assets into the fund pool (currently USDC/USDT/DAI), and traders can open interest rate swaps (IRS) on the fund pool. Automated market makers provide quotes. At maturity or liquidation, the net return will be returned to all parties.


1. Cost

2. SOAP 

3. Asset Management (Leveraged Money Market Returns)



Whenever a trader opens an IRS, they currently need to pay a fee of 1% of the collateral deposit. The entire fee goes to the liquidity provider.

Why do traders have to pay fees to open contracts? Because they want to take a certain stance on interest rates. If no one is interested in the contract, there is no fee. Here are some use cases for IRS.


SOAP 


S.O.A.P. is the sum of all returns. You can think of it as a snapshot view of unrealized profits and losses in the pool at any given time. If you want to learn more about the calculation method of SOAP, please read more information here.


In the IRS of IPOR, traders and liquidity providers will win and lose in multiple contracts. It is important to note that these profits and losses serve a purpose for the traders, which is why they open contracts and pay fees. In terms of returns, the pool typically goes long (paying a fixed rate) and short (charging a fixed rate) in multiple contracts simultaneously. The net result is the pool's realized profit or loss.


An automated market maker aims to maintain risk neutrality in the pool, in other words, it should win and lose an equal number of times. This is why SOAP is a core element for the next tool and iteration of the protocol, so please familiarize yourself with it and stay tuned.


Asset Management 


Liquidity providers' capital guarantee swaps, traders deposit stablecoins, and these funds will only be used when they need to be paid during contract settlement.


If you can use these funds in the currency market, what will happen? That's the fact. The collateral of liquidity providers and traders is directly obtained from AAVE and Compound, without paying them.


This can be seen as leveraged currency market returns for liquidity providers, who can also receive returns on collateral pledged by traders.


Why not allocate stablecoins to potentially higher-yielding opportunities? First, the IPOR index's credit market is based on protocol quality and time selection, so the risk is relatively low.


The design of this protocol utilizes security and risk management to achieve long-term stability. When considering higher returns, return calculations must take into account risks, and given the uncertainty of younger protocols that typically have higher potential returns, asset management tends to use leveraged income methods in low-risk opportunities rather than pursuing higher immediate returns. Another benefit of allocating funds to index component protocols is that it enhances the protocol's utility by becoming a direct participant in the credit market derived from it.


From the perspective of liquidity providers, they have the option to:

1. Directly providing liquidity to the currency market.

2. Or provide liquidity on IPOR to earn fees, SOAP, and leveraged cryptocurrency market returns.



Let's visit: https://app.ipor.io/ and click on "Investment Portfolio". You will see the following image:



Next, click "Redeem".



Here, you can see different indicators of three different stablecoins.


· IPOR USDC Index - IPOR's USDC rate. The IPOR rate is a weighted average of the borrowing rates of Aave and Compound. More protocols may be added or removed from this rate in the future.

· Median value: The median interest rate (average IPOR rate).

· Fixed payment: How much fixed rate do you need to pay if you make an exchange? (Fixed payment refers to holding a long position in interest rates)

· Fixed income: How much fixed interest will you receive if you make an exchange? (Fixed income refers to holding a short position on interest rates)


About exchange instructions


Before conducting actual exchanges, let's remember the following points:


· Exchange involves a 1% opening fee, which will be paid to the liquidity provider.

· The exchange also involves a refundable clearing margin of $25. If no liquidation occurs, this margin will be refunded.

· Positions will be automatically closed when you reach 100% profit or loss, and the maximum profit currently is 2 times.

· 10% of the profit will be deducted as income for IPOR DAO.

· Leverage: You can choose leverage of up to 1,000 times.

· Minimum leverage: 10 times

· Maximum deposit: 100,000 US dollars.

· The maximum deposit for each wallet as an LP: $50,000 USD.

· The maximum deposit in an LP: $300,000 USD.


All of these values are the initial values at the start of IPOR and will be subject to change by governance.



· Collateral: You must provide collateral to carry out the exchange.

· Leverage: How much leverage do you want to use?

· Nominal amount: The amount you wish to hedge (for example, if you borrowed $100,000, the nominal amount would be $100,000. If you set the leverage to 1,000 times, the collateral should be $100).

· Exchange direction: the asset you wish to exchange

· Expiration Date: The validity period of the contract, currently 28 days.

· IPOR Interest Rate: The benchmark interest rate, with a value equal to the median of Aave and Compound interest rates.

· Spread: The difference between the floating rate and fixed rate paid by LP.


The above keywords and explanations can help you open your first position on IPOR.


In order to conclude the in-depth discussion on IPOR, I would like to mention some recently released IPOR updates:


1. IPOR will reduce the circulation

The first proposal took effect on April 25th, which reduced the daily issuance of LM (liquidity mining) from 10,800 pwIPOR to approximately 7,560 pwIPOR. This change resulted in a significant extension of the distribution time for all liquidity mining rewards (25m), from 6.34 years to 9 years.


2. Latest update on the revenue growth curve of pwIPOR.













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