From Change to Stability: The Most Complete DeFi Fixed Rate Agreement in History (Part 2)

A hundred schools of thought contend for fixed-rate agreements

Interest rate income assets are everywhere in DeFi, such as lending, AMM LP transaction fees, protocol lock-up rewards, liquidity mining, income aggregation, etc., but the interest rate on the blockchain is dynamically determined by market forces. The changes are dramatic.

However, the uncertainty of interest rate changes makes it difficult for investors to ensure future returns or control leverage costs, and thus there is no way to efficiently utilize funds and make long-term financial planning, which hinders the further development of DeFi. Even though DeFi is still in the early stages of the innovation adoption curve, with crazy mining opportunities with triple-digit APY everywhere, making early users less sensitive to interest rate fluctuations, there are still many DeFi pioneers who are keenly aware of the importance of fixed interest rates. They use their own wisdom to design DeFi protocols with different mechanisms, trying to open up the fixed interest rate market.

In the last article, we did an in-depth analysis of all the mainstream fixed rate agreements on the market. To sum up, they can be divided into two categories and three small ways:

Category 1: Fixed-rate Loan

Agree on a date, an agreed amount and a fixed interest rate with the counterparty for loan transactions.

  • Zero-coupon Bond:

The borrower sells it to the lender at a discount by issuing a zero-coupon bond, where the difference between the buying and selling price and the denomination of the bond is the fixed interest on the loan between the two.

Category 2: Yield Redistribution

Co-invest in interest rate yielding assets, but distribute yields based on risk appetite.

  • Split Principal & Interest:

The principal and future interest of interest rate income assets are separated, and they are packaged into tradable assets; the interest that changes in the future is sold in advance to obtain a clear fixed interest.

  • Structured Product:

The future risk and income are stratified, the low-risk level can give priority to the agreed income, and the remaining income is handed over to the high-risk level, correspondingly, the high-risk level must bear the risk of market interest rate changes.

According to the above classification, the corresponding agreements are arranged in the following table:


Fixed rate agreement implementation mechanism classification table

The above methods have slightly different ways of generating fixed interest rates and have corresponding advantages and disadvantages, but the common point is that they are all based on a financial market designed based on a certain source of investment income (lending, aggregate income…), and everyone trades in it. not only the interest but also the original investment principal. However, in the process of transitioning from “floating” to “fixed” interest rates, what we really care about is the hedging of “interest rate fluctuations”.

That is to say, we don’t really care about the principal deposited into the yielding asset, or even the interest rate itself. What we care about is the “difference” between the actual interest rate after borrowing/saving for a period of time and the originally expected interest rate, and hope The above volatility risks can be passed on in some way.

In traditional finance, the most commonly used tool at this time is Interest Rate Swap.

Interest Rate Derivatives

In the 1970s, with the onset of the oil crisis and the collapse of the Bretton Woods system, high inflation and higher and more volatile interest rates were pushed up. In order to control interest rate risk, related interest rate derivative financial products began to develop gradually and were welcomed in the market. Since the world’s first interest rate exchange between IBM and the World Bank in 1981, interest rate exchange has become the financial commodity with the largest trading volume in the interest rate derivatives market.

Interest rate swaps are similar to futures markets, consisting of traders with the same underlying but opposite directions. You can go long or short on interest rates, and get corresponding rewards or losses based on future interest rate trends, and a proper purchase of interest rate swaps can just offset the gains and losses of interest rate changes in floating interest rate (borrowing or lending) positions.

For example, Company A has a debt of $1M at a floating rate of USD six-month LIBOR +2%, the company expects LIBOR to rise and wants to lock in interest costs up front. At the same time, Company B also has a debt of $1M, which is paid at a fixed interest rate of 5%, but he also has an investment with a floating interest rate income. He hopes that the future investment income can cover the interest expense, so he hopes to convert it into a six-month term in US dollars. LIBOR-based floating interest.

As a result, the two companies signed a 3-year IRS with a principal of $1M, agreeing that Company A would exchange a fixed interest rate of 6% for Company B’s six-month LIBOR + a floating interest rate of 1%. The result:

Company A: Receives 7% of total fixed interest on debt


Company B: Receives debt with total floating interest of LIBOR


At the same time, when the actual settlement is made, only the agreed difference between the two is exchanged. From the perspective of A, it is equal to 5% – LIBOR.

for example:

The first period LIBOR is 4.8%, and A only needs to pay 1M ⨉ 0.1% spread to B.

Note: 0.1% = (5%-4.8%)/2

The second LIBOR is 5.2%, and A can charge 1M ⨉ 0.1% spread from B

Note: -0.1% = (5%-5.2%)/2

From the above example, we can see the benefits of IRS. Since the two parties actually only settle the part of the interest rate difference and do not involve the principal, the trader only needs to deposit a small amount of margin to be able to pay a large amount of nominal principal (Notional principal). Principal) for hedging, so the capital efficiency is very high.

Based on this concept, we believe that the ideal design direction of DeFi fixed interest rate should be a leveraged interest rate derivatives market, allowing investors to trade a large amount of interest with a small amount of funds, so we proposed iGain — Interest Rate Synth.

iGain — Interest Rate Synth

iGain is a DeFi derivatives trading framework proposed by Hakka Finance. It uses the floating interest rate in the interest-earning income agreement as a settlement indicator (for example, the floating interest rate in the lending agreement), and packages the abstract concept of interest rate into tradable financial products. Create an interest rate synth and build an unprecedented interest rate trading market in the DeFi world.

concept of design

The iGain trading framework adopts Long/Short dual-token design, and we can do long and short operations on any finger. In the IRS, holding Long represents a bullish interest rate, and holding a Short represents a short interest rate.

The core design of iGain is the characteristic of mutual influence of Long/Short price, which is represented by the sum of the two being equal to one dollar:

1 Long + 1 Short = $1

The settlement price of Long is related to the accumulated interest rate during the period, and its price is limited between $0 and $1, while the settlement price of Short is 1 – Long, the two complement each other, so if the price of Long increases, Short will automatically decrease ,vice versa.


The sum of the prices of Long and Short is always $1

All Longs and Shorts in iGain are minted by depositing tokens. According to the aforementioned relationship, each token can mint 1 Long+ 1 Short. On the contrary, it can also be minted by destroying the same amount Long and Short, in exchange for the same amount of tokens.

Build-in DEX

In order to trade Long and Short, liquidity is required first, a decentralized exchange is built in iGain, and the constant product market maker x×y=k is used as the AMM model. This liquidity pool consists of Long and Short. If there are a Long and b Short in the pool, the value of the two currencies in the pool has the following relationship:


Suppose we take DAI as an example, and with the aforementioned relationship of 1 Long + 1 Short = 1 DAI, the simultaneous equations can be solved to obtain the price formulas of Long and Short:


Once a transaction occurs, the amount of a and b in the pool will be changed, which will also affect the prices of Long and Short.

It can be seen from the above introduction that there are no trading pairs such as Long/DAI or Short/DAI in the iGain system, and only the exchange between Long and Short can be done. Therefore, if you want to buy Long with DAI, you must first use DAI to cast it. Equal amounts of Long and Short, and then replace Short with Long in the flow cell.


The process of increasing liquidity and buying Long & Short

Conversely, if you want to sell Long to DAI, you must first exchange some Long for Short, and redeem DAI with the same amount of Long and Short.


The process of selling A Long to X DAI

price settlement

Under the iGain trading framework, different financial derivatives can be created as long as the indicators used for settlement are replaced.

The lending protocol supported by the first version of Interest Rate Synth (IRS) is Aave, and more income assets such as Yearn will be supported in the future. For Aave, the settlement price of Long is based on the “accumulated loan interest during the period” as an indicator. The more interest accumulated during the period, the higher the settlement price of Long, and the lower the settlement price of Short. It means that investors can long interest rates by buying Long, and short interest rates by buying Short.

Implementation method

Debt tokens are obtained when borrowing at a floating rate in Aave, and the exchange rate is determined by the size of the variable getReserveNormalizedVariableDebt in Aave. With the accumulation of loan interest, the loan debt will gradually increase, and the value of getReserveNormalizedVariableDebt will continue to increase. The IRS calculates the interest accumulated by the system based on the “change rate” of this variable during the period, and calculates the settlement price of Long based on this rate of change.

The program implementation method is to record the conversion ratio at the beginning when the contract is initialized:

initialRate = AAVE.getReserveNormalizedVariableDebt(asset)

When the settlement is due, read the last conversion ratio:

endRate = AAVE.getReserveNormalizedVariableDebt(asset)

With initialRate and endRate, you can calculate the percentage increase in floating deposit interest during the period:

ratio = (endRate – initialRate) / initialRate

For example, if the ratio at maturity is 0.04, it means that 4% of the borrowing interest has been accumulated during the period. If you settle directly at this rate, the settlement price of Long is $0.04, and the price of Short is $0.96

In order to increase the efficiency of capital use, we can backtest based on historical data and add appropriate leverage to the interest rate. Following the previous example, if 10x leverage is added, the settlement price of Long becomes $0.4, and the Short is $0.6.

_bPrice = leverage * rate

Long will use bPrice as the settlement price, and its price must be between $0 and $1. If the settlement price exceeds $1, it will be calculated as $1. The specific calculation method is as follows:

Long settlement price: bPrice = min(_bPrice, 1)

Short’s settlement price: 1 – bPrice

How to achieve a fixed interest rate

fixed rate lending

After depositing in Aave, the interest rate will change with the Utilization Rate. At this time, if you buy the corresponding amount of Short to short the interest rate, you can hedge against future interest rate changes after establishing a reverse position to lock up to The total amount of interest on the maturity date (see note), the actual “required purchase quantity” and “the amount of interest rate that can be locked”, please refer to the following description.

Quantity required to purchase:

If you want to just offset the future interest rate change of the deposit position, you need to buy a specific amount of Short, and the size of this amount is related to the leverage ratio. The higher the leverage ratio, the less Short you need to buy, and vice versa.

Taking deposit Dai as an example, without leverage, a deposit position of 1000 Dai needs to buy 1000Short to hedge against changes in interest rates. If the leverage is 10 times, you only need to buy 1000/10 = 100Short.

Required Quantity = Total Deposit / Leverage Ratio

The higher the leverage ratio, the smaller the number of tokens to be purchased, and the higher the capital efficiency.

Fixed rate size:

As can be seen from the previous section, the price of Long is determined by the accumulated interest and leverage ratio.

During settlement, the settlement price of Long can be calculated from the realized interest rate nowRatio. Similarly, we can also calculate the cumulative interest rate markRatio corresponding to this price from the average transaction price of Long. The difference between the two interest rates, deltaRatio, can be hedged. interest rate.

Then calculate the timeToMaturity from the expiration date, and then you can calculate the fixed interest rate APY with compound interest:

Note: It is important to note that since the settlement price of the IRS is calculated based on the borrowing rate, it is impossible for the depositor to offset the future changes in the deposit interest rate. The interest rate actually obtained by the depositor at the time of settlement may be different from the above calculation The result is slightly inaccurate.

iGain — IRS provides one-click service for fixed rate lending

Fixed Rate Borrowing

If you want to borrow at a fixed interest rate, you need to buy a corresponding amount of Long to take a long interest rate to lock in future borrowing costs. The amount of Long to be purchased to hedge the borrowing rate is calculated in the same way as for fixed deposits:

Required Quantity = Total Loan / Leverage Ratio

When calculating the loan APY, you only need to change the calculation method of markRatio to the transaction price of Short:

The rest of the steps are the same as for fixed-rate loans, and you can end up with:

Practical example

Holding Long/Short does not mean that the interest rate in the loan agreement can be directly changed from floating to fixed, but to achieve the effect of fixed interest rate by establishing a position opposite to the change in interest rate.

The following takes fixed-rate borrowing as an example to illustrate the role iGain plays in this system with a practical example.

Suppose that there is a period of iGain that expires in one year, and the leverage ratio is 10x.

Jack borrowed $10,000 from Aave and purchased 1,000 Longs at an average price of $0.4 at the beginning of this iGain period, spending $400 to achieve the effect of a 4% fixed rate loan.

The following is a trial calculation of the final realized interest rate for several different situations:

Case 1:

After one year, Jack’s realized borrowing rate on Aave (a floating cumulative effective rate) is 8%.

At this time, Jack’s total accumulated floating loan interest in Aave is $800, while Long’s settlement price is $0.8, and a total of $800 can be redeemed, which is a net profit of $400 compared to the cost of buying Long.

After adding the profits and losses of the two parts of Aave and Long, it is equivalent to paying a total borrowing cost of $400, which is a 4% interest rate loan.

Case 2:

After one year, Jack’s realized borrowing rate on Aave is 3%.

At this time, Jack’s total accumulated floating loan interest in Aave is $300, while Long’s settlement price is $0.3, a total of $300 can be redeemed, and a net loss of $100 compared to the cost of buying Long.

After adding the profit and loss of the two Aaves and Long, it is equivalent to paying a total borrowing cost of $400, which is still a 4% interest rate loan.

It can be seen from the above two examples that no matter whether the loan realized on Aave is higher or lower than 4% after one year, as long as there is enough Long to buy at the beginning, the final overall net profit and loss will be -4%. The rise and fall can offset each other.

Based on the above descriptions, the various situations are drawn and summarized as follows:

with iGain = without iGain + Long Token PnL

The leverage ratio determines the range of interest rates that can be hedged, and the upper limit of the interest rate is 100% / leverage ratio;

The purchase price of Long or Short determines the size of the fixed interest rate. The lower the purchase cost, the better the fixed interest rate that can be locked.

iGain — The IRS Advantage

iGain — Unlike other fixed rate agreements that use a spot-based mechanism, the IRS has created an interest rate derivatives market, so by comparison we have four benefits:

high capital efficiency

As mentioned in the first paragraph, although the “interest rate” is derived from the “principal” put into the income asset, when we want to achieve a fixed interest rate, we should focus on the interest rate itself, even between the floating interest rate and the expected fixed interest rate Compared with other agreements, we only settle for the spread of “interest changes over a period of time”, and do not involve the principal put into the income asset by investors, so it can produce a high leverage effect. Traders only need to provide a small margin to trade or hedge very large nominal principals.

price discovery sensitive

On the other hand, since iGain’s interest rate derivatives have the effect of high leverage, if there is an arbitrage opportunity that deviates between the interest rate in the protocol and the external market, compared with zero-coupon bond AMMs, such as the yield protocol of fixed-rate lending, Notional and the separation of principal and interest Element, Pendle’s principal tokens, etc. Arbitrageurs need to prepare a large amount of capital to mint zero-coupon bond tokens to drive prices, while IRS does not need a lot of money to drive derivatives price changes, and the corresponding interest rate corrections will be more sensitive. closer to the real market.

Network effects of DeFi building blocks

Since iGain — IRS is an interest rate derivative built on other yield protocols, we can take full advantage of the liquidity and flow of existing protocols. Fixed-rate lending like Yield and Notional will be independent of existing lending agreements, which may lead to fragmentation of liquidity, but for those who use IRS to achieve fixed-rate, their main positions are still on Aave/Compound/Yearn, You only need to set aside a small amount of money to hedge. Through the combination with other protocols, it can have a greater network effect on both parties of the agreement, which not only makes it easier to absorb users of the original DeFi protocol, but also gathers more TVL for the underlying protocol.

Created a short interest rate market

DeFi’s spot fixed interest rate agreement, no matter which method it is, can only hedge interest rate risk for investors, and cannot really short interest rates. For example, the “income redistribution category” creates a “fixed income” and “interest rate long” market by transferring the risk of interest rate fluctuations. For example, the interest token of the principal and interest separation agreement is a long interest rate market; similarly, the high risk level of structured commodities is also using the low risk level principal to deleverage the long interest rate. However, we have the leverage of interest rates to long the market, but we do not have the corresponding leverage to short the market.

If they are pessimistic about future interest rates, investors can only hedge the expected returns of their positions at most, and there is no way to establish a short interest rate position and profit from the decline in interest rates. The iGain-IRS short token does not need to actually save money in the interest-generating agreement, and when held alone, it has a negative exposure to the interest rate trend. It will be the first agreement in the DeFi field to provide short interest rate services.

iGain + Aave = win-win?

iGain — The first derivative of the IRS will be built on Aave. Aave itself already provides stable rate borrowing services, but through the IRS, Aave users can benefit from the to more advanced new features.

First of all, iGain will create a fixed-rate deposit service for Aave, and deposit is the preferred option for more DeFi beginners than borrowing. For newcomers who have switched from traditional finance to DeFi, they are more looking forward to seeing fixed-rate deposits rather than floating interest rates that cannot be expected to yield returns. We believe that the fixed-rate lending function through the combination of Aave + IRS can be extended to more new users.

Second, there is a large interest gap between Aave’s fixed-rate borrowing rate and general borrowing and lending rates, while iGain IRS is an interest rate derivative, and the casting of Long/Short is 1:1, that is, there is no spread between buyers and sellers The fault is equivalent to introducing fixed-rate depositors and borrowers to match each other, so it can narrow the lending spread on Aave.


In traditional finance, most of the debt market is dominated by fixed rate loans, for example, about 90% of US mortgages are fixed rate products, because fixed rate loans are low risk, and stable and predictable interest rates allow lenders/borrowers to pay for them. more confident in their investment portfolios, and are more willing to adopt more and more complex financial instruments.

At the same time, borrowing, as the basic component of building an investment portfolio, is usually expected to have a predictable interest rate. Such as fixed-income products such as real estate mortgage bonds, public bonds as the basis, the capital-guaranteed fund formed, or the Bitcoin leveraged position based on fixed-rate borrowings. Fixed interest rates can be said to be the cornerstone of the development of complex financial products. Therefore, whether DeFi is to attract more traditional financial users, or to create more advanced financial products to expand the market, the fixed interest rate agreement will play an important role in the Primitive .

However, in DeFi, the market value of floating rate agreements is much larger than the market value of fixed rate agreements.

At present, the total locked value of Aave and Compound exceeds 20.5 billion US dollars. As mentioned above, we have sorted out the fixed-rate lending agreements that have formal products, including all the fixed-rate lending agreements such as Yield Protocol, Notional, Element, Pendle, BarnBridge, Tranche, etc. The total locked value is only around $767 million.


TVL of floating interest rate protocols at 2022/01/09. Source: DefiLlama


TVL of fixed interest rate protocols at 2022/01/09. Source: DefiLlama

Therefore, we boldly predict that the DeFi fixed-rate market will have a lot of room for growth. In fact, many fixed-rate agreements have sprung up in 2021, and there are also many innovative designs, which have promoted the development of the DeFi field. In particular, Yield Protocol has developed YieldSpace, a zero-coupon bond AMM pricing model on the blockchain, which has become the field of important example.

Up to now, there have been about twenty or so DeFi fixed-rate lending protocols released or about to be released. Although there are a large number of them, after the comparison in this article, it is not difficult to find that some protocols are just “micro-innovations” of another protocol, and the similarity to each other is very high. Presumably the competition will be fierce in the future. Fortunately, the market is still very broad, and maybe one or two protocols can be qualified for the three types of fixed-rate approaches, bringing exciting new products and applications to the DeFi market.

However, the vast majority of fixed-rate “spot” agreements have not yet escaped the rut of transaction principal. Looking back at the traditional financial market, according to the statistics of the Bank for International Settlements, interest rate exchange is the most traded OTC financial derivative. First of all, interest rate derivatives transactions account for 80% of all financial derivatives transactions, and interest rate exchanges account for more than 75% of the volume of interest rate derivatives. Until the first half of 2021, the outstanding notional balance of interest rate exchanges will exceed 372 trillion US dollars.

The reason why interest rate exchange can occupy a huge proportion in traditional finance is that only the high capital efficiency brought about by “interest rate spread” is deeply favored by enterprises and financial institutions. We learn from the design of interest rate exchange to further transform interest rate exchange In the traditional financial world, because it is not a standardized contract, it needs to match the pain points of counterparties, and create iGain — Interest Rate Synth, an interest derivatives trading market suitable for blockchain.

We believe that the charm of DeFi lies in the fact that, without permission and without the friction of middlemen, anyone can use DeFi most efficiently to meet the financial needs of different risks and returns. At the same time, the composability between protocols can make DeFi united and generate huge The network effect of , together to challenge the traditional financial behemoth!

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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