New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

Combination of fixed income and leveraged income

The new generation of DeFi protocol is aiming at the extremely popular concepts in TradFi:

  • Fixed interest rate investment
  • Break down fixed income assets into principal and interest
  • Leveraged income trading

Asset segmentation may be the holy grail in the financial sector. Different asset segments attract different investors, and each investor is willing to pay a premium for precise solutions that meet their respective needs. In the 1980s, early arbitrage platforms stripped coupons from U.S. Treasury bonds and corporate bonds, and sold the resulting zero-coupon notes to investors who wanted to absolutely determine the date and scale of their investment returns, thereby making a profit. Mortgage traders took the same approach to debt backed by securitization agencies, segmenting cash flows into alternatives with higher or lower leverage for each investor category. Profiting from this decomposability made Wall Street Bank and its traders very wealthy.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

It is not surprising that the protocol uses the same basic concepts to address the needs of multiple types of users. Because the process of splitting/stripping cash flows can benefit from the nearly frictionless composability of cryptocurrencies.

The first goal is the uncertain and frequently fluctuating rate of return obtained when collateralizing or depositing tokens for lending (Aave, Compound), trading (Curve), or active farming (Yearn, Harvest). Yield farming is naturally motivated by borrowing from decentralized exchanges or providing liquidity.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

“Farming” yields used to be as high as three digits, although the least volatile strategy now yields only single digits. USDC’s Year Vault offers a net annualized rate of return of 7.51%, but tomorrow may be half of what it is now, or it may be twice.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

The “revenue tokens” representing Aave or Year deposits are ERC-20 tokens, which will be used in other agreements or strategies, and even further revenue farming. The deposit deposited into the Year USDC vault is represented by yvUSDC tokens.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

The agreement hopes to split the assets into two and sell each asset to a different group of investors, just like splitting the atom to release energy. This will be a value-added proposition for DeFi. Barnbridge SMART Yield, 88mph, Pendle, APWine, Element, and Swivel focus on decomposition. In TradFi’s terms, it is stripping or splitting—turning revenue tokens into:

  • Fixed rate assets
  • “Floating” yield tokens, floating rate bonds or partial (tranche)

Other agreements covered here, such as Horizon and SwapRate, also involve fixed and floating resolutions in their unique ways.

Fixed rate assets

Fixed-rate assets are either with additional yield (BarnBridge or 88mph) or zero-coupon bonds (APWine, Element, Swivel). In the case of additional yields, fixed-rate assets will exchange opportunities for future high yields for specific or zero yields.

For example, in return for depositing yvUSDC tokens, 88mph will provide a guaranteed fixed interest rate, such as 2%, or zero coupon bonds.

On the other hand, floating-rate depositors can obtain excess (floating) income to guarantee a fixed interest rate of 2%.

There are two use cases for fixed-rate assets. In TradFi, fixed-income investors prefer certainty, whether it is a fixed interest rate for their investment or a fixed spread based on a floating interest rate based on a well-known index. In DeFi, although institutions are not the natives of cryptocurrencies, they are also attracted by a fixed rate of return that is higher than the interest on bank deposits. Compound Treasury and Aave Arc believe that 4% is an appropriate fixed interest rate. Passive funds hope to obtain passive and definite returns. Zero coupon bonds can also be combined with options to create guaranteed (PP) tokens linked to risky assets. PP bills provide a full return on the initial principal, but have the ability to profit in a bull market. It is very common in TradFi before interest rates are close to zero or even negative.

The second possibility is that Yield Farmers may want to borrow future output as collateral. By depositing a revenue farm token and selling future interest, users finally get cash that can be deployed elsewhere.

Alchemix is ​​the first agreement to understand that the future excess production of these farms has untapped value at present. The agreement obtains the expected present value of the income farm reward from Year’s DAI (now ETH) vault and uses it to collateralize its alUSD stablecoin or alETH loan.

The income derivatives agreement involved here basically uses excess agricultural output and tokenizes it before selling it. Different agreements provide different amounts of future earnings: some require the sale of all earnings, while others provide a threshold fixed interest rate, after which the excess earnings go to floating-rate investors.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value PotentialFloating/excess income assets

The most obvious use cases for excess return tokens, deposits, bonds or some of them are for leveraged income farming.

Leverage is the first of DeFi and is currently the most important use case. DAI minted in MakerDAO’s ETH vault was sold, and then more cryptocurrency assets were purchased. Compound and Aave allow borrowers to use leverage in the 2020-1 bull market. Alpha Homora uses further leverage on the income farm.

Element Finance refers to Leveraged Yield Farmers as “highly mature users who want to effectively allocate capital to variable interest rates.” The income of floating-rate investors is higher than the prescribed fixed interest rate for the above-mentioned fixed-rate assets. Unlike most market leverage, there is no chance of liquidation.

Some yield farms involve high-risk tokens or strategies. Therefore, Saffron Finance has created a concept in which fixed-rate borrowers will be protected from impermanent losses and agreement failures. Therefore, Saffron provides insurance for senior holders, which is provided by junior holders. This is very different from the income derivatives agreement, which focuses on low-risk agricultural tokens and does not include the loss of principal. The stablecoin vaults of Compound, Aave, and Year account for almost all the revenue derivatives issued to date by BarnBridge, Pendle, 88mph and Element.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

Not all income derivatives involve combinable and tradable tokens in fixed and floating positions. Like Alchemix, 88mph and BarnBridge’s secured fixed-rate deposits remain in the vault. Pendle, Element, APWine and Swivel provide or will provide the transferability of fixed and floating income.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

Zero interest/stripping structure: Pendle, APWine, Element, Swivel

The most direct way to split income tokens is (1) a zero-coupon bond, which pays the initial token investment at maturity and (2) all income generated by the income token. In the example below, the buyer of the revenue token expects a 12-month agricultural output of 7% and a target rate of return of 20% (deducting incentives). Using simple bond mathematics, the yield buyer will pay $5.8 for the token.

Fixed token investors will be able to use this $5.8 to offset the $100 paid for the initial income token. This forms a zero-coupon bond with a price of $94.2 today, and a price of $100 at maturity in 12 months, with a yield of 6%. Unless the agreement fails, the interest rate will not change. This $5.8 can be used for any purpose, such as in Alchemix.

It can be seen that the income token has significant leverage. When the zero-coupon bond yield is 6%, the actual farm yield of 18% is three times the initial investment. Of course, if the realized rate of return of the income farm is zero, the capital of the income token will be completely lost.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

Please note that all numbers are highly stylized and are prior to charging.

The zero-interest/stripping protocol mints fixed and floating tokens and deposits in exchange for the underlying income tokens, so if it does not match the fixed part, no additional income tokens can be minted. This is very different from the other agreements below.

Pendle and APWine also have customized automatic market makers (AMM) to deal with the decay of revenue tokens. This is necessary, especially for Pendl, because as the token approaches its expiry date, its value will approach zero as the future excess return decreases.

There are differences in the pricing of revenue tokens and the way they accumulate value. APWine’s FYTs and Element’s eYs generate interest over time, while the value of Pendle’s YTs declines as the cumulative income can be claimed separately at any time.

Fully mortgaged fixed and floating assets: 88mph, BarnBridge SMART Yield

A very popular variant of the zero-coupon/stripping structure is deposits with a positive fixed rate of return guaranteed by floating-yield tokens or deposits. Time deposits are locked in the vault. In Barnbridge, proceeds are tokenized and transferable. In 88mph, zero-coupon bonds can be minted from fixed-rate deposits and then traded. The income of the income deposit or token is similar to the income in the zero-interest/strip agreement, except that the income can be negative.

In these two protocols, the amount of revenue tokens/deposits and fixed deposits do not have to match the economically determined ratio, as they do in Pendle, APWine, Swivel, and Element.

In 88mph, fixed deposits can be made without matching floating deposits, but not vice versa. In BarnBridge, any amount of revenue or fixed portion can be purchased.

Compared with BarnBridge, the capital efficiency of 88mph’s yield component has been improved because the number of floating-rate bonds is limited to the exact amount required to satisfy fixed-rate debt. In the 88mph screen below, a mortgage of 10,000 3CRV provides a fixed interest rate of 2.31% within 180 days, plus an MPH reward of 21.02% (on the left).

Although there is no floating rate of return in Compound USDC (bottom right), floating rate investors can deposit $146,000 to earn more than $5.5 million in excess interest on Harvest 3CRV’s nominal income farm exposure (top right). If the farm’s rate of return is 5.1%, then the return on income derivatives is 12.5% ​​(no MPH reward).

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

Source: 88mph

In BarnBridge, any amount of floating or fixed investment is allowed. Since only floating tokens are freely incentivized, all liquidity is gathered there, diluting current earnings.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

For BarnBridge’s Aave USDC token library, the fixed balance is almost zero, diluting the income of floating rate buyers. In the absence of BOND rewards, floating rate tokens receive the same interest rate as non-leveraged Aave yield tokens: 2.49%. It can be seen from BarnBridge’s marketing that low leverage is problematic for a floating interest rate economy.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

When the ratio between fixed and floating interest rates reaches a more reasonable 80/20, the benefits of leverage begin to show: Compound’s 3% yield becomes 12.6% of floating-rate tokens. Before incentives are adopted, restricting the participation of floating tokens may bring economic benefits closer to other economies.

88mph and Barnbridge do have significant differences, except for the latter’s revenue token marketability and lack of restrictions on low leverage. Barnbridge uses the same grading technology for zero interest/strips, in addition to the SMART yield, it also offers other products, and there will be more products. 88mph has the lowest TVL and the most avant-garde UI. It was successfully hacked in 2020. Recently, some people claimed to have received a bug bounty due to a bug discovered in the code.

Other fixed agreements: Horizon and SwapRate/Orion

There are several other fixed/floating agreements close to the mainnet deployment. SwapRate provides collateralized fixed floating swaps for income tokens. The token income is very simply equal to the prescribed fixed interest rate minus the total realized income of the farm. Of course, this can be a negative value. By signing a swap agreement, a fixed income of 10% is obtained in exchange for the income of certain farm tokens. If the actual farm rate of return is 15%, the user promises to pay 5%, and if the actual farm income is 7%, the user promises to pay 3 %.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

Source: SwapRate.Finance

Adding a fixed-rate receiver position to the income farm will result in a net fixed-rate farm position, just like in BarnBridge or 88mph.

Horizon provides a complex game of “guessing a fixed interest rate” and is therefore qualified as a derivative of a certain rate of return. Each period will observe the return of the yield farm and pay those people in the order of the threshold of the fixed interest rate bid provided in advance. A lower fixed rate will be filled, but a very high fixed rate may not be filled or only partially filled, resulting in a lower (or zero) interest rate for the period. After all fixed interest rates have been paid, bidders with floating interest rates will receive the remainder. Therefore, the market has established expectations for future farm yields.

Growth, incentives and tokens

The protocol and its tokens are at very different stages of development and have different characteristics. BarnBridge and Pendle are online and have tokens. APWine is in the test network stage and owns a token. Element is active without tokens. Swivel is neither live nor tokens.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

Since reaching a high point in the first quarter of this year, yields have fallen sharply.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

Therefore, the fixed rate of return is also extremely low. Even Aave and Compound are currently subsidizing their promised 4% institutional fixed rate of return. Since there is no demand for low fixed interest rates, income token speculators cannot obtain sufficient leverage to make transactions valuable. Therefore, incentives need to be input.

As far as BarnBridge is concerned, 6000 BOND tokens support the primary part of TVL every month. If there are no incentives, how much will it have?

Pendle only provides Aave USDC and Compound DAI vaults. 88mph provides decomposability for Aave and Compound and more complex Harvest and Year income farms, UNI , stETH and W BTC . BarnBridge insisted on using stablecoins, but added CREAM to Aave and Compound. Element only uses Yearn. Incentives seem to drive most of the transaction volume.

The choice of base income tokens, the distribution of cash flow, and the use of token incentives will all affect the promised fixed interest rate and the expected return of floating-rate tokens or deposits. The three protocols are compared below.

New Trend of DeFi Derivatives Agreement: Fixed Income + Floating Income Combination Releases DeFi Value Potential

Conclusion

Since the first quarter of 2021, the expected return of yield farming has fallen sharply, reducing the attractiveness of fixed and variable returns. Will farm income return to levels during the speculative spring of 2021? Currently, BarnBridge, 88mph and other companies have increased their basic income by 10 times to incentivize depositors in order to obtain TVL. But this cannot last forever. What happens when the incentives are exhausted?

Speculators often seek to exploit the potential of profitable agriculture. Alpha Homora Leveraged Farm has more than $1 billion in TVL. In this mature market segment, revenue tokens and deposits are another option for users. On the other hand, fixed income has a less obvious use case, especially considering the complexity of most current agreements. Although native cryptocurrency investors may not be satisfied with the 4% interest rate, such returns may attract younger and more tech-savvy investors. But will these fixed-rate investors tolerate the complexity required to execute the very simple strategies in TradFi?

For example, 88mph plans to simplify integration with other platforms in its v3 version and provide simplified incentives for partners who can more easily accept new fixed-rate investors. The key to success may be to work with fintech companies and DeFi aggregators to provide the user experience needed to attract TradFi users and cryptocurrency novices to make fixed-rate investments in DeFi. However, if the process of transitioning to fiat currency is not difficult, why not accept JPMorgan Chase when the rate of return linked to the US dollar is high?

Written by: Rasheed Saleuddin, compiled from Messari

 

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/new-trend-of-defi-derivatives-agreement-fixed-income-floating-income-combination-releases-defi-value-potential/
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