Original Title: Interest Rate Perpetuals: DeFi's missing piece
Original author: @defiance_cr
Compiled by: Lawrence, Mars Finance
At the Chicago Mercantile Exchange (CME), the daily trading volume of interest rate futures exceeds one trillion dollars. This huge trading volume mainly comes from banks and asset managers who operate by hedging the risks between floating rates and fixed-rate loans that have been issued.
In Decentralized Finance, we have established a thriving floating interest rate lending market, with a total locked value exceeding 30 billion USD. Pendle's incentive-based order book has liquidity exceeding 200 million USD in a single market, demonstrating the strong demand for interest rate spot.
But we still lack a DeFi native tool like CME interest rate futures for hedging interest rate risk for both lending parties (IPOR swap does not count because it is too complex).
To understand why we need this tool, we must first understand how interest rates work in Decentralized Finance.
Taking AAVE as an example, its interest rates are adjusted based on supply and demand dynamics. However, the supply and demand of AAVE do not exist in isolation; they are nested within the broader context of the global economy.
By comparing the smoothed USDC floating interest rate of AAVE with the price of the 10-year Treasury futures from CME, we can observe this macroeconomic correlation:
The USDC interest rate trend of AAVE is in line with global interest rates, but there is a certain lag. The main reason for this lag is the lack of an immediate linkage mechanism between global interest rates and AAVE interest rates.
It is precisely because of this dislocation that the supply and demand dynamics of the cryptocurrency market play a stronger role in interest rate formation. When we remove the smoothing process and directly compare the interest rate of AAVE with the global 10-year government bond interest rate, this phenomenon becomes even more apparent:
The interest rate of AAVE fluctuates dramatically, and for most of the time, it has a significant premium compared to the U.S. 10-year Treasury yield.
The fundamental reason for this premium is still the lack of direct correlation between these two markets. If there were a simple, two-way connection mechanism between the interest rates of DeFi and TradFi that could hedge or arbitrage, it would better integrate the two ecosystems.
The Perpetual Swaps are the best way to achieve this. Perp has already been validated by the market for product-market fit (PMF), and establishing a perpetual market covering AAVE interest rates and U.S. Treasury rates would bring about significant changes.
For example:
·For borrowers, they can take a long position in a perpetual contract that anchors the AAVE borrowing interest rate. If the annual borrowing interest rate skyrockets from 5% to 10%, the price of this perpetual contract will rise, thus hedging against the risk of rising costs.
On the contrary, if interest rates fall, borrowing becomes cheaper, but perpetual positions incur losses, which is akin to paying an "insurance premium." In this way, the borrower effectively locks in a fixed rate by borrowing + going long on perpetual contracts.
For stablecoin lenders, they can short a perpetual contract based on the stablecoin lending interest rate. If lending yields decline, the short position in the perpetual contract profits, offsetting the losses from reduced loan income; if yields rise, the shorts incur losses, but interest income increases, creating a hedge.
Moreover, these contracts can also use high leverage. In the interest rate market on CME, a 10x leverage is a standard configuration.
Having a liquidity-rich interest rate market can also reduce cascading effects during market stress. If market participants hedge in advance, they will not be forced to withdraw or liquidate on a large scale due to interest rate fluctuations.
More importantly, this also opens the door to truly long-term fixed-rate loans - if this perpetual contract is fully DeFi native, it can be used by various protocols for long-term interest rate hedging, thereby providing users with fixed-rate loans.
In traditional finance, hedging interest rate risk is a routine operation, and most long-term loans are backed by interest rate hedging instruments.
Introducing this mechanism into DeFi can not only enhance efficiency but also attract more TradFi players into this market, truly bridging the gap between DeFi and TradFi.
We can make the market more efficient, and all it takes is the emergence of an interest rate perpetual contract.
The content is for reference only, not a solicitation or offer. No investment, tax, or legal advice provided. See Disclaimer for more risks disclosure.
Decentralized Finance决战TradFi：$100 billion Interest Rate缺口如何被一个合约引爆？
Original Title: Interest Rate Perpetuals: DeFi's missing piece
Original author: @defiance_cr
Compiled by: Lawrence, Mars Finance
At the Chicago Mercantile Exchange (CME), the daily trading volume of interest rate futures exceeds one trillion dollars. This huge trading volume mainly comes from banks and asset managers who operate by hedging the risks between floating rates and fixed-rate loans that have been issued.
In Decentralized Finance, we have established a thriving floating interest rate lending market, with a total locked value exceeding 30 billion USD. Pendle's incentive-based order book has liquidity exceeding 200 million USD in a single market, demonstrating the strong demand for interest rate spot.
But we still lack a DeFi native tool like CME interest rate futures for hedging interest rate risk for both lending parties (IPOR swap does not count because it is too complex).
To understand why we need this tool, we must first understand how interest rates work in Decentralized Finance.
Taking AAVE as an example, its interest rates are adjusted based on supply and demand dynamics. However, the supply and demand of AAVE do not exist in isolation; they are nested within the broader context of the global economy.
By comparing the smoothed USDC floating interest rate of AAVE with the price of the 10-year Treasury futures from CME, we can observe this macroeconomic correlation:
The USDC interest rate trend of AAVE is in line with global interest rates, but there is a certain lag. The main reason for this lag is the lack of an immediate linkage mechanism between global interest rates and AAVE interest rates.
It is precisely because of this dislocation that the supply and demand dynamics of the cryptocurrency market play a stronger role in interest rate formation. When we remove the smoothing process and directly compare the interest rate of AAVE with the global 10-year government bond interest rate, this phenomenon becomes even more apparent:
The interest rate of AAVE fluctuates dramatically, and for most of the time, it has a significant premium compared to the U.S. 10-year Treasury yield.
The fundamental reason for this premium is still the lack of direct correlation between these two markets. If there were a simple, two-way connection mechanism between the interest rates of DeFi and TradFi that could hedge or arbitrage, it would better integrate the two ecosystems.
The Perpetual Swaps are the best way to achieve this. Perp has already been validated by the market for product-market fit (PMF), and establishing a perpetual market covering AAVE interest rates and U.S. Treasury rates would bring about significant changes.
For example:
·For borrowers, they can take a long position in a perpetual contract that anchors the AAVE borrowing interest rate. If the annual borrowing interest rate skyrockets from 5% to 10%, the price of this perpetual contract will rise, thus hedging against the risk of rising costs.
On the contrary, if interest rates fall, borrowing becomes cheaper, but perpetual positions incur losses, which is akin to paying an "insurance premium." In this way, the borrower effectively locks in a fixed rate by borrowing + going long on perpetual contracts.
For stablecoin lenders, they can short a perpetual contract based on the stablecoin lending interest rate. If lending yields decline, the short position in the perpetual contract profits, offsetting the losses from reduced loan income; if yields rise, the shorts incur losses, but interest income increases, creating a hedge.
Moreover, these contracts can also use high leverage. In the interest rate market on CME, a 10x leverage is a standard configuration.
Having a liquidity-rich interest rate market can also reduce cascading effects during market stress. If market participants hedge in advance, they will not be forced to withdraw or liquidate on a large scale due to interest rate fluctuations.
More importantly, this also opens the door to truly long-term fixed-rate loans - if this perpetual contract is fully DeFi native, it can be used by various protocols for long-term interest rate hedging, thereby providing users with fixed-rate loans.
In traditional finance, hedging interest rate risk is a routine operation, and most long-term loans are backed by interest rate hedging instruments.
Introducing this mechanism into DeFi can not only enhance efficiency but also attract more TradFi players into this market, truly bridging the gap between DeFi and TradFi.
We can make the market more efficient, and all it takes is the emergence of an interest rate perpetual contract.