The Development and Application of Fixed Interest Rate Protocols in Decentralized Finance

With the deepening of global financial integration, the demand for a stable financial ecosystem is growing. More than 20 years ago, the European Parliament first proposed the necessity of enhancing price stability in a working document. The document pointed out that the integration of global financial markets is increasing the impact of external factors on domestic monetary policy. Although the major central banks of the world differ in their specific implementation methods, there is a broad consensus on the fundamental goal of pursuing price stability and financial market stability.

In analogy to the cryptocurrency industry, this field has developed to the stage where DeFi has become the protocol standard. Blockchain technology is likened to "financial Legos," allowing developers to integrate with other protocols to build innovative financial products. However, such progress has not changed the highly unstable nature of the crypto industry.

Stable interest rates are one of the key elements of a healthy financial ecosystem. While the cryptocurrency industry has a large number of lending protocols and yield aggregators providing interest rates for lenders, relatively few offer fixed rates. With the popularity of yield farming and the growing demand for more stable lending interest rates, some Decentralized Finance protocols have begun to attempt to address this issue, giving rise to a new class of fixed-rate protocols (FIRP).

Unlike traditional financial fixed deposits or bonds, FIRP utilizes its underlying token structure to provide different incentives to maintain the Intrerest Rate. The FIRP ecosystem can be roughly divided into two categories: lending/borrowing type and yield aggregator type. Each protocol has its unique "fixed" rate approach, resulting in different application scenarios. Some offer "fixed rates" or "fixed interest yields," while others create an environment conducive to fixed rates.

The following introduces three representative fixed interest rate protocols:

1. Overview of Fixed Interest Rate Protocols

Yield

Yield is a decentralized lending system that offers fixed interest rate lending and interest rate markets through a new type of token called "fyTokens". The current version includes fyTokens for the DAI stablecoin, referred to as "fyDai". fyDai is an ERC20 token based on Ethereum that can be redeemed for DAI after a predetermined maturity date, similar to zero-coupon bonds or discount bonds.

Borrowers need to provide ETH as collateral to mint or sell fyDai, with a collateral ratio the same as MakerDao (150%). Lenders purchase fyDai, typically at a price lower than DAI. The discount value represents the difference between the maturity value of 1 DAI( and ), which is the loan interest rate or borrowing interest rate.

fyDai not only reflects the Intrerest Rate for borrowing and lending but can also be traded separately as a bond instrument, as there are multiple fyDai series with different maturities. The system is closely integrated with Maker, allowing Maker users to migrate their DAI vaults to the fyDai vault, locking in a fixed rate for a period of time and then transferring back to the Maker vault upon maturity.

The interest rate is determined by the market pricing of fyDai. For lenders, the higher the valuation of fyDai, the lower the interest rate earned at maturity. For borrowers, the higher the valuation of fyDai, the lower the borrowing interest rate. Both parties in the loan can decide their respective interest rates based on the timing of purchasing fyDai.

The Yield plan will launch the second version of the protocol in the summer of 2021, which will include new types of collateral and allow borrowing of assets other than DAI, such as USDC and Tether.

Saffron.Finance

Saffron Finance is a centralized yield aggregator protocol that is the first to adopt a phased system. This system categorizes liquidity pools based on characteristics such as risk and maturity time, to accommodate different investor needs. Users can choose different investment portfolios based on their risk preferences.

Saffron Finance has created an internal insurance system where high-risk investors provide insurance for low-risk investors. Its native token SFI is primarily used to access high-yield Tier A, and can also be used to earn liquidity pool rewards and for protocol governance voting.

The installment system allows for the division of returns, creating different interest rates for different capital pools. The A-tier yield is 10 times that of the AA-tier, while the S-tier provides variables to balance the interest rates of the A and AA tiers, maintaining a fixed interest yield difference of 10 times between the two.

In the event of platform risks such as black swan events (, AA-grade collateral loans will have priority in obtaining deposit assets and returns, and this portion of funds will be drawn from the principal and interest earnings of A-grade.

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) Horizon Finance

Horizon allows users to create their own markets based on game theory principles. Users can submit collateral to the liquidity pool and then lend it to loan protocols like Compound. To provide fixed interest rates, Horizon invites users to submit sealed bids for the fixed interest rate ### as the yield cap ( or floating rates in each round.

After each round, the bids will be announced, forming a bidding order book. The protocol will sort the bids from the lowest to the highest interest rate, and then distribute the variable income from the lending agreements from the lowest to the highest interest rate, with excess income flowing into the floating pool.

All bids are publicly displayed on the Horizon website, allowing users to actively compete and determine the most popular Intrerest Rate. Users are free to modify their bids, including switching to a floating exchange rate. Horizon is essentially an Intrerest Rate prediction protocol.

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2. How to Choose the Right FIRP?

FIRP cannot be simply classified for comparison. There is an essential difference between lending protocols and yield aggregation protocols. Before studying indicators such as interest rate competitiveness, one should first examine FIRP's ability to maintain a "fixed interest rate." FIRP's operating method has three decisive characteristics:

1. Type of Commitment: Different protocols make different commitments. Understanding the types of commitments helps users choose the appropriate product.

2. Maintenance of commitment methods: Each type of commitment requires a different maintenance method. Understanding the maintenance method can determine the reliability of the protocol.

3. Degree of dependence on external factors: Identifying the factors that influence user behavior in the protocol mechanism can help understand the extent to which commitments are controlled by factors outside of the user.

Considering these criteria, it is not easy to determine which protocol is the most suitable. The choice depends on individual risk preferences, the type of financial instruments required, and confidence in the underlying protocol mechanisms. Many protocols are still under construction and have yet to be tested by the market.

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Relevant Risks

One of the most important risks is the ability of FIRP to maintain a fixed Interest Rate. These protocols often rely on external agents or other users actively participating to drive market functionality. If the community is not active, or if the user structure and liquidity are unbalanced, such as when the number of lenders in Yield exceeds the number of borrowers, or when the number of A-participants in Saffron Finance exceeds the number of AA-participants, FIRP may not be able to support its fixed Interest Rate.

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3. Other Protocols Worth Noting

• Notional: Provides fixed interest rate and fixed term lending for crypto assets, creating a zero-coupon bond system through fCash. Similar to Yield Protocol, but with differences in the automated market maker and collateral options.

• BarnBridge: Utilizes a tiered system to achieve yield-based products and also offers SMART Alpha products, providing market price exposure through tiered volatility derivatives.

• 88mph: a yield aggregator that offers fixed Intrerest Rate, maintaining the rate through the introduction of floating rate bonds and a unique tokenomics structure.

• Pendle: An upcoming protocol that allows users to tokenize future interest rates and sell them in the form of upfront cash, effectively locking in the interest rate.

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4. Summary

FIRP is a type of emerging protocol that will become an important force in the Decentralized Finance field. They showcase the potential of integrating DeFi with traditional fixed income tools. This field is rapidly evolving, offering unique products and services. More innovations may emerge in the future, such as protocols that combine price prediction with interest rate aggregation, or protocols that allow individuals to create and sell bonds.

As the field continues to develop, it is expected that more institutions will be interested in FIRP products. Fixed income instruments are common in traditional finance. However, as the total debt levels and inflation continue to rise, and the value of the dollar continues to decline, FIRP may offer a more reliable yield option.

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