Overview of Fixed Interest Rates Protocols
Conversely, a higher valuation of fyDai will lower the borrowing rate for borrowers as it would be sold off to purchase the respective stablecoin (e.g., DAI). This means that depending on the time of purchase of fyDai tokens, both borrowers and lenders can determine their borrowing/lending interest rate.
Example:
Assume that a borrower deposits 1.5 ETH as collateral and intends to borrow 900 DAI at an annual borrowing rate of 10%. Once executed, the borrower will receive 1000 fyDai with a value of 900 DAI - this will be automatically sold off in the marketplace by the protocol, and the borrower will receive 900 DAI. At the end of the one year maturity period, the borrower will have to repay 990 DAI if they wish to withdraw their collateral.
For lenders, assume that a lender lends 1000 Dai. In return, the lender receives 1000 fyDai which will accrue value as it approaches maturity.
Initially, 1 fyDai received is worth 1 Dai, but after one year has lapsed, 1 fyDai will be worth 0.909 Dai. The lender may then redeem 1000 fyDai for 1100 Dai. This effectively puts the lending interest rate at 10%.
In practice, users can only select fyDai series that have been pre-programmed by Yield. This is similar to how regular bond instruments function, where there are different bond rates and maturity periods.
In Q1 2021, Yield has proposed integration with the MakerDao protocol that would permit MakerDao to be a fixed-rate Dai lender to Yield borrowers. The proposal has been accepted by MakerDao governance and is in the process of being integrated into the MakerDao protocol.
Yield is also expecting to launch version 2 of their protocol in Summer 2021.
It will include new collateral types and permit borrowing of assets beyond Dai, like USDC and Tether.
Did you know?70
In January 2021, an anonymous individual paid off his mortgage loan with a bank and is now paying down his refinanced home loan through DeFi protocol Notional Finance. Notional has similar functionalities as Yield as they also use a zero-coupon bond system via the introduction of a novel financial primitive called fCash.
Saffron.Finance
Saffron Finance is a decentralized yield aggregator for liquidity providers and was one of the first protocols to utilize a tranche-based system.71 Tranches are segments created from liquidity pools that are divided by risk, time to maturity, or other characteristics to be marketable to different investors.
With the various tranches, Saffron Finance users can select different portfolios based on their preferred risk appetite. More importantly, the Saffron Finance ecosystem creates an internal insurance system where investors in the higher-risk tranches insure investors in the lower-risk tranches.
Saffron Finance’s native token, SFI, is primarily used as a utility token to access tranche A, the higher-earning tranche. However, SFI can also be staked to earn pool rewards and vote on protocol governance.
A tranche system allows one to divide up the earnings and create different earning rates for different pools. In Saffron Finance’s case, the A tranche makes ten times the earnings of tranche AA. Tranche S offers a variable
70 Fernau, O. (2021, February 2). Engineer Becomes His Own Lender in First DeFi Mortgage. The Defiant - DeFi News. https://thedefiant.io/engineer-becomes-his-own-lender-in-first- defi-mortgage/.
71 saffron.finance. Saffron. (n.d.). https://app.saffron.finance/#docs.
interest rate that balances the A and AA tranches; they are always in a perfect equilibrium to maintain the fixed-interest earning ratio of ten times between tranche A and tranche AA.
Example
If Tranche AA earns 100 DAI:
1) Tranche A will earn 1,000 DAI
2) Tranche S will earn DAI at a rate that ensures Tranche A pays off 10 times more than Tranche AA
If, however, there is a platform risk (e.g., black swan event), Tranche AA will get their deposited assets and earnings first - this is taken from Tranche A’s principal and interest earnings.
Horizon Finance
Unlike conventional yield aggregators, Horizon allows users to create their own markets based on game-theory principles.72 Game theory envisions an environment where there are only rational actors. In such a hypothetical situation, buyers and sellers will make optimal decisions based on the available information.
Horizon allows users to submit their collateral into a liquidity pool, which is then lent to lending protocols such as Compound. To provide fixed interest rates to users, Horizon invites users to submit their sealed bids for fixed interest rates (acting as yield caps) or floating interest rates in each round.
72 Whitepaper. Horizon. (n.d.). https://docs.horizon.finance/general/whitepaper.
The bids are revealed after each round, thus creating an order book of bids.
The protocol will rank the bids from the lowest interest rate to the highest interest rate. The lending protocol’s variable earnings are then distributed from the lowest interest rate bids to the highest interest rate bids, with any excess income spilling over into the floating pool.
One notable feature is that all bids will be displayed on Horizon’s website.
The displayed bids allow users to actively compete and ascertain which interest rates are the most popular. On top of that, users can freely amend their bids, including switching to the floating rate. Horizon essentially doubles up as an interest prediction protocol.
Example
To illustrate this, let’s say that the round for Pool X lasts from 1 May 2021 - 14 May 2021:
On 1st May,
● Participant A deposits 100,000 DAI and bids that he will earn a 20% interest rate.
● Participant B deposits 100,000 DAI and bids the floating rate.
On 7th May,
● Participant C deposits 100,000 DAI and bids that he will earn a 10% interest rate.
At this point, Participant A reconsiders his bid as Participant C submitted a much lower bid. If Pool X earns too little, he may not get anything at all.
On 13th May,
● Participant A amends his bid to a 5% interest rate.
After the round ends, let’s say the 300,000 DAI in Pool X managed to earn an interest rate of 4% for a total of 461 DAI, therefore:
● Participant A fulfills his bid and gets 192 DAI, earning 5%
interest rate.
● Participant C partially completes his bid and gets the remainder 269 DAI, which is a 7% interest rate. His original bid of 10%, if fully fulfilled, would have generated 383 DAI during the two weeks period if Pool X had earned sufficient interest.
● Participant B fails in his bid and does not get anything.
As you can see, there are a lot of mind games involved! Moreover, interest rates are not technically fixed. However, the system rewards users who can gauge the amount of interest they should earn from their bids. This incentivizes users to conform to a ‘safe’ bid if they are uncertain about the amount they could earn. Bidding too high or bidding the floating rate could result in lesser gains or none at all. Thus ‘safe' bids effectively become the
‘de facto’ fixed interest rate over time.