Will interest rate swaps bring liquidity to DeFi?

Interest rate swaps will not only make the DeFi ecosystem more complete and reliable, but additionally allow visitors to use predictable and stable cashflow to create services.

Original title: "Science | Why DeFi Needs Interest Swaps" (Why Decentralized Finance totally needs interest rate swaps! )

Written by: Andrey Belyakov

Translation: Min Min

This article explains the significance of interest rate swaps (also referred to as "interest rate swaps"), particularly for the present DeFi field. We will elaborate on the next two points: First, interest rate swaps are an "average" expectation of future floating interest levels, which can be used to guage market conditions; second, the scale and need for the centralized swap market. We also gave examples of just how to use swap rates to arbitrage. Probably the most exciting part of this article is liquidity. The supply and demand of interest rate swaps result from market participants. Finally, this article introduces the Swap Rate and Swap Rate API/SDK in line with the Opium protocol. With Swap Rate, you can quicker hedge or invest through swap transactions.

Swap rate may be the market's expectation of floating rate. Let me fleetingly introduce what's "swap rate"? This is a fixed interest rate provided by the marketplace to switch variable interest levels (floating interest rates) that have perhaps not yet expired. Different contract lock-up periods correspond to different swap rates. For that reason there might be 1-month, 4-month and 254-day swap rates available in the market. At Swap Rate, we offer 12 interest levels for the following 12 months.

https:swaprate.finance

Swap rates will fluctuate along based on market expectations, liquidity as well as other factors. For that reason our order book runs on meta-transactions (just just like the 0x protocol) and can provide hundreds of quotes per second. Why don't we first speak about how swap rates reflect market expectations.

How swap rates reflect market expectations The curve in the figure above shows the 12 swap rates available available in the market to switch variable rates. Suppose I exchange with a variable interest rate (from now until October 1st), the marketplace provides me by having an annualized swap rate of 3%. By October 1st, we will know what the floating interest rate is after which settle.

Joe Lubin announced on Twitter that he would start investing a great deal of Dai in to DeFi in September. What impact will this news have? The swap rate starting in September will soon be significantly paid down. Market makers and users will cancel the order on the Swap Rate and place a brand new order with less attractiveness. Indeed, after understanding that the deposit interest rate will drop in September, if I were to buy the variable interest rate, the fixed interest rate I was prepared to offer would certainly become lower. From now on I'll react, but 9 Swap rates after the month can be specially low.

For that reason the swap rate (the alleged “swap curve”) reflects the market's average expectation of the specific annualized swap rate in a certain period of time. Basically disagree with these expectations, I could use this to make money. In fact , if my expectations are correct, I could make 10 times the income.

DeFi vs CeFi Centralized Market This article will not discuss the significance of interest rate swaps to the traditional economic climate. We only provide charts. The final outcome is yours.

Market size (source: wikipedia)

Interest rate swaps will be the largest market in the world.

DeFi's market expects that swap rates will reflect market expectations and become adjusted accordingly, and it can also reflect the market's views on specific interest levels.

The most obvious use case for hedging DeFi's interest rate swaps is always to freeze deposit and loan interest levels. Indeed, when I really do not need to take chances and desire to obtain a guaranteed in full deposit rate, someone just desires to obtain a locked-in loan rate. We could look at the huge difference between the deposit rate and the loan rate before reaching a swap agreement. In the "Liquidity" section below, we will explain this example in more detail.

Why can swaps be properly used for arbitrage? Because through swaps, you can easily hedge the bucks flow between fixed income instruments with different maturities.

Suppose you view a 1-year bond with a yield of 10%. You can invest $100 instantly and acquire $110 in 12 months. Assuming this can be a 1-year swap, the interest rate is 6%. You possibly can make arbitrage: borrow $100, work with a swap to correct the loan interest rate at 6%, after which purchase the bond. After the bond matures in 12 months, you'll get 110 USD, and after returning 106 USD to the lender, you will earn 4 USD!

As greater numbers of individuals use this way for arbitrage, bond prices will rise and yields will fall.

Why liquidity is required on the supply and demand sides Liquidity may be the key. Next, we will explain why liquidity is required on the supply and demand side.

Deposits and loans are hedges against one another. As we explained above, both borrowers and lenders dislike risk and uncertainty.

Natural demand for swaps

In this model, interest rate swaps not merely make the DeFi ecosystem more complete and reliable, but additionally allow visitors to use predictable and stable cashflow to create services.

Alice uses variable interest levels as a swap for a 3% fixed interest rate, and Bob pays a 5% fixed loan interest rate. They all conducted swap transactions on Swap Rate. Since Swap Rate is really a non-custodial platform, market makers act as their counterparties. As is visible from the figure above, the marketplace maker charged 5%, paid 3%, and earned 2% interest! However , market makers also have to bear the interest rate differential between the AAVE loan interest levels. Luckily, this interest rate differential is quite stable, staying at around 1 . 8%, therefore the market maker makes a net profit of 0. 2%.

This is a win-win situation: Alice gets a fixed deposit interest rate. Bob gets a fixed loan interest rate. The marketplace maker also made money.

If the marketplace maker expands the interest rate differential and Alice with a deposit interest rate of 2. 5% and charges Bob that loan interest rate of 5. 5%, it's going to net a 1 . 2% interest rate differential! The marketplace maker can also offer Alice a deposit rate of 3% and charge Bob that loan rate of 6%, after which earn the exact same interest rate differential.

Market maker's expected get back = 5%-3% + floating deposit rate-floating loan rate = 0. 2%

In fact , the marketplace maker's revenue fluctuates between 0. 2% and 5% according to market conditions.

Based on statistics, the interest rate huge difference between deposit interest rate and loan interest rate is quite stable:

Statistical arbitrage can be done

Why does Swap Rate API/SDK have unique advantages of meta-transaction? Swap Rate provides 12 order books for several variable interest levels. The order book contains meta transactions for specific orders. After the two orders are successfully matched, they'll certainly be settled on the Ethereum blockchain instantly. Swap Rate allows users to store and cancel orders at no cost. Users can send a large number of quotes per second based on market conditions, or cancel orders when market expectations change. While enjoying the security brought by the blockchain, we are able to also rival the centralized market in terms of transaction speed.

The order book is divided by month. The parameters of v orders in the book might be different, nevertheless the expiration month may be the same. Each swap traded has got the transaction date while the starting date and the first day of the expiration month while the expiration date.

For instance , today I placed a swap order due on June 1st, hoping to acquire a fixed interest rate of 5%. The order (meta transaction) I signed will soon be stored in the "June" order book instantly, waiting for the matching order (the order that's prepared to pay a fixed rate of 5%) to seem. When there is a matching order the next day (I haven't cancelled the order at that time), the two sides will soon be traded. This very day may be the start date of the swap transaction. From the start date to June 1st, gains based on variable interest levels will accumulate. On the maturity date, this accumulated income will soon be exchanged for the income obtained from the fixed interest rate prior to the agreement.

High-speed order book (meta transaction)

Using Swap Rate to Arbitrage Suppose you find that an asset may be arbitraged through swap transactions. To be able to undoubtedly achieve arbitrage, you need to buy or sell the asset at the same time while the swap transaction-completed in the exact same Ethereum transaction.

swaprate. finance is online, welcome to arbitrage. Within the next article, we will introduce API and SDK in more detail for market makers and DeFi hedge funds, and give a few examples. You can call us and read it first.