DeFi needs more fixed-rate lending protocols: Messari researcher

Researcher argues that fixed rate lending and borrowing would bring DeFi closer to traditional finance

DeFi lending protocols have attracted billions of dollars in liquidity provision by offering huge returns, however the sector badly needs more fixed rate lending options according to one researcher.

A number of protocols, including Yield Protocol, UMA Protocol, and Mainframe are already venturing into fixed rate lending and borrowing markets for crypto collateral.

According to Messari researcher Jack Purdy fixed rates provide certainty for lenders and borrowers looking to accurately forecast their costs and returns on capital.

Referring to yield curves, which plot interest rates against varying maturity dates, he added that steeper curves mean that lenders require a higher return to compensate them for locking up capital. Flatter curves indicate that lenders are content with lower returns as the prospects for future growths are not so bright.

Fixed-rate lending is one of the most important primitives underpinning the global financial system And yet it has been sorely lacking in DeFi... that is until recentlyThis is a big deal and here’s why pic.twitter.com/r9TtwWwp8S

— Jack Purdy (@jpurd17) October 28, 2020

Stable and predictable financial markets are important for future planning in calculating returns and gauging longer-term investor sentiment. The researcher also mentioned a yield curve inversion which occurs when investors are willing to lock in low long-term rates as they expect a more severe downturn.

In traditional finance, this leads to central banks lowering interest rates and the indicator can be used to predict recessions.

The current DeFi scene is anything but predictable and could be described as a Wild West mashup of protocols offering largely unsustainable returns and boasting yields in four figures to lure liquidity providers and degen farmers.

Some of the recent vaults on Yearn Finance that tap into other protocols are illustrative. The new GUSD vault is currently offering over 2200% APY for stablecoin deposits.

When the yETH vault was launched it boasted annual returns of three figures, however this rapidly plunged. As a result ETH liquidity also plummeted by around 60% since the vault was opened in early September.

Yield hopping is where DeFi farmers jump from protocol to protocol seeking out the next quick buck, resulting in token pump and dumps, and surging network fees, all of which is largely unsustainable for longer term investing and financial planning.

The researcher highlighted a couple of DeFi protocols that are taking the fixed term approach to crypto borrowing and lending including Yield Protocol which went live on October 20. The platform has created a new type of token called ‘fyTokens’ (fixed yield), the first of which will be fyDai to enable fixed-term and rate borrowing/lending using the MakerDAO stablecoin.

The UMA Protocol has a yield dollar whereby investors can deposit ETH to mint up to 80% of the USD value in uUSD, which is then redeemable for $1 of collateral at maturity. The token can be sold before maturity at a discount for those wanting to wait for the premium.

The Mainframe Lending Protocol uses a bond-like instrument, or guarantor pool, representing an on-chain obligation that settles on a specific future date so that buying and selling the tokenized debt enables fixed-rate lending and borrowing. The researcher concluded that more fixed rate lending and borrowing will bring TradFi and DeFi closer together.

“These new fixed-rate products will do for all types of financial instruments we're accustomed to as well as new ones enabled by this uniquely composable world of DeFi”