The fixed-rate products currently available in the decentralized finance (DeFi) sector are an essential part of the financial derivatives market; but downsides, such as low interest rates, intense competition and less overall attractiveness to investors, remain. An overhaul of integrating a variety of lending protocols offering higher interest rates is needed to keep fixed-rate DeFi products relevant to investors, according to a report by Huobi Research Institute in partnership with Huobi Tech and EmergentX.
Named “Fixed Rate DeFi Protocols: A Bear Market Haven?“, the report notes that fixed rate products serve a vital function, especially during a bear market by allowing investors to hedge risk. However, a downside occurs during periods of market fluctuation, where it is almost inevitable The report observes an impossible trilemma in typical DeFi product design: that of balancing risk, interest rate, and stability (Figure 1).
The report further examines the three most commonly adopted fixed rate protocols in the DeFi market today: zero coupon bond, separated principal and interest, and junior and senior bond.
According to the report, Notional, an example of a zero-coupon bond that operates on a simple supply and demand curve where interest is fixed at the time of borrowing, has notable drawbacks in the form of interest rates. low interest due to insufficient fund turnover and inflexible maturity. periods of only three months and six months, which could be insufficient for both lenders and borrowers.
In a separate principal and interest model, the Principal Token (PT) is offered for sale at a discounted price while the Yield Token (YT) works to widen the income gap while remaining below the liquidation line. Pricing is a significant drawback for this protocol, the report notes, due to challenges associated with market forecasting.
Frequently adopted in the traditional financial market, junior and senior bonds classify funds into different tiers with different levels of risk aversion; essentially transferring additional risk exposure from investors who prefer stable income to those willing to take on increased risk.
The report noted that Notional, despite its drawbacks, stands out among TVL-wise lending protocols. However, Terra’s collapse and the prospect of an impending bear market have not helped adoption, which the report attributes to three reasons: systemic risks brought on by sharp swings in the crypto market; the liquidation risks faced by loan-type fixed rate products and how investors will need more time to determine their investment strategies, given the variety of fixed rate product structures currently available.
“Fixed-rate products face intense competition from professional investors and reputable financial institutions,” says Hugo Hou, researcher at Huobi Research Institute and co-author of the report. “The low interest rate remains a headache for fixed rates in DeFi and is preventing the industry from continuing to grow.”
“An increase in interest rates can only be achieved through fair pricing, redistribution of profits to participants, and increased profits from the underlying assets,” says Yeyan Wei, a researcher at the Huobi Research Institute and co-author of the report. “We hope that more innovative fixed rate products will soon emerge.”
Click on here to download the full report.
About Huobi Research Institute
Huobi Blockchain Application Research Institute (referred to as “Huobi Research Institute”) was established in April 2016. It is committed to researching and exploring new developments in the global blockchain industry. Its goal is to accelerate the research and development of blockchain technology, promote its applications, and improve the global blockchain industry ecosystem. Huobi Research Institute covers industry trends, emerging technologies, innovative applications, new business models, and more. The Huobi Research Institute partners with governments, companies, universities and other institutions to create a research platform that covers the entire blockchain industry. Its professionals provide a solid theoretical basis and analyze new trends to promote the development of the industry.
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