Revelo Roundtable #14 - Fixed Rates

In this episode of Revelo Intel’s Twitter Spaces on May 9, 2024, Kirk hosted Gaspard Peduzzi, Dion Chu, Charles, and Ken Chia to discuss the importance of fixed rates in DeFi, strategies to improve liquidity and user engagement, and the future of fixed and variable rate markets. Read our notes below to learn more.

Background

Kirk (Host) – Head of Business Development at Revelo Intel

Gaspard Peduzzi (Guest) – Co-founder of Spectra Finance

Dion Chu (Guest) – Contributor at Term Labs

Charles (Guest) – CEO of DELV

Ken Chia (Guest) – Contributor at Pendle

Spectra Finance – an open interest rate derivatives protocol

Term Finance – a non-custodial fixed-rate collateralized protocol lending on-chain

DELV Hyperdrive – a new AMM for fixed and variable yield positions underpinned by a novel pricing mechanism

Pendle – a permissionless yield-trading protocol where users can execute various yield-management strategies

Exploring Fixed Rates in DeFi: Perspectives from Pendle, DELV, Term, and Spectra

Kirk mentions that fixed rates do not get enough credit in the DeFi space, where the focus is often on speculation and high APRs. Kirk says that good fixed-rate protocols are essential for DeFi to evolve, especially with institutional involvement.
Gaspard says that he has been in crypto for more than 10 years and discovered Ethereum naturally. He mentions that he started exploring various protocols and began building during the DeFi summer of 2020 with a group of students from his computer science school. They initially created a protocol called APWine to speculate on the sustainability of high APYs.
Gaspard explains that APWine v1 was launched in early 2021 as a permissioned protocol with manual integrations for each protocol like Aave and Compound. He notes that they discontinued the initial pools last year and have been developing APWine v2 for almost two years, which is now on mainnet in a private launch phase. He highlights that the new design is completely permissionless, AMM agnostic, and more efficient.
Dion says he comes from traditional finance as a government bond trader and launched a small family office a few years ago, which led him into DeFi. He mentions buying Bitcoin in 2013 and initially being a Bitcoin maximalist. Dion gets involved in DeFi through various crypto projects and serves as a DAO treasury managing short-term liquidity. He notes the need for fixed rates and fixed terms, leading to the creation of Term Finance, which focuses on fixed-rate borrowing and lending through a traditional collateralized model and weekly auctions.
Charles introduces himself as the CEO of DELV, formerly known as Element Finance. He recounts his entry into DeFi in 2016-17 with Polymath, a security token platform. He then moved on to explore Ethereum, contributing to Ethereum Foundation. Charles contributed to MakerDAO, working on multi-collateralized $DAI and decentralized governance. Seeking new challenges, he joined Element Finance, which evolved into DELV. DELV focuses on Hyperdrive, an AMM for trading fixed and variable rates, addressing liquidity fragmentation and eliminating the need for rollovers.
Ken shares that he comes from a tradfi background, working at JP Morgan and then transitioning to crypto by accident, initially working at an exchange. He later leads a lending desk for Abra before moving into DeFi.
Ken says that DeFi worked as intended during the credit cycle collapse in 2022-23. Pendle, founded in 2020, gains traction in 2023 with liquid staking tokens and perps DEX assets and sees significant growth in 2024 with narratives around restaking and EigenLayer. Pendle offers attractive fixed rates and a points market for diverse users.

Perspectives on Fixed Rates and Interest Rate Swaps in DeFi

Kirk asks if the fixed rates or interest rate swaps market will be primarily adopted by current market participants or institutions.
Gaspard believes that the fixed rate tools will eventually integrate into DeFi similarly to traditional finance. He highlights that protocols need to cater to current DeFi market participants and acknowledges Pendle’s success in aligning with popular narratives like LST points. Gaspard notes that DeFi is still in its early stages, and for fixed-rate instruments to be attractive, they must reflect the dynamic liquidity strategies of current users.
Dion agrees that most of DeFi is retail-driven, with users looking for high returns through speculation. However, he points out that the top 1% of users on platforms like Aave hold a significant portion of the total value locked (TVL), indicating a substantial market already exists on-chain. He highlights that institutional participation will grow, citing BlackRock as an example, and believes there’s plenty of room for growth in the fixed-rate market.
Charles says that retail traders are more interested in speculation than safe yields. He suggests that early fixed-rate protocols made a mistake by targeting retail users instead of institutions. Charles talks about the importance of targeting institutional users and adding tools to facilitate their participation in DeFi. He says that fixed-income markets are more suited to institutional users than retail traders.
Ken explains that Pendle started in 2020 and initially targeted high APY assets from the DeFi summer, which were unsustainable. He notes that Pendle focused on simplifying the user interface and educating users from 2023 onwards, which helped increase adoption. Ken highlights the importance of both retail and institutional players for price discovery and mentions that Lido’s $stETH established a sizable yield market, which became Pendle’s first significant use case. He highlights the need to make the mechanics accessible and understandable for users to drive adoption.

Optimizing Liquidity

Kirk asks about addressing liquidity depth and slippage in various protocols.
Charles explains that Element Finance initially faced issues with fragmented liquidity due to separate markets for PTs and YTs. Hyperdrive addresses this by combining liquidity pools for longs and shorts, with shorts offering multiplied exposure to variable rates. Hyperdrive also features mint-on-demand, eliminating race conditions and partial maturity issues, thus making the market more efficient and robust.
Gaspard describes how Spectra also combined PT and YT pools by changing their yield mechanism, allowing progressive claims. This change concentrated liquidity and made it easier to manage. Spectra is working on a liquidity module for better management and leveraging well-integrated infrastructure like Curve AMM to capitalize on volume and LP revenues, aiming to attract more liquidity.
Dion explains that Term Finance uses a weekly auction model, similar to a low-frequency order book, which eliminates slippage by matching supply and demand at a single price. This model focuses on primary market clearing, separating it from secondary market liquidity, which will be tackled later. The approach simplifies finding borrowers and lenders without the need for third-party LPs, making it more efficient for large-scale transactions.
Ken talks about the importance of identifying the right narratives and assets, which drive liquidity. Pendle relies on the liquidity of underlying assets to create markets, focusing on popular and promising assets. He acknowledges the slippage issue, particularly on the YT side, due to its leveraged nature, and mentions expected improvements in Pendle’s v3. Ken notes that the liquidity of top pools has mitigated price impact issues for PT and YT trades.

Navigating Liquidity Fragmentation

Kirk asks about the potential for a dual model combining AMM and order book systems, exploring how this might address liquidity issues and slippage for different types of assets.
Charles suggests that a combined model could be viable, highlighting the importance of liquidity and how AMMs are well-suited for certain needs. He acknowledges that while he can see potential, it ultimately depends on the liquidity available.
Gaspard explains that Spectra initially deployed on Ethereum mainnet and Polygon, facing high gas fees as a challenge on the mainnet. He notes that while they focus on mainnet and some L2s, the merging of liquidity across different chains is not yet operational for them. They plan to expand to different chains based on yield opportunities and community needs.
Dion confirms that Term Finance focuses primarily on Ethereum L1, which remains the liquidity layer valued by large whales despite high gas fees. He mentions their recent expansion to Avalanche and considers other L2s, noting the challenges with token mobility and security across chains. Dion highlights the importance of evaluating each chain as a separate market and recognizing the current limitations of cross-chain liquidity.
Ken says that Pendle’s expansions are primarily asset-driven, focusing on EVM-compatible chains where liquidity already exists. They prefer a calculated approach, consolidating resources where they have a presence unless a new chain offers a compelling asset opportunity.
Ken describes how Pendle differentiates use cases between Ethereum mainnet and L2s, with the former attracting larger entities and whales and the latter fostering a vibrant yield trading environment.
Charles shares that Hyperdrive will launch on the Ethereum mainnet initially but aims to provide users access to the best liquidity across chains. DELV plans to abstract away the chain selection process for users, using tools like liquidity routers and bridges to ensure users get the best rates and liquidity regardless of the chain. Charles highlights the goal of a seamless user experience, focusing on sustainable yield sources and remaining EVM-focused for the initial launch.

The Future of Fixed Rate and Rate Swap Markets

Kirk asks the panelists to share their vision of the fixed rate and rate swap market five years into the future.
Gaspard believes both fixed rates and variable rates will coexist. He mentions that while institutional use might drive more sophisticated instruments, the DeFi space will still need highly liquid and viable variable rates to cater to current and new DeFi users.
Dion predicts a steady state where fixed rates slightly dominate, referencing TradFi markets where fixed rates are preferred for longer-term needs. He sees both types coexisting due to their distinct use cases.
Ken envisions a maturing market that moves beyond the current circular crypto lending structure. He highlights the need for diverse borrowers, including traditional firms, to create a more mature and varied credit market. Ken believes this will drive demand for term rates in crypto, fostering the development of a yield curve.
Charles agrees that both fixed and variable rates will exist, highlighting that DeFi’s experimental nature supports various models. He points out that over-collateralization in DeFi works well, but reputation-based models will likely emerge as zk technology advances, enabling better on-chain credit systems.

Updates from the Protocols

Gaspard from Spectra mentions their imminent public release, along with a backlog of features and integrations. He highlights plans for better liquidity provision and market decoration customization.
Dion from Term Finance announces their recent formal verification and upcoming release with fallback oracles. He also teases a new campaign and plans for auto-looping features to broaden the borrower base, making the protocol more accessible.
Ken from Pendle focuses on product improvements, including better trading experiences and auto-rolling liquidity for more passive management. He mentions ongoing UI and educational enhancements, new asset listings, and the early development of v3, which will enable markets not possible with v2.
Charles from DELV highlights their upcoming Hyperdrive launch and subsequent focus on integrations and growth. He outlines future features like fixed borrowing across multiple protocols, leveraging fixed rates, and user-friendly UX improvements. Charles also mentions ongoing research into optimizing liquidity fragmentation and multi-term variants.

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Show Information

Medium: Twitter (Audio)

Show: Revelo Intel Twitter Space

Show Title: Revelo Roundtable #14 – Fixed Rates

Show Date: May 28, 2024