Can savings DeFi come to the fore as the crypto market goes down?

Since the beginning of 2022, the crypto asset market has been on a downward trend, with a total market value of $1.81 trillion, a 38% drop from the historical high of $2.92 trillion in 2021. The total value of the on-chain ecosystem is also shrinking. According to Defipulse data, the total locked crypto asset value (TVL) on Ethereum, the largest on-chain ecosystem, is $76.4 billion, a 43% drop from the peak of $110 billion in 2021.

A common feeling among crypto asset users is that the "market is bearish". How to safely reduce asset shrinkage in the face of downside risks has become a need for some people. Savings DeFi applications have become one of the reference methods. The TVL of such applications happened to increase in the context of a bear market.

Take Anchor, a stablecoin fixed-rate savings app on the Terra (LUNA) chain, for example. Its TVL has been rising steadily since February 2022, from $7 billion to $14 billion today, with a TVL growth rate of 100%. The increase in Anchor's locked value may reflect the needs of users in a bear market - more pursuit of products with stable growth.

Fixed-rate savings applications can be classified into the category of DeFi lending products. Lending applications such as Compound, Aave, and MakeDAO are mainly based on "floating interest rates". The interest rate calculation is determined based on the "supply and demand relationship", that is, in the lending agreement, the interest rates of the lender (paying interest) and the borrower (earning interest) are presented in an algorithmic manner based on the demand for funds. When the market is volatile, interest rates will also change accordingly. When funds are in short supply, the borrowing interest rate will rise sharply and even reach more than 100% to increase the cost of borrowing.

When the interest rate is fixed, it is easy for people to think of the savings function of a bank, and such products are beginning to appear in the DeFi market.

Fixed-rate products can minimize systemic income risk. Since the interest rate is fixed, users do not need to adjust their positions according to interest rate fluctuations. They can also clearly control the on-chain investment costs and have fixed income. Some industry opinions believe that fixed-rate products may become the primary channel for traditional institutions to enter the crypto asset market and even the DeFi field.

Last June, Compound Labs, the company behind the DeFi lending protocol Compound, established a new product, Compound Treasury, for enterprises and institutions. By cooperating with Fireblocks and Circle, it allows non-crypto enterprises and financial institutions such as banks and fintech companies, as well as large US dollar holders, to exchange US dollars for USDC and obtain a fixed interest rate of 4%.

At present, in addition to fixed-rate products such as Compound Treasury and Anchor, many developers have also deployed fixed-rate products, but the results are not satisfactory, because compared with liquidity reward projects with annualized returns of tens of millions, the returns of these products are not conspicuous in the bull market. But when the market is quiet, the demand for fixed-rate products is increasing. This issue of DeFi Honeycomb will introduce the representative applications and operating mechanisms of fixed-rate products.

Notional, a zero-interest bond platform

Introduction

Notional (NOTE) is a decentralized fixed-rate lending application built on Ethereum. It supports DeFi, CeFi, institutional traders and individual users to complete the lending of crypto assets at a fixed interest rate and fixed term.

The Notional team created this application because fixed-rate financing is the most common method in the traditional financial market. For example, bonds are issued at a fixed rate. Fixed interest rates provide market participants with certain investment returns or borrowing costs, which can control risks. Notional hopes to build a fixed-rate lending platform in the decentralized financial system to provide crypto users with a stable financing channel.

Notional official website

Operational Mechanism

Notional uses the mechanism of minting "fCash" Tokens by collateral to achieve a state where storage has a fixed income and loans require fixed interest payments. Transferable fCash represents the "right to claim interest at a specific point in the future", which can be understood as the tokenization of "zero-interest bonds".

"Zero-coupon bonds" are bonds that do not pay interest. They are loan certificates issued by borrowers. Usually, their trading price is lower than the face value. They are discounted bonds and will be paid to bondholders at face value after maturity. The "lender" purchases zero-coupon bonds at a discount, which is equivalent to making a fixed-rate deposit, and can receive the funds on the face value of the bond on the maturity date. The "borrower" can borrow zero-coupon bonds by mortgaging assets and sell them at a discount for cash. If you want to get back the collateral, you must repay the outstanding amount on the face value of the bond after the maturity date. Therefore, the difference between the amount obtained from selling the bond and the face value of the zero-coupon bond is the interest paid on the loan.

For example, borrower A wants funds, and after pledging assets, he issues a zero-coupon bond with a face value of $110 for a period of 6 months, and then sells it to lender B at a discount of $100 in the market. At this time, borrower A obtains $100 in cash, and lender B has the right to claim a $100 loan with a fixed interest rate of 10% for 6 months. When the loan matures, borrower A needs to pay the face value of $110 to redeem the zero-coupon bond. For A, he gets a $100 loan with a fixed interest rate of 10% for 6 months.

Under the zero-coupon bond mechanism, since the borrower's cost is the depositor's income, there is no need to adjust the market supply and demand of funds to determine a fixed interest rate acceptable to both borrowers and lenders.

With the concept of "zero-interest bonds", Notional tokenized it and turned it into a transferable on-chain zero-interest bond like fCash. Therefore, on the platform, each fCash has an associated Token exchange pool. Since the platform allows the circulation of "cToken" (cToken is a deposit certificate of Compound and is an interest-bearing asset), the liquidity of the exchange pool is composed of fCash and cToken.

The mechanism of Notional fixed-rate deposit and loan is as follows:

• Fixed-rate deposits - When a lender deposits DAI, Notional will first deposit it into Compound and exchange it for cDAI. Then, it will purchase discounted bonds fDAI from the zero-interest bond liquidity pool, redeem cDAI on the maturity date, and then exchange it back to DAI to obtain fixed interest income.

  
  

  For example: Lender A deposits 100 DAI in Notional. The platform will first convert it into cDAI, and then purchase 103 fDAI with 100 cDAI. Assuming it matures in 1 year, the difference between fDAI and DAI is A's deposit interest income.

• Fixed-rate borrowing - After the lender pledges assets (such as ETH), fDAI can be minted, and then sold at a discount for cDAI in the exchange pool "fDAI/cDAI", and then exchanged for DAI in Compound. The amount of fDAI face value can be returned on the maturity date. The difference between fDAI and the borrowed DAI is the borrowing cost.

  
  

  For example, borrower A pledges 1 ETH in Notional and borrows 100 DAI at an interest rate of 3%, which means that borrower A owes the platform 103 DAI. Assuming the maturity date is 1 year, the borrower must repay the outstanding balance on the maturity date before he can redeem the pledged ETH.

Currently, the Notional platform supports depositors to deposit ETH, WBTC, DAI or USDC to obtain fixed interest income, and also supports borrowers to mortgage these assets to mint fCash and borrow DAI. In addition, users can also provide liquidity for the "fCash/cToken" exchange pool by providing cETH, cWBTC, cDAI or cUSDC, and obtain Notional platform token NOTE rewards.

"Principal and interest rate separation" application Element

Introduction

Element is also a decentralized fixed-rate income platform built on Ethereum, which achieves interest rate stability by splitting the principal and future income and tokenizing them.

Element official website asset fixed income situation

Element splits the deposited asset principal and income and tokenizes them separately. The pricing of "income token" at settlement depends on the market's expectations of future interest rates, while "principal token" is equivalent to a zero-interest bond, which can be redeemed at par on the maturity date. Before the maturity date, the zero-interest bond will be sold at a discount depending on the length of the maturity period.

At this time, users who want to avoid risks by fixed interest rate returns can sell the uncertain "income tokens" and buy the "principal tokens" that are on sale. Since these "principal tokens" are sold at a discount, after maturity, users can redeem the tokens at face value, that is, they can obtain fixed income at a discounted price.

Operational Mechanism

All funds deposited on the Element platform (ETH, DAI and USDC) will be divided into two parts. One part is the "Principal Token (PT)", which represents the value of the deposited principal, that is, the "Principalized Token"; the other part is the "Yield Token (YT)", which represents the variable interest obtained from the platform in the future, that is, the "Yielded Token".

The deposit funds on the Element platform are divided into two parts

• The principal token PT - equivalent to a zero-coupon bond, cannot be redeemed before the end of the lock-up period, so it will trade at a discount relative to the underlying asset. Element allows users to purchase discounted PT through AMM, and after maturity, PT holders can redeem the underlying asset at a 1:1 ratio.

  
  

  Users who purchase PTs determine their fixed-rate return based on the asset's discount rate at the time of purchase. Buyers of PTs that have not yet matured will trade at a discount to their underlying assets. The further the principal is from maturity, the higher the discount.

  
  

  For example, a user purchased a principal token PT (yETH) with a 1-year term at a 10% discount, which means that if he purchased it with 10 ETH, he would get 10.1 principal tokens PT (yETH). After 1 year, he can redeem 10.1 ETH, and the fixed rate of return is 10%.

  
  

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User purchase of principal token PT process

• Yield token YT - represents the interest that will be generated in the future. This interest is variable and uncertain, but YT is liquid and tradable.

  
  

  On the one hand, users can choose to deposit funds in Element and then sell the minted income token YT directly to realize future interest in advance and realize fixed interest rate income. On the other hand, users can also choose to buy YT, which means going long on future interest rates, because the price of YT represents the market's expectations of future interest rates, and the higher the accumulated interest during the period, the higher the price of YT. Borrowers can hedge their borrowing costs by purchasing YT. As long as the assets that can be redeemed at maturity are higher than their purchase cost, they can make a profit.

Take ETH that can be deposited in Element as an example. If a borrower deposits some ETH into Element, he will receive newly created ptETH and ytETH. Now he can control the principal and income with PT and YT. If he decides to sell PT immediately and hold YT, PT will be sold at a discount (such as a yield of 10%, 1ETH=0.9ptETH), and ETH will be obtained, while the held YT will still be earning interest. At this time, the borrower can use the exchanged ETH for revolving lending to improve the utilization rate of funds. Lenders can obtain fixed income by purchasing discounted principal tokens PT.

"Stablecoin Bank" Application Anchor

Introduction

Anchor (ANC) is a fixed-rate savings application built by the Terra team. It provides users with stablecoin savings products and pays interest to depositors. It supports users to deposit UST and obtain a fixed annualized rate of return.

Anchor locked crypto assets

Anchor balances interest rates by coordinating the block rewards of different PoS consensus blockchains, ultimately achieving a storage rate with a stable yield, thereby providing a reference interest rate for the on-chain crypto asset lending market.

Operational Mechanism

Anchor is like a bank, attracting depositors to deposit money, and the bank gives depositors a fixed interest, and then lends the deposits to users in need. It is essentially still a mortgage lending application, similar to the "stable interest rate version" of Compound. Depositors deposit stablecoins (currently only UST is supported) into the Anchor platform, and depositors can obtain a fixed annualized rate of return.

The depositor income of the Anchor platform mainly comes from the interest paid by borrowers, because the agreement will lend the deposited assets to borrowers in need to obtain income. Borrowers need to pledge "bAsset" to obtain the loan amount.

"bAsset" is the core of Anchor's operation. It is bound to the block production rules of the blockchain and is also called "equity security assets". It is the proof of ownership of the underlying token of the POS blockchain network, proving the ownership of the assets pledged in the POS blockchain network for node verification.

Simply put, blockchain networks such as Terra (LUNA) and Ethereum 2.0 (ETH) are based on the POS mechanism to ensure the operation of the blockchain network. By staking a certain amount of the underlying network tokens (LUNA, ETH), you can become a node validator and receive verification rewards. After the validator completes the pledge, the assets can become "bAsset" on Anchor. In other words, bAsset on Anchor is a proof of "stake".

Since the underlying token assets pledged in the blockchain network nodes have no liquidity, the liquidity can only be released by unstaking after the pledge period ends. For example, the staking period of LUNA in Terra's network nodes is at least 21 days, and the staking period of the Ethereum 2.0 network is even longer. This means that during the staking period, the assets pledged by users lose liquidity. In addition to receiving additional rewards ANC (Anchor's governance token), users holding bAsset certificates can also trade them.

Currently, bAsset supports two blockchain underlying token assets as collateral, namely LUNA and ETH. After the borrower pledges LUNA or ETH, Anchor will stake these LUNA or ETH on the node to obtain verification rewards. To put it simply, Anchor itself will also serve as a node validator on the blockchain network, and the block rewards obtained will be sold for UST to pay depositors' interests and provide a stable interest rate source for Terra deposits.

Therefore, the Anchor protocol's income comes from two main sources: one is the "interest paid by the borrower", and the other is the "blockchain staking reward".

BainBrige, a structured risk management platform

Introduction

BainBridge (BOND) is a cross-platform protocol that optimizes and hierarchically manages the yield and volatility risks in DeFi applications. It was first launched in 2020 and aims to reduce return volatility for conservative investors, long-term holders and risk-averse institutions, while also providing high-volatility options for risk-takers.

Barnbridge Asset Returns

Barnbridge integrates multiple lending platforms such as Compound, AAVE, Cream, etc. through algorithms to obtain data related to crypto assets that generate income, and improves the efficiency of fund use by stratifying and grading risks to increase users' yields. It is similar to a machine gun pool, but different from the volatile yield of a machine gun pool, because its ultimate goal is to integrate the income pools of multiple lending platforms to build a more complex structure and bond rating system.

Operational Mechanism

BainBridge adopts a risk structured management mechanism, which believes that future returns and interest payments are uncertain, but everyone has different risk tolerance and opportunity costs of funds. Users need to reallocate risks according to their own needs and divide volatile returns into different levels to complete risk investment in investment targets.

When integrating lending applications such as Compound and Aave, BainBridge used a mechanism called "Smart Yield Bond" to provide users with fixed interest rates or leveraged variable returns on stablecoins. Smart Yield Bond consists of two income products, "Junior Pool" and "Senior Pool".

• Senior Pool (sBONDs) - has the priority right to profit distribution within the system and locks in fixed interest rate profit, and is also commonly known as the "senior citizen pool".

• Junior Pool (jTokens)——The right to distribute residual income. The income obtained is the remaining assets after paying the fixed income of the Senior Pool in the same system. The income is not fixed and is volatile. It is commonly known as the "children's pool".

Features of Junior Pool and Senior Bond income products

In BainBridge, users can deposit stablecoins into the primary pool or the advanced pool according to their risk tolerance. For users, there is a difference. The primary pool is high-risk because the interest rate is variable due to leverage, while the advanced pool is low-risk because the interest rate is fixed.

The position certificate sBond obtained by depositing in the Senior Pool is an NFT asset that can be traded in the secondary market or used for other composable purposes. When the principal and interest are redeemed at maturity, the NFT will be destroyed.

The position certificate obtained by depositing into the Junior Pool is jToken, which is a 1:1 stablecoin asset certificate, not an NFT.

In theory, both sBond and jToken holders can earn a return, but if the APY offered by the underlying loan market is lower than the guaranteed yield on the senior bonds, then the returns to junior bondholders will need to make up the shortfall first.

The primary pool of the stablecoin FEI needs to subsidize the income to the advanced pool

In fact, both the funds in the primary pool and the advanced pool have entered the lending market such as Compound and Aave. In other words, the actual risks of the primary pool and the advanced pool are the same. The reason why the interest rates are inconsistent is that the returns in the lending market are always fluctuating. Some people get a fixed interest rate, while others subsidize the former when the market is not good, or receive additional returns when the market is good.