In the financial market, different people have different risk preferences. Some people prefer lower stable returns, while others are willing to take on greater risks for higher returns. DeFi (Decentralized Finance) continues the characteristics of cryptocurrencies, namely unstable returns. So, how can some people achieve stable cash flow?
To address this issue, a group of DeFi projects called "Fixed Interest Rate Protocols" have emerged. For the same underlying asset, these protocols promise fixed returns to a portion of people, while the remaining portion's profits and losses are borne by others. This function of redistributing risks and returns within the asset is similar to traditional "graded funds".
88mph is one such protocol that implements fixed interest rates. It sits between investors and other protocols. For example, if you want to deposit USDC into Compound but also want to earn fixed returns, you can deposit USDC into 88mph and set the maturity date. 88mph will calculate the moving average of the USDC yield rate in Compound over the past 30 days and set the fixed interest rate at 75% of that value. After depositing, you will receive an NFT (Non-Fungible Token) representing a fixed interest rate bond. Therefore, for investors, the interest rate they receive may be lower than the actual returns provided by Compound, but they can at least know in advance how much returns they will earn during the term.
If the actual yield rate of the target asset remains lower than the fixed interest rate bond for a long time, the protocol will not be able to provide the promised interest. 88mph also designed a mechanism for floating interest rate bonds to transfer the risk of returns to investors with higher risk preferences. Each fixed interest rate bond will generate a floating interest rate bond, which will be available on the market for others to purchase. The price of the floating interest rate bond is the interest of the corresponding fixed interest rate bond. For example, if a fixed interest rate bond with a principal of 1000 USDC matures in six months and the sum of principal and interest after six months is 1030 USDC, then the principal of this floating interest rate bond is 30 USDC. This principal is used to guarantee the interest of the fixed interest rate bond. For example, if the yield rate of the target asset is 0 within six months, meaning only the principal of 1000 USDC is returned after six months, then the 30 USDC of the floating interest rate bond investor will be used to compensate for the interest of the fixed interest rate bond. If the final interest is 20 USDC, then 10 USDC from the 30 USDC will be used to compensate for the shortfall, and the floating interest rate bond investor will receive 20 USDC, resulting in a loss of 33%. If the final benefit is 50 USDC, then the excess 20 USDC will be the return of the floating interest rate bond, resulting in a return of 67%.
Floating interest rate bonds can be understood as speculation on interest rates. In a market with sufficient liquidity, bond prices will fluctuate with the yield rate of the underlying asset. It can be seen as a product similar to an "interest rate swap".
Despite such mechanisms, there is still a risk of being unable to fulfill the benefits. For example, if the fixed interest rate yield is too high and no one purchases the floating interest rate bonds, and the yield rate of the target asset does not reach the promised yield rate. 88mph has other mechanisms to mitigate this issue. For example, when the yield rate of the target asset is higher than the promised yield rate, the protocol will have a surplus. When a fixed interest rate bond is redeemed early, a 5% early redemption fee is required, which serves as a buffer.
There are other fixed interest rate options in this market as well. For example, Yield allows borrowers to deposit collateral and issue zero-interest bonds, which are sold at a discount to attract investors. The discount represents the investment interest. The implementation of Saffron Finance and BarnBridge protocols is more similar to traditional graded funds, where the same investment target is divided into multiple tranches with different interest rates and risks.
Currently, participants in the cryptocurrency market generally have a higher risk preference, and the market has not yet shown a preference for such projects. The demand for fixed income requires two characteristics: low risk preference and not spending too much time adjusting positions. Perhaps only when more people with medium to low risk preferences enter the cryptocurrency field for investment, these types of protocols will have the possibility of broader usage.