Most successful first generation DeFi products were pool-based.
Aave struggled to get traction with a P2P model (as ‘EthLend’) until they conceptualized their pool-based model with variable rates. The aggregated liquidity and simplicity (along with a confluence of DeFi Summer hype and low interest rates) built Aave into a product currently valued at more than $1B.
Recently, we’ve seen order book DEXs like GMX and dYdX thrive where we once only had pool-based DEXs like Uniswap.
And yet lending continues to be almost fully dominated by pool-based products.
Slow Growth for Fixed Rate DeFi Products
We have yet to see fixed rate lending take off. Notional and other well-funded fixed rate protocols are sitting at <$20m valuations despite strong development, incentives, and marketing. Perhaps the most successful product is Pendle, and yet it is mainly focused on productizing existing yield, not originating new loans.
I think there may be a few reasons why demand for fixed rates is so low:
Most DeFi users are short-term focused and variable rates are a good fit for farming
Sophisticated investors and institutions haven’t yet taken the full DeFi dive
There’s not much liquidity for pure fixed rate products
Here we can see we have a chicken and egg problem. Sophisticated investors require liquidity, and we wont have deep fixed rate liquidity until sophisticated investors generate demand. But there’s another problem that is preventing deep liquidity: fractured liquidity across loan term/maturity.
Fractured Liquidity Problem
Different maturities demand different rates, which is why we have a yield curve. Pool-based fixed rate lending protocols typically have separate pools for each maturity in order to allow supply and demand to work its magic for each maturity.
Available maturities on Notional Finance for USDC
Offering borrowers more choices has unfortunately meant further fragmenting liquidity among each pool, and why we see only three maturities on protocols like Notional despite it being one of the top fixed rate lending protocols.
Size Lending: Unifying Liquidity
The Tinkering Society has helped guide the development of a new fixed rate lending protocol called Size which unifies liquidity across all loan terms/maturities.
Size accomplishes this through a P2P model where lending offers are structured as yield curves.
An example Size offer by a lender in light green, and aggregate market yield curve in dark green
Borrowers can then pick any due date, and liquidity is aggregated from all offers spanning the chosen date.
Where borrowers were previously forced to choose from a small and suboptimal set of maturities, they can now choose whatever date, or even time, that fits their needs.
Lenders benefit from earning a passive variable rate (currently via Aave) until their custom offers are matched with borrowers.
Lenders may also exit their obligations at any time to other lenders “through the aggregate yield curve”, provided there is sufficient depth for their size.
Having deep liquidity on both sides of the market (offers to lend and bids to borrow) is ultimately what will facilitate speculation on rates.
We hope to see applications like Size eventually increase market efficiency by allowing speculation on rates for any day in the future, resulting in a high resolution DeFi yield curve.
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