Completing the DeFi Credit Market
Decentralized Finance (DeFi) is a new initiative based on blockchain technologies that aim to create a new financial system by creating a network of interconnected distributed apps (or dApps), open source, and non-custodial protocols. By combining some of these dApps, we cannot only recreate instruments of traditional finance but also create new ones that were not possible before.
Exactly’s mission is to create a protocol that brings an essential missing piece into the ecosystem: the “Time Value of Money”; that is, to be able to make a deposit or loan at a fixed rate for a certain period, which is known in the traditional financial world as “fixed income.” That way, users will have an efficient means to hedge interest rate volatility.
Some protocols approach this problem using a P2P strategy, where borrowers and lenders are individually matched. While conceptually simple, this approach entails many inefficiencies related to matching both amount and time in each transaction. Protocols such as AAVE take a different direction, offering a stable (not fixed) rate if the market condition remains within a certain threshold of liquidity (Utilization Rate). While this provides greater predictability, it doesn’t eliminate the risk, and it only works for some borrowers.
On the other hand, a series of protocols were recently launched. Some use one token to create an element resembling a “Zero Coupon Bond” (Yield/Notional), whereas others use two tokens (one for the principal and one for the interest), much like a “Coupon Stripping” (Element/Pendle) technique, to try to discover the fixed interest rate based on the price of one or more assets with specific expiration date represented by one or two ERC-20 tokens.
This type of protocol has not managed to capture enough liquidity yet (less than $1bn in TVL or less than 5% of the TVL in money market protocols) due to their complexity and the challenges they pose when it comes to implementing them in the Ethereum blockchain and other smart contract architectures. The key metric in this type of protocol is the stock of loans; so far, the fixed-income protocols have borrowed less than $0.4bn (2%) versus the over $18bn borrowed in money market protocols.
Regarding the token approach for interest rate discovery, when there is a slippage in the price of these types of tokens, the interest rate to be discovered is indirectly affected, resulting in the protocols requiring their AMMs implementation. This poses additional challenges since these unique tokens can’t be traded on AMMs like Uniswap. The constant product invariant formula x*y=k is not ideal for Yield Tokens, where time is an additional factor. Utilizing a formula that is a pure function of reserves would cause pools to suffer from unpredictable losses to arbitrage as YT maturity approaches, so all the YT protocols have developed their AMMs that can be utilized for time tokens.
Liquidity is like water coming down a hill, and our goal is to remove the obstacles to make it flow fast and easily through the river. Exactly’s methodology is based on finding a solution to the problem of fixed income using the first-principle approach, considering all the challenges and constraints that appear when bringing traditional finance and DeFi to blockchain technologies. That is why the Exactly protocol will discover the fixed interest rate directly from the supply and demand of credit in each of our Fixed Rate Pools for each asset, for each maturity term. The interest rate will be a function of the supply and demand of credit for each Fixed Rate Pool of each token according to its respective expiration date.
The next challenge will be even more demanding, as we want to connect DeFi with the legacy financial system. To succeed, we need to bring fixed rates and a superb experience to the Alices and Bobs of the world. We can add value to a few hundred thousand DeFi users, but the world has 8 billion people to serve, and we’re eager to tackle this massive opportunity.
Stay connected; more news is coming your way very soon!
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PS: If you would like to join our team, please complete this challenge: https://github.com/exactly-finance/challenge
