IPOR V2: A User-Friendly Credit Hub for DeFi

In a recent announcement, IPOR Labs, the prominent player in the decentralized finance (DeFi) space for interest rates derivatives, revealed its plans for IPOR V2, an upgraded version of its platform and AMM (Automated Market Maker). V2 will bring a complete overhaul, with improved architecture, new products, a rebranding, and more, which will be rolled out gradually. Here’s what’s in store and how it can help improve DeFi.

Setting the Foundation with IPOR V1

IPOR V1 introduced DeFi to interest rate indices and interest rate swaps, and subsequently released power tokens as a new tokenomics template in January 2023. These developments provided users with valuable tools for managing interest rate exposure, contributing to the overall growth and adoption of DeFi.

The core product of IPOR is the ability to trade Interest Rates derivatives for a period of 28 days denominated in stablecoins (USDC, USDT, DAI) allowing users to fix their borrowing or lending rates using an interest rate swap with the liquidity pool as contract counterparty

For more info about IPOR V1 and key learnings from the first 10 months on mainnet, check out our previous article

IPOR V2 Improvement #1: Better IRD pricing

IPOR has worked on reducing the bid-offer spread for the user benefit, and a more sophisticated bid-offer skew to protect the AMM from attacks or predatory behavior.

On the skew first, IPOR has enhanced the dynamic of their bid-offer spread model, developing a new hybrid engine where the spread is not only affected by the state of the supply and demand, but also by the dynamic of supply and demand and the macro environment.

But the most important feature for the user is the reduction in bid-offer spreads through the introduction of the concept of swap unwinding.

In IPOR v1, IPOR swaps are cancellable, meaning that users can terminate their contracts at any time before maturity. This provides users with flexibility and liquidity, especially for crypto-native audiences who may lack experience in trading interest rates.

In TradFi, this service is provided by OTC desks which have tailored pricing based on a customer’s requirements. To put that into a formula for an AMM, on-chain, it was a heavy lift for the IPOR team. Cancellability is incredibly hard to price.

Logic of cancellable swaps

A cancellable swap embeds the pricing of a plain vanilla interest rate swap and the price of the option to cancel it at any time before maturity (called a Bermuda swaption), cashing in the P&L of the swap.

One commonly used model for pricing interest rate swaps is the multi-curve framework, which takes into consideration the term structure of interest rates and discounting curves. This model incorporates market data, such as interest rate swap rates, yield curves, and market expectations, to determine the fair value of the swap.

The pricing of cancellable interest rate swaps often involves more complex calculations and may require advanced modeling techniques, such as Monte Carlo simulations or numerical methods, to account for the flexibility of early termination and the associated risks.

There are three uncertainties which make the model so complex

• the interest rate index price at the time of cancellation
• the level of the liquidity pool at the moment of cancellation,
• the level of liquidity in the market at the moment of cancellation.

The IPOR quant team likely worked with conservative assumptions, the stablecoin market having a relatively recent history, there is no known term structure of interest rates yet in DeFi (IPOR aims at building it), and the historical data on Stablecoins term rates are as old as IPOR protocol is. Even if the model could adapt to the collection of data, the impact on the bid-offer of the current swap is detrimental for active trading.

In line with these conclusions, IPOR V2 will remove the swap cancellability, which will likely reduce the bid-offer spread by at least 50%. This innovation was ahead of the current developments in DeFi and we expect IPOR to capitalize on this work in the interest rates options space when a surface of volatility on crypto rates develops.

Unwinding swap

The unwinding of an interest rate swap refers to the termination or early termination of the swap contract before its original maturity date. In IPOR V2, users will be able at any time of the life of an open position in an interest rate swap to “unwind” it, by locking the expected Pay-out of the swap until maturity and cashing it in.

Differently from a cancellable swap, in the swap unwinding, the user receives not only cash in the accrued interest rate difference since inception (the realized P&L), but as well the expected value of the remaining life of the swap against the market valuation (the unrealized P&L).

By unwinding an interest rate swap, a user can potentially eliminate future cash flow obligations or modify their interest rate exposure to align with their current objectives. This can result in cost savings if the new interest rate environment is more favorable.

For instance, a user entered into an IRS where he is paying fix for 28 days. After 2 weeks he/she has accumulated a profit from an IPOR index being in average higher than the fixed rate, while the new 28 days rate has not moved. He/she can then “unwind” his existing position, cash in his/her profit, and re-enter in a new swap for another 28 days.

IPOR V2 Improvement #2: Increased flexibility and opportunities

IPOR V2 offers a number of tradable tenors (1 month, 2 months, 3 months), creating a tradable yield curve for DeFi. This is a historical moment for DeFi.This opens many new opportunities, for instance:

• Extending the duration of your exposure to enjoy more carry in a steep curve (if the 3 months is the highest point of the curve, you can receive fixed rate and accrue slowly and everyday the differential of rate between the high fixed rate and the low index rate).
• Protect yourself for a longer period against a possible rise of stablecoin interest rates towards USD rates which have been significantly higher for months now.
• Taking advantage of kinks in the curve: assuming the 2-months rate is significantly lower at 2.5% than both 1-month 3% and 3-months 3.2%, you can enter in a pay fix position in 2-months and receive fixed rate in both 1-month and 3-months respectively in half the size of the 2-months, collecting the difference (3*0.5+3.2*0.5–2.5)=0.6% on a daily basis until the abnormally corrects.

A serie of educational articles written by IPOR Labs can guide you through the relative value opportunities and new Alpha in trading interest rates derivatives using IPOR (Part I, Part II, Part III)

IPOR V2 Improvement #3: Improving capital efficiency

At a high level, the risk management and the computation of the collateral factors will rely on a new risk oracle. In IPOR V1, many risk parameters were static, the parameters computation becomes now automated and adaptative in IPOR V2, increasing further the level of decentralization and the path towards an hyperstructure.

Importantly, the level of leverage and its capping will follow the same adaptive logic.

At this stage we can only assume the quant team is working hard on the version V2 of the AMM to deliver efficiency in capital management, maybe drawing inspiration from recent innovations by other derivatives protocols.

In theory, interest rates derivative pricing on different tenors are usually highly correlated, more so than options products, and should be easily manageable through a single pool for each stablecoin using numerical methods of risk management known in TradFi like Finite Difference Method or Monte Carlo simulations.

But this is usually true when the liquidity is plenty, when the tenors are significantly far. Furthermore, short term curves can experience kinks due to expectation of specific events (FED decisions, a L1 or stablecoin protocol upgrade,…)

For instance, options protocol Premia V3 uses a risk-based model to assess user positions in an isolated fashion. This approach is a blend of traditional Reg-T and Portfolio Margin Systems. A risk-based model is used to assess user positions in an isolated fashion in terms of liquidation, Premia V3 borrowers are in a first-loss position for exposure taken on. This means that their collateral is first used to cover any losses if a position becomes unprofitable. All profits from borrowing capital are retained by the user, less capital usage fees. This approach is designed to protect lenders and ensure that they are not exposed to undue risk.

To improve capital management, IPOR will probably experiment and implement some of the recent innovations in margining and collateralization seen in DeFi, these include:

Concentrated Liquidity

Some AMM protocols have introduced features that allow liquidity providers to concentrate their liquidity in specific price ranges. Instead of providing liquidity evenly across the entire price spectrum, LPs can allocate their assets to specific price ranges where they believe trading activity will occur. This concentrated liquidity approach improves capital efficiency by targeting areas of higher trading demand.

Multi-Asset Collateral at the pool level

Some protocols have introduced the concept of using multiple assets as collateral for borrowing or lending within the AMM. This approach allows users to collateralize their positions with a basket of assets instead of a single asset. By accepting multiple assets as collateral, AMM protocols can increase the available liquidity and enable users to utilize a wider range of assets to optimize their borrowing and lending strategies. In the IPOR case, each tenor (1, 2 or 3 months) could become an asset in this computation, with a dynamic collateral ratio that adjusts based on the risk profile of the portfolios, most likely according to duration and direction. In this cross-asset approach, margin requirements could be shared or offset across different positions or assets ultimately reducing overall collateral needs.

Partial collateralization at the exchange level

A margin architecture can avoid a fractional reserve system, where a lending market is used to fully collateralise positions at the exchange layer, while enabling users to provide a smaller portion of collateral on margin. This is the approach taken by Premia V3. If IPOR was to use something similar, the protocol would work like an asset manager at the exchange level. Each liquidity pool would have variable weights that can be adjusted dynamically, allocating more capital to assets they believe will experience higher trading volume or volatility, further optimizing capital usage.

IPOR V2 Improvement #4: a user-friendly interface to access a large DeFi Credit pool.

An expanded vision demands abstracted complexity, choice in products, improved communication, visuals (UI) and customer experience (UX). By embracing this vision, IPOR can democratize access to financial instruments traditionally available only through the opaque OTC market, and open a large scope of tailored solutions within DeFi.

For instance, leverage, a key driver of activity, could be introduced via increased utility of the IPOR yield-bearing LP tokens (ipUSDC, ipUSDT, ipDAI and any other ipToken that IPOR could be indexing) in the lending/borrowing market. For example, borrowing against LP tokens.

The ipTokens could have an increased utility in that process of collateralization within the system itself, being the core representation of each user open lending positions.

With the success of the largest crypto ecosystem upgrade in April, Ethereum’s Shanghai, Ethereum-based Liquid StakingDerivatives (LSD) became pristine collateral in DeFi and the ETH staking rate turned into the de facto risk-free rate in the industry. These ETH staging rates are now the benchmark, the same way US Treasury yields are the benchmark for all yield curves and bond issuances in the world. IPOR’s indices can be expanded to include non-stablecoin assets. ETH (Liquid) Staking Yield seems to be the prime candidate as it is seeing increasing adoption. IPOR Labs recently engaged in a conversation with ClearpoolFin’s co-founders, discussing the potential enablement of an IPOR ETH staking rate through IPOR V2.

With real-world assets RWA entering the DeFi space en masse, IPOR is well-positioned to incorporate them into core products. This vision could include 1-click fixed-rate borrowing or lending solutions through predefined vaults for predetermined terms, being a back end to Tradfi. For instance, for swapping tokenized securities.

IPOR sees an increase in utility through those developments being a yield bridge for any type of DeFi or TradFi fixed income product. We could envision a customization of the user risk profile (floating or fixed rate, extending or reducing duration, change of underlying cryptocurrency of your investment or liability) through a single “Zap” or a one-click action.

IPOR is shaping the future of Decentralized Finance

IPOR Labs is committed to delivering the first batch of V2 improvements, which will include upgraded derivatives, improved pricing, additional tenors, a more efficient AMM architecture and UI/ UX design revamp. The highly anticipated announcement for IPOR V2 is set to take place at EthCC, one of the largest Ethereum community events held annually in Paris. IPOR Labs will have a dedicated booth at the EthCC conference. Attendees will have the opportunity to interact with the IPOR Labs team, gain valuable insights, and acquire unique IPOR swag. The company recognizes the importance of face-to-face interactions and aims to create a memorable experience for conference participants.

IPOR Labs invites individuals to join the next phase of DeFi by becoming part of the IPOR DAO and community. By actively participating in the IPOR ecosystem, community members can contribute to building the future of decentralized finance alongside IPOR Labs, creating a more accessible and user-centric financial ecosystem. Join the Discord to partake in the discussions and be up to date with governance: https://discord.com/invite/bSKzq6UMJ3

If you liked this piece, please consider supporting us by liking, retweeting, and commenting. You can also follow me, Trading Alpinist, and subscribe to the Deus Ex DAO newsletter for more such content.

We, Deus Ex DAO, invite teams and builders to reach out to us when they are seeking expertise, guidance and assistance regarding their fundraising, business development, product building or marketing. Deus Ex DAO wants to hear from you. We are a group of critical DeFi users with a broad network. View our services and reach out through our website or Twitter if you think we may be a fit.

(Any views expressed in the below are my personal views and the product of my own research, it should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions. Do your own research.)