Interest Rate Markets in DeFi

AMM to Orderbook

Kenji Mitsusada
Secured Finance
Published in
7 min readOct 26, 2022


Automated Market Maker Pool or AMM Pool is one of the greatest inventions created in Decentralized Finance (DeFi). In this article, I would like to go through the brief history and the challenges of the AMM pool on both Spot and Interest Rates and explain why Secured Finance decided to operate using the Orderbook system.

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Spot AMM Pool

Uniswap is the first and the biggest case of the AMM Pool system for spot currency exchanges. The Pool successfully gathers liquidity to exchange one currency for another managed by the smart contract. One of the key actors is the Liquidity Providers (LP), who put money into the Pool to get rewards. AMM Pool allows people to access a variety of tokens very handy and quickly. We can buy tokens without waiting for the listing by local central exchanges. (Due to regulations, the token listing process is super slow in Japan, which we can discuss in the coming articles)

The other key actor is arbitragers. The Pool price will change depending on the transactions through the Pool, and sometimes it deviates from the other markets, including central exchanges. Hence, Pools rely on the arbitragers, usually High-Frequency Trading (HFT) Bot, to maintain consistency with the other environment.

However, there has been some weakness in the AMM Pool, such as ‘Impermanent Losses’ (IL), which is inevitable as a product design. Most of these IL are compensated by the earned transaction fees and/or additional LP/Project tokens granted by the protocol. However, this business model is unsustainable. Soon enough, projects will cut the token incentives, leading to less margin, less liquidity, and fewer transactions. Copycats of Uniswap are suffering to maintain the tractions even with the effort to improve the ILs.

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How about the Interest rate market in DeFi?

Interest Rates AMM Pool

AAVE and Compound are the most popular projects on the DeFi Lending platform, which rely on the AMM Pool system. They give you interest rates depending on their rate model based on the borrowing demand on the specific currency Pool.

In short, their business model is similar to the retail bank.

On the one hand, banks receive individuals’ deposit money and give some interest to depositors. On the other hand, they lend the aggregated money to corporate, mortgage loans, or invest in higher-interest products to make money through the interest spread. How a bank decides upon the deposit interest rate depends on the capital efficiency. The interest rate may be higher if the borrowing demand increases or vice-versa. You may see the deposit rate difference between Bank A and B as the rates depend on internal rationality. How they make money is the spread between borrowing and lending.

The Liquidity Pool works well in terms of aggregating liquidity in DeFi and successfully making money through the yield spread. However, something is missing with the Pool Lending system: a)fixed rate, b) longer-term lending, and c)composability. Recent DeFi projects are trying to fix a) and b) such as Notional, Yield Protocol, Elements, etc. However, it is impossible to achieve the c)composability with the Pool system.


What is the ‘composability’ in the interest rate market? We define composable rate as a ‘universal standard rate’ that anyone can see and trade. For example, you can see the 10y US yield at 4% on TV news which is the ‘standard rate’ of the US 10y bond. Banks and accredited investors can borrow/lend at 4% trading the US bonds even when your deposit rate is 2% or borrowing rate is 7%.

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You may ask, why is it crucial to have a ‘composable’ interest rate?


The history of finance is the history of hedging. It is said that the first options trade was made in B.C. 600 in Greece to hedge the harvest of olives. The Greek philosopher Thales profited handsomely by purchasing the rights to use the olive pressure machine one year ahead at a reasonable price.

Since then, the hedging solutions have expanded to FX forwards, options, swaps, structured notes, etc., so-called derivatives which have amplified to a $ 600 trillion scale today. This can not happen without the ‘composable’ benchmark Index rate, for example, the WMR FX fixing rate and/or LIBOR.

Then how are we able to have a ‘Composable’ rate to scale the cryptocurrency market? We believe it is possible with the traditional way, the Over-The-Counter (OTC) orderbook system.

The difficulty of on-chain OTC trading

The biggest challenge is liquidity. AAVE started the project in 2017 as ETHLend with peer-to-peer lending and borrowing protocol. Then they switched the protocol from OTC to Pool system to relaunch AAVE in 2020. We think there are a couple of reasons why they failed with the OTC trading system. One is the standardization, and the other is the timing.

ETHLend tried to make a matching system on DeFi for borrowers and lenders. Clients can make orders depending on their needs of funds, including amount, maturity, currency, interest rate, and so on. And then, a counterparty decides whether they agree to trade or not after checking the conditions. However, they gave too much freehand for users, which resulted in the dispersion of liquidity, and few transactions happened. We believe it is critical to make a standardized trading experience to maintain liquidity.

In terms of timing, when they started ETHLend in 2017, the market was less mature and had few participants in the DeFi rates space, and the project lost steam coincident with the Crypto bear market during 2018–2019. It was a great time for them to switch the direction as a result. Now, if you look at the current environment, it is totally different. Even though it is said to be a ‘crypto winter’, many institutional investors are getting involved and looking for opportunities in this area.

Our Platform

The first product of Secured Finance is the Loan Exchange market for cryptocurrencies to have a yield curve. We create an interest rate match-making system based on the orderbook that is run by a smart contract. We design this as the bond trading market since borrowing/lending essentially has the same economy.

Our system is unique in terms of having both primary and secondary market functions. A borrower sells a bond to receive some cash which is a bond-issuing primary market function after pledging sufficient collateral. You can buy and sell those bonds through our orderbook system, which is the secondary market.

Photo by Secured Finance
Photo from Secured Finance

There are a couple of key features on our Orderbook systems to maintain high liquidity and transactions: Standardizing and Novation.

  1. Standardizing — We set specific maturity dates quarterly in March, June, September, and December, following the standard of the traditional listed future market. We also defined our rates product as zero-coupon bond trading. Instead of receiving the coupon, you can buy the bond at a discounted price depending on the rates and maturities. You can benefit from less transaction cost and interest rate compounding effect.
  2. Novation — We decided to make our platform based on the orderbook system, which is OTC, peer-to-peer trading. However, you must consider the credit risk when you face counterparty A. In addition to the credit risk, you will be troubled when you want to unwind your transactions as you need to go and ask counterparty A. To remove these concerns, we have brought some wisdom from traditional finance and designed our smart contract as a clearing house that face every counterparty for peer-to-peer transactions. This separates the credit risk between clients and makes the unwinding straightforward. The lender’s funds will be secured by the over-collateralized asset from borrowers managed by the smartcontract.


Secured Finance creates a fixed-income trading platform based on the orderbook system. Our interest rate is transparent and composable. After drawing the yield curve for the cryptocurrencies, we can expand our product line to derivatives such as FX forwards, NDF, Swaps, cross-currency basis, options, etc., to achieve a multi-trillion-dollar scale.

Through this project, Secured Finance will contribute not only to DeFi expansion but to everyone’s financial demand.

Please follow us and create the future of finance together.

About Secured Finance

Secured Finance is building interbank-grade capital markets for digital assets. We designed a protocol for a secure, flexible, and scalable fixed-income business for digital assets. Our team is an expert group of investment bankers to bring 40-year traditional finance wisdom into cryptocurrency and digital assets.

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Kenji Mitsusada
Secured Finance

Head of Markets @ Secured Finance. 18 years of interest rate derivatives trading experience. Former Co-Head of G10 FX Forwards and STIR Trader at Goldman Sachs