Mental Models: Timeswap as a Dual Investment Product

Preface

Before we proceed, make sure you read the introductory post to the series to grasp the basics of a Timeswap pool, Mental Models: Intro!

Now let’s head on to the meat of it all. In the second issue of our blog series, we will learn the inner workings of Timeswap pools, using dual investment products as an analogy. Specifically how lending in Timeswap pools is in essence, entering a dual investment position.

For those of you who are familiar with dual investment, you’ll love this piece! For those of you who aren’t, hopefully you’ll love us for giving alphas!

Dual Investment Products

Dual investment products are a very popular investment product across centralised exchanges (CEXes). They’re not new — their TradFi equivalent is dual currency products. The retail traction for dual investment products is amazing, it’s fair to say that CEXs did a great job at communicating such a complex financial instrument.

They cracked the code on bringing dual investment products to the masses, and now we’ve cracked the code on bringing dual investment products to DeFi!

Dual investment is a financial product which allows you to buy/sell tokens at your desired price and time, while earning interest on them. See for yourself, all major CEXs offer this product, it’s lucrative for them, and for you.

A dual investment product has four key parameters:

1. Asset pair: Y-X assets that act as the base and quote asset (e.g., ETH/USDC). The quote assets are typically stablecoins.
2. Target price: The price level (with respect to the quote asset) at which the investor agrees to buy/sell the base asset at (e.g., 2,000 ETH/USDC).
3. APR: The interest rate investors will receive on their principal.
4. Settlement date: The date at which the outcome of the agreement is determined.

Examples are best to understand how the parameters integrate with each other. There are two types of dual investment products, namely: 1) Buy low and 2) Sell high.

Buy low

Investors that subscribe to this product commits the quote asset (e.g., USDC) and selects a target price they want to buy the base asset at and the corresponding settlement date. For example, an investor subscribing to an ETH buy low strategy at a target price of 2,000 and current spot price of 2,500.

If at the settlement date, the spot price of the base asset (e.g., ETH) falls under the target price (e.g., 1,800 spot; 2,000 target), the investor will receive ETH (essentially buying the ‘dip’ at 2,000).

Else, if ETH does not fall under the target price, the investor will receive their USDC principal, along with the APR. A lucrative strategy for the investor to buy the dip while earning interests.

Here is a screenshot of the buy low dual investment product payoff for ETH/USDT on Binance, with target price of 1,900, APR of 35.4% and settlement date of 2 days post-screenshot:

Sell high

Investors that subscribe to this product commits the base asset (e.g., ETH) and selects a target price they want to sell the base asset at and the corresponding settlement date. For example, an investor subscribing to an ETH sell high strategy at a target price of 2,000 and current spot price of 1,800.

If at the settlement date, the spot price of the base asset (e.g., ETH) rises above the target price (e.g., 2,200 spot; 2,000 target), the investor will receive USDC (essentially taking profits at 2,000).

Else, if ETH does not rise above the target price, the investor will receive their ETH principal, along with the APR. A lucrative strategy for the investor to take profits while earning interests.

Here is a screenshot of the sell high dual investment offerings for ETH/BUSD on Binance:

Another advantage of dual investment products on CEXs is that they do not incur trading fees. It’s a win-win: you don’t pay fees, get to buy low/sell high and earn yield if your order is not fulfilled… and (options traders or the MMs on top of the CEXs) earn the spread between the spot price and your target price at maturity, voila!

Timeswap as Dual Investment Product

A quick recap on the parameters of Timeswap pools, from our introductory piece — a must read before you read the sections below.

1. Asset pair: X-Y assets that act as debt and collateral assets.
2. Transition price: The price level which changes the bias of the pool.
3. APR: The annualised interest rate at which borrows/lends occur.
4. Maturity date: The date at which the pool expires.

In case you forgot, here’s the explainer for transition price.

The transition price is a parameter that can be set by the pool creator at the time of pool creation. This is the price level which determines the expected behaviour of borrowers and thus the expected outcome of lenders (i.e., whether the borrowers will repay the loans or not; which assets the lenders will receive).

Here is a screenshot of pools for ARB/USDC on Timeswap (spot price at time of writing was 1.3 ARB/USDC):

The four parameters between dual investment products and Timeswap pools can be mapped into one another.

Now let’s go over how lending positions in Timeswap mimics dual investment positions. As a refresher, there are two possible scenarios in a Timeswap pool (before maturity):

1. Upward Expectation
2. Downward Expectation

Let’s take ETH/USDC as the example asset pair.

Upward Expectation

In this scenario, lenders can deposit USDC in the pool to earn fixed interests on them. At the same time, if the price of ETH/USDC falls below the transition price, they will receive ETH at maturity (priced in at the transition price). If you didn’t already notice, this is exactly the outcome of a buy low dual investment strategy!

For example,

ETH price = 2,000 USDC

Transition price = 1,500 USDC

APR = 12%

Maturity = 1 month

Bob lends 1,000 USDC to the pool.

There can be 2 ways this plays out (we’ll ignore the outcome of spot price = transition price for ease of understanding):

At maturity, Spot price > Transition price

Let’s say the spot price remains constant (2,000) throughout the duration of the loan.

Principal USDC received = 1000 USDC

Interest USDC received = (12% of 1,000)/12 = 10 USDC

∴ Bob receives = 1,000 + 10 = 1,010 USDC

Now, Bob gets back his principal while earning interest as ETH didn’t reach the target price!

At maturity, Spot price < Transition price

Let’s say the spot price drops to 1,400. It is now under the transition price.

Principal ETH received = 1,000/1,500 = 0.6666 ETH

Interest ETH received = (12% of 0.666)/12 = 0.00666 ETH

∴ Bob receives = 0.666 + 0.00666 = 0.6726 ETH

Now, Bob buys ETH at the target price (buy low), while earning ETH interest!

Downward Expectation

In this scenario, lenders can deposit ETH in the pool to earn fixed interests on them. At the same time, if the price of ETH/USDC rises above the transition price, they will receive USDC at maturity (priced in at the transition price). If you didn’t already notice, this is exactly the outcome of a sell high dual investment strategy!

For example,

ETH price = 2,000 USDC

Transition price = 2,500 USDC

APR = 12%

Maturity = 1 month

Bob lends 1 ETH to the pool.

There can be 2 ways this plays out (we’ll ignore the outcome of spot price = transition price for ease of understanding):

At maturity, Spot price > Transition price

Let’s say the spot price rises to 2,800. It is now above the transition price.

Principal USDC received = 2,500 USDC

Interest USDC received = (12% of 2,500)/12 = 25 USDC

∴ Bob receives = 2,500 + 25 = 2,525 USDC

Now, Bob ‘sells high’ as ETH has reached the target price!

At maturity, Spot price < Transition price

Let’s say the spot price remains constant (2,000) throughout the duration of the loan.

Principal ETH received = 1 ETH

Interest ETH received = (12% of 1)/12 = 0.01 ETH

∴ Bob receives = 1+ 0.01 = 1.01 ETH

Now, Bob gets back his principal with interest as ETH didn’t reach the target price!

Key Differences: Timeswap Pools vs Dual Investment Products

Now that we understand how Timeswap as a protocol can be utilised as a dual investment product (hint: through lending), let’s go over the key differences between lending in Timeswap pools and a regular dual investment product.

Flexible exits: In dual investment products, your principal is locked for the entire duration (up until the settlement date). In Timeswap pools, lenders are able to exit and withdraw from their positions given there is enough liquidity in the pool, the interest earned will simply be prorated with the time in the pool.

Market-driven APRs: In dual investment products, the APR is set by the exchange. In Timeswap pools, the APR is a function of the supply and borrowing demand for that asset (calculated through our AMM). This enables unbiased, market-driven rates for all parties.

Permissionless asset pairs: Typically, dual investment products only support < 20 asset pairs, which are commonly paired against stablecoins. Timeswap is a decentralised and permissionless market. Hence anyone can create a lending pool to enable dual investments for any pair of assets. Wanna bet on the flippening? Just spin up a BTC/ETH pool.

Underlying settlement mechanism (and transparency): So you’re getting into this exotic position, who’s your counterparty? In CEXs, our guess would be the exchange itself, option contract buyers or market makers hedging their books. But that’s it, nothing more than a guess. In Timeswap, your counterparty would be borrowers, and it’s all on-chain! If you’re keen to learn more on this, let us know and we’ll write a follow up thread on the exact relationship between borrowers and lenders in Timeswap!

What’s Next?

By now, you should have understood the basics of a Timeswap pool (from the first issue of the series) and how lending positions mimic a dual investment product!

For the upcoming issue, we will be laying out more models you should already be familiar with.

Here’s a reminder of what’s coming up next:

• Timeswap as an options market
• Timeswap as a lending market, as it is

Stay tuned!