Analysis of Voltz: AMM-based Interest Rate Swap Protocol

Author: Crescent

Voltz announced the completion of a $6 million seed round financing on December 9, led by Framework Ventures, with participation from Fabric Ventures, Coinbase Ventures, Amber Group, Wintermute, Robot Ventures, Mgnr, Entrepreneur First, and other angel investors.

Voltz is a non-custodial automated market maker (AMM) for interest rate swaps (IRS), with the standout feature of bringing interest rate swaps into DeFi, achieving a capital efficiency 3000 times higher than other models.

An interest rate swap is a method of changing the structure of debt or credit by exchanging interest payments, such as swapping a floating rate for a fixed rate, where the parties do not exchange principal; the principal is merely a basis for calculation.

The common AMMs we see operate between different tokens, while this protocol provides an AMM between fixed and floating rates. Different DeFi protocols have varying borrowing rates, some with significant fluctuations ranging from 2% to over 40%, creating ample operational space. The existence of this protocol eliminates the restrictions on exchanging between fixed and floating rates.

Project Introduction

Interest rate swaps, also known as interest rate exchanges, are a type of derivative.

This project provides a market for trading interest rates, offering everyone a platform to go long or short on APY. For example, if a user expects the interest rate of a certain project to rise in the future, they can pay a fixed rate to receive a floating rate, which is going long on the floating rate. When the interest rate rises as expected, they can earn a spread return. Of course, on this platform, one can also pay a floating rate to receive a fixed rate.

In the Voltz IRS market, it allows users with hedging needs to hedge on the platform, those who are optimistic about a project's future mining pool returns can choose to go long, and one can also profit from the price differences based on interest rate fluctuations. Traders and LPs can operate with leverage of about 10-15 times, providing users with more options for play.

Features ------ AMM

In addition to this protocol, there are several others that use AMM as a mechanism to introduce fixed rates into DeFi, but they have many limitations. This project makes some adjustments regarding capital efficiency, interest rate returns, and the flexibility of traders entering and exiting positions.

Like many other AMMs, Voltz uses a constant product invariant, but with some significant differences:

First, traditional AMMs place assets into liquidity pools, while this protocol differs in that Voltz uses a concentrated liquidity virtual AMM (vAMM) for price discovery. This method decouples collateral management from AMM reserves, increasing flexibility.

Second, since the IRS AMM allows traders to exchange fixed and floating rates, it has designed a rate-based axis. Among them:

The x-axis represents 1% virtual fixed tokens, with the concept that if a participant is entitled to receive 100 of these 1% virtual fixed tokens, assuming the term of the IRS pool is exactly one year, then at the expiration of the IRS pool, they can claim one token of the underlying asset.

The y-axis represents variable tokens, indicating the quantity of virtual variable tokens (e.g., aDAI) in the IRS pool. The Voltz IRS vAMM also uses the constant product formula (xy=k), where (x) represents the number of 1% fixed tokens, (y) represents the number of variable tokens, and (k) is a constant. Thus, the vAMM defines the rate at which traders can exchange fixed cash flows or variable cash flows.

Voltz vAMM

The relationship between vAMM prices and implied fixed rates is as follows:

Third, like Uniswap v3, this protocol can concentrate liquidity, allowing LPs to deposit liquidity within a certain range.

In ordinary constant product AMMs, LPs spread liquidity across the entire price (implied fixed rate) range (0, ∞), meaning a large portion of liquidity ultimately goes unused. To alleviate this, the Voltz IRS vAMM is inspired by Uniswap v3 and adopts the idea of concentrated liquidity.

Concentrated liquidity means LPs can deposit liquidity within a limited custom price (implied fixed rate) range. They deposit floating rate tokens and 1% fixed rate tokens into the vAMM. When the fixed rate exceeds the LP's position (range), the liquidity becomes inactive.

This increases the capital efficiency of LP deposits by 3000 times compared to other models, and LPs can deploy liquidity at market rates they deem appropriate, allowing for better control of their capital.

Fourth, the assets of this protocol are managed through a margin engine, which effectively defines the leverage available to traders and liquidity providers, manages the protocol's collateral, and handles liquidation events in adverse situations. It also enables liquidity providers and traders to control their positions.

The following diagram illustrates the operational flow of this mechanism:

In the diagram, Fixed Takers (FT) are the fixed rate receivers trading floating rates for fixed rates, while Variable Takers (VT) are the variable rate receivers trading fixed rates for floating rates. Price discovery and asset management are conducted through the vAMM and margin engine.

Features ------ LP

Like other AMMs, vAMM requires liquidity providers (LPs) to function, but there are some differences.

First, each IRS pool is built on a single underlying variable asset (e.g., aDAI). To deposit liquidity, LPs must provide margin for the interest generated by the underlying token (e.g., DAI). Since variable rate payments and fixed rate payments are made in the same asset, LPs only need to deposit this single asset to act as IRS LPs (in this case, DAI).

Second, the operation of Voltz's margin engine is linked to LP margin recycling.

Voltz's margin engine operates through participants providing margin to Trade or LP on the Voltz protocol. To maximize capital efficiency, all participants must provide margin. The Voltz protocol allows traders and LPs to partially collateralize their positions.

Liquidity providers deposit liquidity within their designated ranges, allowing FT and VT to trade. Each time a trade occurs, LPs earn fees. The Voltz protocol includes the concept of LP margin recycling; when corresponding FT and VT positions can match, trades offset each other, and LP margin is recycled for use in charging fees to traders again.

As shown in the diagram below:

LP Collateral Recycling

Third, regarding funding interest rate risk.

In this project, since LPs only need to deposit a single asset to create any side of the market, the Voltz AMM eliminates the concept of impermanent loss. However, due to the introduction of the interest rate swap concept, LPs face "funding interest rate risk," a new type of risk specific to interest rate swaps.

The project has not yet issued tokens, and its Twitter account has 1,771 followers, which is not many. It is stated that the testnet will launch in the first quarter of 2022, initially introducing stablecoin pools. VoltzDAO is under development, and over time, the Voltz protocol will be managed by VoltzDAO, completing a gradual decentralization process.