In the downturn of the cryptocurrency market, can savings-type DeFi projects stand out?

Original Title: Cryptocurrency Market Downturn, Can Savings DeFi Breakthrough?

Author: Tangyuan, Hive Tech

Since the beginning of 2022, the cryptocurrency asset market has been in a downward trend, with a total market capitalization of $1.81 trillion, evaporating 38% from the historical high of $2.92 trillion in 2021. The total value of on-chain ecosystems has also shrunk. According to Defipulse data, the total locked value (TVL) of the largest on-chain ecosystem, Ethereum, is $76.4 billion, down 43% from its peak of $110 billion in 2021.

A common sentiment among cryptocurrency asset users is that "the market is bearish." How to safely reduce asset depreciation amid downward risks has become a demand for some. Savings-type DeFi applications have emerged as one of the options to consider, and the TVL of these applications has actually increased against the backdrop of a bear market.

Taking Anchor, a fixed-rate savings application on the Terra (LUNA) chain, as an example, its TVL has steadily risen from $7 billion in February 2022 to the current $14 billion, a growth rate of 100%. The increase in Anchor's locked value may reflect users' demand during a bear market—more pursuit of stable growth products.

Fixed-rate savings applications can be categorized under the broader category of DeFi lending products, such as Compound, Aave, and MakerDAO, which mainly feature "floating rates." The interest rates are determined based on "supply and demand," meaning that in lending agreements, the rates for lenders (who pay interest) and borrowers (who earn interest) are presented algorithmically based on capital demand. When the market is volatile, interest rates will also fluctuate. When capital is in short supply, borrowing rates can spike dramatically, even exceeding 100%, increasing borrowing costs.

When interest rates are fixed, people easily associate them with the savings function of banks, and such products have begun to appear in the DeFi market.

Fixed-rate products can minimize systemic income risks. With fixed interest rates, users do not need to adjust their positions based on interest rate fluctuations, allowing for clear control over on-chain investment costs and fixed income. Some industry views suggest that fixed-rate products may become the primary channel for traditional institutions to enter the cryptocurrency market and even the DeFi space.

In June last year, Compound Labs, the company behind the DeFi lending protocol Compound, established a new product called Compound Treasury aimed at enterprises and institutions. By collaborating with Fireblocks and Circle, it allows non-crypto enterprises and financial institutions, such as banks and fintech companies, as well as large dollar holders, to exchange dollars for USDC and earn a fixed interest rate of 4%.

Currently, besides fixed-rate products like Compound Treasury and Anchor, many developers have also laid out fixed-rate products, but the results have been unsatisfactory. Compared to liquidity reward projects with annualized returns in the tens of millions, these products' yields are indeed not prominent in a bull market. However, as the market cools down, the demand for fixed-rate products is increasing. This issue of DeFi Hive will introduce representative applications and operational mechanisms of fixed rates.

"Zero-Coupon Bond" Platform Notional

Introduction

Notional (NOTE) is a decentralized fixed-rate lending application built on Ethereum. It supports DeFi, CeFi, institutional traders, and individual users to complete cryptocurrency lending at fixed rates and fixed terms.

The Notional team created this application because fixed-rate financing is the most common method in traditional financial markets, such as bonds, which are issued at fixed rates. Fixed rates provide market participants with certainty in investment returns or borrowing costs, allowing for risk control. Notional aims to build a fixed-rate lending platform within the decentralized financial system to provide crypto users with stable financing channels.

Notional Official Website

Operational Mechanism

Notional operates on a mechanism of collateralized minting of "fCash" tokens, achieving a state where deposits yield fixed returns and loans incur fixed interest. Transferable fCash represents "the right to claim interest at a specific future point in time," which can be understood as the tokenization of "zero-coupon bonds."

A "zero-coupon bond" is a bond that does not pay interest, issued as a borrowing certificate by the borrower. Typically, its trading price is below par value, making it a discounted bond, which will be paid at par value to the bondholder upon maturity. The capital "lender" purchases the zero-coupon bond at a discount, equivalent to making a fixed-rate deposit, and can receive the bond's face value at maturity. The "borrower" can borrow the zero-coupon bond by collateralizing assets and selling it at a discount for cash. To reclaim the collateral, they must repay the face value of the bond after the maturity date, so the difference between the amount received from selling the bond and the bond's face value is the interest paid on the loan.

For example, if borrower A wants funds, they collateralize assets and issue a zero-coupon bond with a face value of $110 for a term of 6 months, then sell it at a discount for $100 to lender B. At this point, borrower A receives $100 in cash, while lender B effectively holds a claim to $100 of borrowing at a fixed interest rate of 10% for 6 months. Upon maturity, borrower A must pay $110 to redeem the zero-coupon bond. For A, they have obtained a loan of $100 at a fixed interest rate of 10% for 6 months.

Under the zero-coupon bond mechanism, since the borrower's cost is the depositors' income, there is no need to adjust through market supply and demand to determine a fixed rate acceptable to both parties.

By leveraging the concept of "zero-coupon bonds," Notional tokenizes it into transferable on-chain zero-coupon bonds like fCash. Therefore, on this platform, each fCash has an associated token exchange pool. Since the platform allows circulating assets to be "cToken" (cToken is a deposit certificate of Compound, representing interest-bearing assets), the liquidity of the exchange pool is composed of fCash and cToken.

The mechanism for fixed-rate deposits and loans in Notional is as follows:

• Fixed-rate deposits ------ Lenders deposit DAI, and Notional will first deposit it into Compound, converting it into cDAI, then purchase discounted fDAI from the zero-coupon bond liquidity pool. At maturity, they redeem cDAI and convert it back to DAI, thus earning fixed interest income.

  Example: Lender A deposits 100 DAI in Notional, the platform first converts it to cDAI, then uses 100 cDAI to purchase 103 fDAI, assuming a 1-year maturity, the difference between fDAI and DAI is A's deposit interest income.

• Fixed-rate loans ------ Borrowers collateralize assets (like ETH) to mint fDAI, then sell it at a discount in the exchange pool "fDAI/cDAI" for cDAI, and exchange it for DAI in Compound. At maturity, they only need to repay the face value of fDAI, and the difference between fDAI and the borrowed DAI is the borrowing cost.

  Example: Borrower A collateralizes 1 ETH in Notional to borrow 100 DAI at a 3% interest rate, meaning A owes the platform 103 DAI, assuming the maturity date is 1 year, they must repay the debt before redeeming the collateralized ETH.

Currently, the Notional platform supports depositors depositing ETH, WBTC, DAI, or USDC to earn fixed interest income, and also allows borrowers to collateralize these assets to mint fCash for borrowing DAI. Additionally, users can provide cETH, cWBTC, cDAI, or cUSDC to provide liquidity for the "fCash/cToken" exchange pool and earn rewards in the Notional platform token NOTE.

"Principal-Interest Separation" Application Element

Introduction

Element is also a decentralized fixed-rate yield platform built on Ethereum, achieving stable interest rates by separating and tokenizing principal and future yields.

Element Official Website Asset Fixed Income Situation

Element separates the principal and yield portions of deposited assets and tokenizes them separately. The pricing of "yield tokens" at settlement depends on the market's expectations of future interest rates, while "principal tokens" are equivalent to zero-coupon bonds, redeemable at face value upon maturity. Before maturity, zero-coupon bonds are sold at a discount based on the remaining time until maturity.

Users seeking fixed-rate yields to hedge risks can sell the uncertain "yield tokens" and purchase the currently discounted "principal tokens." Since these "principal tokens" are sold at a discount, users can redeem tokens at face value upon maturity, effectively obtaining fixed income at a discounted price.

Operational Mechanism

All funds deposited on the Element platform (ETH, DAI, and USDC) are split into two parts: one part is "Principal Token (PT)," representing the value of the deposited principal, which is the "principal token"; the other part is "Yield Token (YT)," representing the variable interest that can be earned from the platform in the future, which is the "yield token."

Element Platform Deposited Funds Split into Two Parts

• Principal Token PT ------ Equivalent to a zero-coupon bond, it cannot be redeemed before the lock-up period ends, thus it will trade at a discount relative to the underlying asset. Element allows users to purchase discounted PT through AMM, and upon maturity, PT holders can redeem the underlying asset at a 1:1 ratio.

  Users purchasing PT determine their fixed-rate yield based on the discount rate of the asset at the time of purchase. PT buyers before maturity will trade at a price lower than their underlying asset. The further the principal is from maturity, the higher the discount.

  For example, if a user purchases a principal token PT (yETH) at a 10% discount for a 1-year term, this means that if they buy it with 10 ETH, they will receive 10.1 principal tokens PT (yETH), and upon maturity in 1 year, they can redeem 10.1 ETH, resulting in a fixed yield of 10%.

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User Purchase Process for Principal Token PT

• Yield Token YT ------ Represents future interest that will be generated, which is variable and uncertain, but YT has liquidity and is tradable.

  On one hand, users can choose to sell the yield tokens YT directly after depositing funds in Element, realizing future interest early to achieve fixed-rate yields. On the other hand, users can choose to purchase YT, which means betting on future interest rates, as the price of YT represents the market's expectations of future interest. The higher the accumulated interest during this period, the higher the price of YT. Borrowers can hedge their borrowing costs by purchasing YT, as long as the redeemable assets at maturity exceed their purchase cost, they can profit from it.

Taking ETH that can be deposited in Element as an example, if a borrower deposits some ETH in Element, they will receive newly created ptETH and ytETH. Now they can control the principal and yield through PT and YT. If they decide to sell PT immediately and hold YT, PT will be sold at a discount (e.g., if the yield is 10%, 1 ETH = 0.9 ptETH), obtaining ETH, while the held YT continues to earn interest. At this point, the borrower can use the obtained ETH for circular borrowing to improve capital utilization. Lenders can obtain fixed yields by purchasing discounted principal tokens PT.

"Stablecoin Bank" Application Anchor

Introduction

Anchor (ANC) is a fixed-rate savings application built by the Terra team, providing users with stablecoin savings products and paying interest to depositors. It supports users depositing UST to earn a fixed annual yield.

Anchor Locked Cryptocurrency Asset Amount

Anchor balances interest rates by coordinating block rewards from different PoS consensus blockchains, ultimately achieving a stable storage rate, thereby providing a reference interest rate for the on-chain cryptocurrency lending market.

Operational Mechanism

Anchor functions like a bank, attracting depositors to deposit money, offering fixed interest to depositors, and then lending the deposits to users in need. Essentially, it remains a collateralized lending application, similar to a "stable rate version" of Compound, where depositors deposit stablecoins (currently only supporting UST) into the Anchor platform and can earn a fixed annual yield.

The depositors' income on the Anchor platform mainly comes from the interest paid by borrowers, as the protocol lends out the deposited assets to borrowers in need to generate income. Borrowers need to collateralize "bAssets" to obtain borrowing limits.

"bAssets" are core to Anchor's operation, bound to the blockchain's block production rules, also known as "staked securities." They are proof of ownership of the underlying tokens of PoS blockchain networks, certifying the ownership of assets staked in PoS blockchain networks used for node validation.

In simple terms, blockchains like Terra (LUNA) and Ethereum 2.0 (ETH) operate based on the PoS mechanism to ensure the functioning of the blockchain network. Staking a certain amount of underlying tokens (LUNA, ETH) can make one a node validator to earn validation rewards. The assets staked by validators can then become "bAssets" on Anchor. In other words, bAssets on Anchor are proof of "staked" assets.

Since the underlying token assets staked in blockchain network nodes lack liquidity, they can only be released after the staking period ends. For example, the staking period for LUNA in the Terra network is at least 21 days, while Ethereum 2.0 has a longer staking period. This means that during the staking period, the staked assets lose liquidity. Users holding bAsset certificates can not only earn additional rewards in ANC (Anchor's governance token) but can also trade them.

Currently, bAssets support two types of underlying tokens as collateral, namely LUNA and ETH. After borrowers collateralize LUNA or ETH, Anchor will stake these LUNA or ETH to earn validation rewards. In essence, Anchor also acts as a node validator in the blockchain network, and the block rewards obtained will be sold for UST to pay interest to depositors and provide a stable interest rate source for Terra deposits.

Therefore, the revenue of the Anchor protocol has two main sources: one is the "interest paid by borrowers," and the other is "blockchain staking rewards."

Structured Risk Management Platform BainBridge

Introduction

BainBridge (BOND) is a cross-platform protocol that optimizes the tiered management of yield and volatility risks in DeFi applications. It was first launched in 2020, aiming to reduce yield volatility for conservative investors, long-term holders, and risk-averse institutions, while also providing high-volatility options for risk-tolerant investors.

Barnbridge Asset Yield Situation

Barnbridge algorithmically integrates data from multiple lending platforms such as Compound, AAVE, and Cream to obtain yield-generating cryptocurrency asset-related data, and improves capital efficiency by layering and tiering risks to enhance user yields. It is similar to a yield pool but differs from the yield volatility of a yield pool, as its ultimate goal is to integrate yield pools from multiple lending platforms to construct a more complex structure and bond rating system.

Operational Mechanism

BainBridge employs a structured risk management mechanism, believing that the future yield and interest payments are uncertain, but each individual has different risk tolerances and opportunity costs for their capital. Users need to reallocate risks based on their needs, dividing volatile yields into different levels to complete risk investments in their investment targets.

When integrating lending applications like Compound and Aave, BainBridge utilizes a mechanism called "Smart Yield Bond" to provide users with fixed rates on stablecoins or leveraged variable yields. The Smart Yield Bond consists of two yield products: "Junior Pool" and "Senior Pool."

• Senior Pool (sBONDs) ------ Has priority in the distribution of yields within the system, locking in fixed-rate yields, commonly referred to as the "senior pool."

• Junior Pool (jTokens) ------ Holds the residual yield distribution rights, with the yields obtained being the remaining assets after paying the fixed yields of the Senior Pool within the same system. The yields are not fixed and are volatile, commonly referred to as the "junior pool."

Characteristics of Junior Pool and Senior Bond Yield Products

In BainBridge, users can deposit stablecoins into either the junior pool or the senior pool based on their risk tolerance. For users, this distinction is significant; the junior pool is high-risk due to leverage causing variable interest rates, while the senior pool is low-risk because of fixed rates.

The position certificates obtained from depositing in the Senior Pool are sBond, which is an NFT asset that can be traded in the secondary market or used for other composable purposes. Upon maturity, the principal and yield can be redeemed, and the NFT will be destroyed.

The position certificates obtained from depositing in the Junior Pool are jTokens, which are 1:1 stablecoin asset certificates, not NFTs.

Theoretically, both sBond and jToken holders can earn yields, but if the APY provided by the underlying loan market is lower than the guaranteed yield for senior bonds, the yields for junior bond holders need to first cover the gap.

The junior pool of stablecoin FEI needs to subsidize yields to the senior pool

In fact, whether in the junior pool or the senior pool, the funds are all entering lending markets like Compound and Aave. This means that the actual risks of the junior pool and senior pool are the same. The reason for the differing interest rates is that the yields in the lending market are always volatile; some people receive fixed rates, while others subsidize the former during poor market conditions or collect additional returns during favorable market conditions.