3-Minute Overview of Fixed Rate Lending and Interest Rate Derivative Agreement Swivel

Author: Liang Yushan

According to DeFi Pulse data, among the top twenty DeFi projects by total locked value, lending projects account for one-third. Maker, Compound, and Aave have a staking scale exceeding $7 billion, which is about half of the total locked value in DeFi.

DeFi lending is developing rapidly, but there are still two pain points that need to be addressed for lending users: first, most DeFi projects require over-collateralization and floating exchange rates, leading to low capital utilization and unstable returns; second, investors face the risk of asset liquidation during significant price fluctuations.

Recently, the lending protocol Swivel Finance, which completed its seed round financing with investments from top venture capital firms like Multicoin Capital, DeFiance Capital, and the founder of Aave, is attempting to provide a solution by offering fixed-rate lending products. However, Swivel Finance's mainnet has not yet launched, and the project is in its early stages.

1. What is Swivel Finance?

Swivel Finance (formerly known as DefiHedge) is a fixed-rate loan and interest rate derivatives protocol, where users only need to collateralize 100% of the same type of asset (rather than the common over 100% collateralization) to borrow and trade.

In simple terms, a fixed rate means that regardless of how market interest rates change, users can earn returns based on the rate they initially set at the end of the contract; interest rate derivatives refer to interest rate trading, allowing users to go long on interest rates with an implied leverage of 10 to 100 times.

Interest rate derivatives are typically used by institutional investors, banks, corporations, and individuals as hedging tools to protect themselves from changes in market interest rates, but they can also be used to increase or improve the holder's risk profile or to speculate on interest rate changes.

From the types of services provided by Swivel Finance, we can see that the protocol targets two types of investors:

1. Conservative investors who want to reduce investment risk and increase the certainty of returns;

2. Aggressive investors who have a strong risk tolerance and seek higher returns.

2. How Swivel Works

Let's assume Alice is a conservative investor and Bob is an aggressive investor to see how Swivel operates.

1. Submit Order

Users can submit orders at their desired interest rate or the current market rate to reach a loan agreement with counterparties.

●Alice

Alice holds $1,000 in USDC and chooses to lend it out at a fixed rate of 5% for one year.

●Bob

Bob holds $50 in USDC and wants to go long on the USDC interest rate on Compound (currently at 8%).

2. Earn Returns (Interest)

Users can earn a fixed interest rate on their principal or leverage the market interest rates from protocols like Compound and Aave.

●Alice + Bob

Alice and Bob deposit their respective principal amounts ($1,000 USDC and $50 USDC) into Swivel, and then this capital is pooled into the Swivel smart contract, where it is deposited into Compound for the duration of the contract (e.g., one year).

3. Release Funds

At the end of the contract, funds are released. Fixed-rate lenders receive their initially set returns, while floating-rate lenders receive the remaining returns.

Assuming that at the end of the contract, the USDC interest rate remains at 8%, Alice and Bob's returns are as follows:

●Alice

Alice receives $1,050, which is her principal of $1,000 plus $50 in interest (at her originally set fixed rate of 5%);

●Bob

Bob receives $84, which is his principal of $50 plus $34 in interest (leverage), resulting in a return on investment of 68%. Typically, when the interest rate is 8%, if Bob lends $50 in Compound, his return at the end of the contract would be $4 (totaling $54). In Swivel, Bob leverages his exposure to interest rates, increasing his returns compared to Compound by 8.5 times.

How is the interest rate determined? It is decided by the market of lenders taking on fixed and floating positions. Similar to traditional sellers, fixed-rate lenders want to lend at the highest possible rates, while floating-rate lenders want to support at the lowest possible rates, akin to buyers (Note: Swivel allows users to go long on interest rates, not short).

3. Advantages of Swivel

From a product service perspective, Swivel offers fixed rates and interest rate trading, both of which are in a blue ocean of the DeFi market. Thus, Swivel is ahead of the curve in the lending sector and aims to cover a broader user base.

However, it should be noted that Swivel is not the first DeFi protocol to propose fixed interest; Yield, Mainframe, and Notional have all made moves in this area, but they also require over-collateralization from investors. In contrast, Swivel only requires a 100% collateralization rate, significantly improving capital liquidity and utilization.

Regarding liquidation risk, according to an analysis by Multicoin Capital, Swivel does not rely on price oracles, so user assets will not be liquidated. However, since the protocol uses Compound's liquidity, its risk profile depends on the latter's mechanism risks.

Overall, in terms of market competition, Swivel has a first-mover advantage and covers two types of investors with one product, which is beneficial for its future scaling and user growth.

In terms of protocol design, Swivel provides fixed rates, offering investment tools for investors seeking stable returns, especially those financial institutions that wish to enter DeFi but hesitate due to high risks. Additionally, the design of no over-collateralization and no asset liquidation gives Swivel a unique advantage, facilitating the formation of a "strong liquidity" lending market.

4. Conclusion

The DeFi market is currently in the stage of mimicking traditional finance, and the fixed-rate loans and interest rate derivatives offered by Swivel have already gained some scale in the traditional financial market. Data shows that about 90% of mortgages in the U.S. are fixed-rate loans; the daily trading volume of interest rate derivatives exceeds $6.5 trillion.

From the perspective of the DeFi market's own development, there is a significant demand for fixed rates from investors. According to Swivel Finance co-founder Julian Traversa, "For a long time, we have been hearing lenders request fixed-rate products, but previous protocols did not provide incentives for supporting fixed rates."

With Swivel providing fixed-rate loan services and using interest rate derivatives as incentives, allowing users to go long on interest rates with an implied leverage of 10 to 100 times, it may have the opportunity to occupy an important position in the lending market in the future.