Introduction of Fixed Yield Protocol — — Dank Protocol
Fixed-rate lending are currently the most common type of credit in traditional finance. It allows participants to lock in a predetermined interest rate and maturity time without having to bear the risk of interest rate fluctuations. There are two mainstreams for decentralized lending products to obtain fixed income:
Discount Issuance & Separate Trading of Interest and Principal
Design of Fixed Yield Protocol
Essentially, discount issuance can be regarded as a zero-coupon bond. Daniel Robinson first proposed on-chain zero-coupon bonds and a yield curve in the paper 《The Yield Protocol: On-Chain Lending With Interest Rate Discovery》. Moreover, UMA has launched the first yield USD token, named yUSD-SEP20. The token can be exchanged for 1 USDC after expiration. Users can gain fixed income by trading at a discount on Balancer. For instance, a bond buyer bought a yUSD expires in 3 months at 0.95 USDC, and the buyer can be recovered its underlying value. Different maturity dates are accompanied by different discount rates, so we can construct a yield curve similar to the yield curve of treasury securities.
Source: Cryptovalley. Analysis of Three Types of DeFi Fixed Income Protocol: Fixed Rate Lending, Interest Rate Markets and Securitization.
On the basis of conventional interest rate products such as AAVE and COMPOUND, fixed income products separate the principal part from the variable interest part and makes corresponding tokens respectively. The underlying value of the principal token can be recovered when it expires, and the variable interest token is circulated in DEX for trading. When the variable interest token is sold for stablecoin, it is equivalent to the user locking the interest in advance. Therefore, the transaction of variable interest tokens is essentially an interest rate swap contract, which is exchanged for fixed by variable interest. The pricing model is no different from traditional swapping products.
Dank Protocol
The two fixed income protocols can actually be combined. Let’s take Dank Protocol as an example. The steps are as follows:
1. User deposits the token and obtains the deposit certificate — dToken
2. Mint dToken into principal token dOT and interest token dYT
3. Sell dYT in DEX to get fixed income
4. Redemption of the underlying principal with dOT at maturity
Resource：Dank Protocol
The first two steps are the principle of separation of principal and interest mentioned above. By marking the interest-bearing tokens, the tokens will be generated into two types of tokens, dOT and dYT. dOT represents the ownership of the locked interest-bearing tokens. dOT has an expiration date, which means the underlying assets cannot be transferred during this period (transfers in the future will be allowed, and will support dOT trading pool and re-mint). dYT represents the future yield in the same period, so the current rate of return is unknown.
The third step is to adopt the combination of order book and AMM pool to realize the exchange of dYT and USDC. The order book allows the seller to place orders of dYT in their expected price for fixed income. After the transaction, the sellers will get their expected revenue. The buyer or investor can purchase any position according to their revenue expectation, which can effectively control the risk. Meanwhile, the order book model provides customization and high capital efficiency for all participants in the market (liquidity providers and receivers). On the other hand, the transactions between both parties of AMM are interacting with liquidity pool on the chain. The liquidity pool allows users to swap tokens on the chain in a fully decentralized and non-custodial manner. Meanwhile, liquidity providers receive earnings in dYT and in transaction fees. Transaction fees are based on the percentage of their contribution to the pool. In a way, the AMM model helps liquidity provider to avoid theta attenuation.
The fourth step is the biggest innovation of Dank. In addition to redeeming the principal with dOT, the protocol allows users to auction dOT. The auction price is set by the holder at the expected price, and the buyer bids within a limited time. After the auction ended, the ownership of dOT will be transferred. The ownership of dOT and the corresponding dYT can be exchanged back to the underlying asset after expiration.
The process of auction is actually equal to buying a zero-coupon bond for the buyer. Because the current price of dOT must be lower than the redeemable underlying value at maturity, and the buyer can buy it at a discount and earn the difference in the price from the underlying assets they exchanged when it expires. On the other side, seller can immediately sell their dOT to increase capital efficiency, and they can lend asset repeatedly to rise the leverage for interest rate. However, user should be aware of the risks if the discount rate is greater than or equal to the coupon rate. Because this cycle will only make the income become lesser and lesser. For example, assuming that the discount rate and the coupon rate are both 10%. Bob deposits 100 USDC to get 100 dUSDC and 10 dYT, and holds 110 USDC at maturity; but if Bob sells 100 dUSDC at 90 USDC and deposits the minting again for 90 dUSDC and 9 dYT, Bob can only get 109 USDC at maturity. If the discount in the above example is changed to 9%, that is, 100 dUSDC can be sold at 91 USDC, then Bob will eventually get 110.1 USDC. Therefore, the lower the discount rate or the higher the coupon rate, the higher the return of recurring fixed-income products. However, this is based on the premise that only dYT is held to maturity. If dYT is also sold in the market, there will be more variables, and investors need to carefully assess the risks of all parties.
Currently, there are few protocols focusing on fixed income + variable interest rates, and Dank Protocol is the only deployed on layer 2. At present, the Dank Fixed-rate Lending Protocol has been deployed on the Arbitrum testnet, and has passed the security audit by CertiK. On October 13, 2021, Dank has official launched on Arbitrum mainnet, users are able to interact with the innovative fixed + variable rate protocol by Dank.
Reference
https://www.chainnews.com/articles/750609466746.htm
https://www.chainnews.com/articles/461585160172.htm
Note: This article is sponsored by dank and does not represent Wu Blockchain’s financial advice..
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