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Pantera Partners Read Notional Finance: Defi Fixed Rate Lending Agreements

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Defi's high volatility in lending rates implies high risk, while Notional Finance's fixed-rate loans can attract a broader range of use cases with longer duration and lower risk.

原文标题：《 Pantera 合伙人解读 Notional Finance：DeFi 固定利率借贷协议》

原文来源： VeradiVerdict，链闻

原文编译： Paul Veradittakit，卢江飞

Yesterday a friend asked me where I could deposit Bitcoin or Ethereum and borrow stablecoins at a fixed interest rate and for a fixed term, and I told him, wait for this article!

Notional Finance recently closed A Series A funding round, led by Pantera Capital, which is addressing my friend's problem: getting people, especially during the bear market, to not have to sell their cryptocurrencies or give up their asset positions and borrow to fund their daily expenses.

Most DEFI loans on the market now offer variable rate loans, which means the interest rate on the loan changes over the life of the loan. One of the better known is the Defi Loan Agreement. Aave For example, in December 2020 alone, USDC's loan rates fluctuated between 2% and 65%. Because of this high volatility and low confidence in interest rates, floating-rate loans are generally considered risky.

In contrast, fixed-rate loans, in which interest rates remain constant throughout the life of the loan, account for a significant share of the global lending market. Because interest rates are known to be set in advance, fixed-rate loans are less risky and thus attract many broader, longer, less risky use cases.

For cryptocurrencies on the Ethereum blockchain, there is now a decentralized fixed rate term loan agreement: Notional Finance. Users can use stablecoin DAI and USDC to borrow, lend, or provide liquidity to the protocol. Notional Finance deals offer very competitive annualized rates of around 6-7% for loans with six-month maturities compared to other competitors in the market.

The certificate token corresponding to the Notional Finance agreement is "FCash", which is defined by two key elements: 1. The associated cryptocurrency; 2. 2. Expiration date. On the back end, the Notional Finance agreement deploies several pools of liquidity between FCash and backed assets and uses custom automated market makers (AMMs) to support fixed-rate lending.

Borrowers can withdraw assets from the Notional Finance agreement in exchange for receiving a negative FCash balance (also based ona fixed interest rate) in the relevant cryptocurrency. On maturity, the FCash balance requires the borrower to return an equivalent amount of the associated cryptocurrency back to the protocol.

Lenders can deposit assets into Notional Finance agreements in exchange for receiving FCash tokens linked to the cryptocurrency (also based ona fixed interest rate). At maturity, lenders can redeem these FCash tokens for an equivalent amount of the associated cryptocurrency.

The Notional Finance agreement opens up an entirely new use case in the DEFI space, the fixed-rate lending service, which is popular with many users, especially those who are risk averse and do not want to take on long-term debt. There are a number of applications for fixed-rate loans being explored on the Notional Finance protocol, including: 1) funding for low risk low return trading strategies and 2) providing early sustainable liquidity for the new DEFI project. 3. Use crypto assets for personal purposes such as paying off a home mortgage.

There is no doubt that globally, DEFI is capturing more market share in the financial ecosystem. In this process, the platform of fixed interest rate crypto loan products is very important. The Notional Finance agreement has actually provided a very promising model for the fixed interest debt market operating on the Ethereum blockchain, allowing users to borrow and lend cryptocurrencies with lower risk than ever before, while also greatly expanding the scope of DEFI's use cases.

What is NOtional Finance?

For cryptocurrencies on the Ethereum blockchain, Notional Finance is a regular decentralized lending agreement based ona fixed interest rate. Since its launch last fall, the agreement has locked up more than $19.5 million and processed $9.5 million in loans. By building a fixed-rate debt market platform on the Ethereum blockchain, Notional Finance aims to introduce a new set of financial use cases in decentralized Finance, namely retail lending (a service that is already widely used in mainstream financial markets).

At the present stage, Notional Finance supports DAI and USDC to lend and provide liquidity, and the lending rate is fixed within the term of the loan. However, the interest rate will vary for different lending conditions, which mainly include:

The size of the loan

Select the base stablecoin

Length of loan

For a six-month loan, for example, Finance deals typically offer a fixed annual interest rate of around 6-7%.

Some use cases for providing fixed-rate loans in the DEFI domain

As of this writing, the total outstanding debt under the DEFI loan agreement is approximately $19 billion. By comparison, the total size of the US debt market is estimated at $46tn and the total size of the global debt market is estimated at $128tn.

Outside the DEFI sector, most debt markets are driven by fixed-rate loans, which are loans at a fixed, constant interest rate. Fixed-rate loans usually can reduce the risk, because this kind of loan contracts can let the lender and the borrower borrowing and repayment more confidence in yourself, in order to formulate long-term strategies and leveraged trading positions, and this is why the fixed interest rate loans in countless classical financial cases the dominant reason (for example, housing mortgages, corporate loans and public bonds).

By contrast, most of the Defi deals offer variable-rate loans, where the interest rate can change at any time during the life of the loan. But, want to use these lending agreement, can only hold assets (exchange) encryption, so if encryption money market appear higher volatility, often cause these products rates appear huge fluctuations, which may lead to a variable rate loan risk to be amplified, if you want to have long-term investment returns through DeFi lending, So these variable rate loans are not really reliable.

For example, as one of the largest DEFI loan agreements in the crypto market, the annual yield of their USDC loan products will fluctuate by 2-70% during December 2020. For ordinary investors who are seeking low risk and reliable investment, Such high volatility is not what they are looking for.

Figure 1: Trend of single-month USDC borrowing rates on Aave platform in December, 20 (source)

In this case, in order for cryptocurrencies to be better used in the financial debt market, the lending agreement must provide fixed-rate lending service, so as to attract more traditional non-crypto users, and the scope of the use case can be expanded.

At present, the market there have been some encryption program by way of centralized financial encryption to provide users with fixed rate loan services, including lending institutions effectively play a role, the role of them is very similar with the central bank - we know that under the traditional financial pattern, people need to use the legal currency and exchange loan assets, Crypto lenders based on a centralised financial model use cryptocurrencies. For example, BlockFi, a crypto lending service based on a centralised financial model, has $15 billion in assets under management, which shows that there is still huge demand. But even so, cryptographic lending protocols based on a centralized financial model still have some key problems, such as:

Poor accessibility (similar to the problem with most traditional banking services today)

Transparency is poor

There is significant counterparty risk (any lending service agent could default on a financial transaction)

In other words, those crypto loan agents based on a centralized financial model may be at risk of default in financial transactions. Crypto loan service provider CRED, for example, had to declare bankruptcy in 2020 due to a series of botched pledges and fraudulent transactions that ultimately cost its liquidity provider more than $100 million.

Decentralized finance is completely different from centralized finance. Since the DEFI protocol is transparent, automated and decentralized, the decentralized lending service has the following three advantages thanks to the liquidity brought by the large number of users:

Counterparty risk can be significantly reduced;

Lenders and borrowers can have sufficient foresight of how the funds will be used;

Loan rates and parameters are usually controlled by the user community rather than by a central authority.

Through the fixed rate lending market built on Ethereum, Notional Finance combines the convenience and low risk of fixed rate lending with the accessibility, efficiency and security of DEFI.

How does NOtional Finance operate?

At the heart of the Notional Finance agreement is its voucher token FCash. Each FCash token is defined by two factors:

The associated cryptocurrency

Due date

Users with FCash tokens can exchange them for the associated cryptocurrency of equal value on or after the expiration date.

Lenders can deposit assets into Notional Finance agreements, set a maturity date and then receive FCash tokens linked to the value of the assets deposited. The initial amount of FCash that lenders receive is proportional to the amount of crypto assets they deposit, which means that they can redeem their FCash tokens in a 1:1 ratio to their initial cryptocurrency investment on or after the maturity date, and then receive a fixed interest income.

Borrowers can withdraw assets from the NOtional Finance agreement, they also need to set a maturity date, different from the lender, in exchange, they will get a negative balance of FCash, the size of the negative balance is proportional to the total amount that the borrower must pay at the fixed interest rate at the maturity date, that is to say, At maturity, the FCash balance is effectively exchanged for a specified maturity rate, receiving a negative FCash balance for the underlying cryptocurrency. As with the credit side, the size of the negative FCash balance is proportional to the total amount the borrower must pay at maturity under the fixed interest rate. After the maturity date, the FCash balance is essentially the basis for the borrower's obligation to provide an equivalent amount of the associated cryptocurrency.

What's more, FCash tokens are always created in pairs: an asset (the credit token) and a liability (the debit balance), meaning that the net value of the assets and liabilities in the ecosystem is zero, in a nod to the traditional financial saying: "There is no borrowing without borrowing."

Figure 2: Assets and Liabilities in FCash (Source)

To facilitate the effective exchange of these fixed exchange rates, as well as FCash tokens and associated cryptocurrencies, the Notional Finance agreement uses several pools of liquidity. Each liquidity pool holds the cryptocurrency that FCash is associated with, meaning that each liquidity pool corresponds to a specific cryptocurrency and a specific maturity date. The share of FCash vs. the number of cryptocurrencies in the liquidity pool will change as the date of maturity approaches, in order to match the ratio with the fixed interest rate.

To manage these pools of liquidity, Notional Finance uses its own automated market makers (AMM) and custom enhancements such as dynamic curve sensitivity to help stabilize rates and reduce slip-points (reducing the impact of deposits or withdrawals on real rates).

Potential use cases

Broadly speaking, Notional Finance has unleashed a number of new lending use cases in decentralized Finance and the service has been well received by many users, especially those who are risk averse and do not want to take on long-term debt.

Potential use cases for using Notional Finance agreements to explore classic fixed rates in the decentralized financial world include:

Trading firms often prefer to borrow at fixed rates rather than floating ones because they can fund more reliable, low-return trading strategies; While the expected return on fixed interest rates may be low, the high volatility of interest rates can expose the company to risk and no guarantee of profit.

Traditional lenders often prefer to borrow at fixed rates because they also pay customers a fixed rate. Floating-rate loans could hurt these companies' profit margins and introduce significant risk into their business models.

Cryptocurrency holders in need of liquid assets may prefer to borrow at a fixed rate rather than directly sell their cryptocurrency assets and lose their positions. Fixed-rate lending products allow such holders to explore greater investment opportunities, and they can use their cryptocurrency holdings to provide flexible funding with much lower risk. It is reported that some customers have taken out fixed-rate loans directly from Notional Finance to pay off their entire mortgage.

Defi, which is desperate for liquidity, may also look to fixed-rate loan products rather than liquidity-mining. By liquidity, mining and DeFi projects must be within a relatively short time liquidity provider returns returns, but specific results depends on whether the project success, once appear problem, this return may become unsustainable, even lose everything, whereas fixed-rate loan which can ensure project responsibilities and obligations.

What's the next step?

Notional Finance is currently launching the first version of fixed-rate loans, but they are not stopping there. The project team has started to build version V2, which will have some major improvements, such as:

A longer maturity date can be set

There will be more types of collateral to choose from

The returns available to liquidity providers would be better

Notional Protocol is expected to announce and go live a number of feature upgrades in the next few weeks.

Final Thoughts

In fact, over the past few months, Defi has gained a lot of mainstream interest as more and more ordinary people try to explore various Defi applications and use this user-facing, decentralized protocol to replace inefficient traditional financial products. The fixed-rate debt market plays a pivotal role in today's financial world, so decentralized fixed-rate crypto lending protocols such as Notional Finance have great potential to become one of the most important decentralized financial applications.

Notional Finance is one of the first lending agreements to offer fixed-rate services on the Ethereum blockchain, which offers a very promising model that allows users to borrow and lend cryptocurrencies with lower risk than ever before. As the cryptocurrency market continues to grow, Notional Finance will unlock more new cryptofinance use cases, ranging from mortgage lending to other trading strategies with greater complexity.

There is no doubt that DEFI will become a bigger and bigger part of the global financial ecosystem in the future, and fixed-rate crypto lending agreements like Notional Finance will pave the way for this to happen.