Introduction
In traditional finance, interest rate swap is a type of forward contract between two parties to exchange one stream of interest payment for another based on a specified principal amount over a set period of time. By trading interest rates, borrowers can reduce future uncertainties and eliminate risks of the increase of the interest rate.
Using this concept, Hakka Finance proposes a highly capital-efficient financial derivative called "Interest Rate Synth (IRS)" based on iGain option trading framework. The selected settlement index for IRS is the borrowing interest rate.
Lending constitutes the main part of crypto financial demands, and the most well-known platforms are Compound and Aave. Investors can either earn interests by depositing capital to this type of contract (Lender) or borrow crypto by providing collateral (Borrower). However, the interest rate fluctuates with the market. In a bull market, the increasing borrowing demand results in higher interest rates, while in the bear market, the decreasing borrowing demand lowers interest rates.
Every individual has his or her risk tolerance. Compared to floating interest rate, some people tend to pursue stability. That means, to avoid extra loss along with market fluctuations, risk-averse investors may expect a fixed interest rate while lending or ensure the fixed interest rate in the period of time while borrowing.
Interest Rate Synth (IRS) is an interest rate derivative to provide lenders and borrowers a platform to hedge the risk of future changing interest rates and to empower investors to lock future interest rates with a small amount of capital. The entire system design doesn't involve any principal deposit to smart contract. The capital efficiency can be maximized because all the capital and liquidity are gathered in the trading market of the interest rate derivative.
IRS, as the second product in the iGain ecosystem, adopts a dual-token design as well. Investors can long future interest rate by purchasing Long token, and vice versa. There are two major scenarios.
Fixed lending or borrowing interest rate
Lenders/borrowers can lock future interest rates by purchasing Long/Short tokens based on their principal. The amount of purchase needed is determined by the leverage level while the fixed interest rate is decided by the purchase price.
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Speculate on future interest rate：
By the expiry day, the Long and Short tokens can be transferred so users can 'long' or 'short' interest rates based on their prediction of the future interest rates. As the settlement day is approaching, the changes in future interest rates become less possible so the potential arbitrage chance tends to be more obvious.
Why iGain IRS?
Fixed interest rate protocols, as the foundation of asset management, are springing up as the infrastructure of the decentralized financial services gets mature. Each protocol has different mechanisms, but iGain IRS has at least 3 advantages compared to other competitors.
Maximized capital efficiency
Existing fixed interest rate protocols require principals to get interest incomes, which reduces the capital efficiency wildly. In contrast, iGain can greatly improve capital efficiency by gathering all system capital and liquidity into a single interest derivative marketplace.
Better equilibrium in one pool
iGain pool constitutes ERC-20 based Long and Short tokens, which can be transferred, used in 0x protocol and traded in any AMM to satisfy investor needs. The dual-token design can serve both interest lenders and borrowers. Moreover, the competitive dynamics between both sides is supposed to reach equilibrium with the prediction of the future interest rate.
Enabling short interest rate
Most of the fixed interest rate protocols can merely purchase yield token to 'long' interest rate, and investors thereby fail to effectively 'short' interest rate as the yield token is overpriced. Consequently, the price becomes less sensitive to market change. In iGain, investors can directly buy Short token to 'short' interest rate and gain profits as the interest rate drops.
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