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Interest rate swaps — those futures contracts that swap one form of future interest payment for another based on a specified amount of principal — have found a home in the world of decentralized finance.
The Voltz protocol announced on Wednesday that it has launched DeFi’s first synthetic, capital-efficient interest rate swap AMM, which now offers DeFi the ability to compete with the interest rate swap marketplace in traditional finance and new opportunities for decentralized applications (DApps ) to serve the financial needs of the world, particularly for those in parts of the world that do not have access to traditional finance.
Automated Market Makers, or AMMs, are smart contracts that create liquidity pools of Ethereum ERC20-based tokens, which are then traded automatically using an algorithm rather than an order book. AMMs enable decentralized (permissionless) cryptocurrency trading using liquidity pools that operate 24/7. AMM users supply crypto to liquidity pools, the prices of which are determined by a continuously calculating mathematical formula.
AMMs are becoming formidable competitors to one of the institutional pillars of traditional finance, the derivatives marketplace, typified by the Chicago Mercantile Exchange Group, whose exchanges average more than three billion contracts worth about $1 trillion a year. (Yes, that’s quadrillions.)
Taking the volatility out of DeFi
DeFi might represent the future of finance for many people due to its technical prowess, but for Voltz CEO and co-founder Simon Jones, it is a magical space bounded by potential volatility.
In an exclusive interview with ZDNet, Jones said he believes DeFi’s limitation is that its technology creates a sector that is inherently variable. “If you get to the bottom of proof-of-stake mechanics, you essentially have supply and demand dynamics, meaning that the rates coming off nodes are variable. If you go to the protocol layer, most protocols produce variable returns, and then when you try to build products and services on top of them, by definition you’re going to end up with products and services that are inherently variable,” he said.
And where there is variability, there is often volatility. “So if we look at some of the credit borrow rates of some of the major protocols, they’ve gone from over 40% to under 2% in a month,” Jones said. That’s fine for those who aren’t put off by variability and volatility, but Jones adds, “If we actually want DeFi to become the financial system for the entire world… we need to find a way to overcome this limitation at the macro level.” is that they enable us to develop products and services that have built-in stability and that can meet the financial needs of the entire world,” he said.
As part of the current “Alpha” rollout, Voltz said its liquidity providers (LPs), which include Wintermute and Amber Group, can use the Voltz protocol for interest rate swaps. There will be an initial cap on the liquidity that can be provided as an LP with a margin of $1.5 million per pool. However, trading will be unlimited. The cap will gradually increase until it’s completely lifted for the full public launch. The Voltz protocol will initially launch with Aave and Compound base stablecoin courses and will add more markets over the coming months, including Lido’s stETH token. The protocol is designed so that pools can be created for any variable return asset.
The design of the Voltz protocol includes a “Virtual AMM” (vAMM) with concentrated liquidity for price discovery, with the management of the underlying assets performed by the “Margin Engine”. This combined structure allows counterparties to create and trade fixed and floating interest rates through a mechanism that is up to 3,000 times more capital efficient than alternative interest rate swap models, while giving liquidity providers and traders significant control over their positions, the company said .
Because the Voltz protocol is open-source and highly combinable, developers can leverage it to build DApps for products including on-chain fixed-rate mortgages, loans, savings accounts, risk management, DAO treasury management swaptions, IRS caps and lower bounds. “I am very pleased that we are acting as a catalyst for a whole host of new products in this space,” Jones told ZDNet.
The Voltz protocol also eliminates the concept of “impermanent loss” for liquidity providers. (A temporary loss is the amount of money you lose after depositing tokens into a liquidity pool, and its price drops a few days later.) It’s a risk inherent in DeFi until now. According to Voltz, eliminating fickle losses through single-asset LP-ing is a new dimension for DeFi, giving DApps more opportunities to use the protocol to create new products.
Understand the benefits of DeFi
If all this talk of interest rate swaps, liquidity pools, and DApps has you confused, you’re not alone. Even explaining the concept of DeFi to those who are new to digital finance can be challenging. However, Jones prefers to approach the concept from a different perspective. “If you don’t want to understand the details, then understand the benefits,” he said. Compared to traditional, centralized finance, DeFi is “fairer, more transparent, more anti-fragile, and more efficient.”
In order for DeFi to become the financial system for the whole world, the Voltz team – 15 so far – will develop many more products and services in the coming year with the help of more employees and close cooperation with the teams, according to Jones’ vision of the products and services develop based on the protocol.
“We want DeFi to become the financial system for the whole world. There are still 1.7 billion people who don’t even have a bank account… it’s about 25% of the population. Allowing everyone, no matter where they’re born, to have equal equal access to a financial services system is something we’d personally like to see,” Jones said.
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