Borrow Crypto With Certainty

VeradiVerdict - #137

A friend asked me yesterday where to go to deposit Bitcoin or Ethereum and borrow stablecoins at a fixed rate and fixed term, so I told the person to stay tune for the next newsletter!

Pantera recently led the Series A of Notional Finance which is solving this exact problem, enabling folks (especially during a bear market) to not have to sell their cryptocurrencies and forgo that exposure, while being able to borrow capital to use for their everyday expenses.

  • Most existing DeFi lending protocols offer variable-rate lending, where a loan’s interest rate can change during the loan term. Aave, one popular DeFi lending protocol, offered an interest rate on USDC that fluctuated between 2 and 65% in December 2020 alone. Variable-rate lending is often seen as risky, due to this high volatility and low confidence in interest rates.  

  • In contrast, a massive share of global debt markets is driven by fixed-rate lending, where interest rates remain constant through the loan term. Due to a pre-determined, known interest rate, fixed-rate lending is seen as less risky, making it appealing for a wide spread of longer-term, low-risk use cases. 

  • Notional Finance is a decentralized fixed-rate, fixed-term lending protocol for cryptocurrencies on Ethereum. Users can borrow, lend, and supply liquidity to the protocol in the form of DAI and USDC. For a six-month loan, the protocol generally offers a competitive APR of around 6-7%. 

  • Notional’s protocol centers on the fCash token, which is defined by a cryptocurrency and a maturity date. Under the hood, Notional uses several liquidity pools between fCash and supported assets and a custom AMM to enable fixed-rate lending. 

  • Borrowers can withdraw assets from Notional and receive a negative fCash balance of the associated cryptocurrency (based on the fixed interest rate) in exchange. On the maturity date, the fCash balance obligates the borrower to return an equivalent amount of the associated cryptocurrency to the protocol. 

  • Lenders can deposit assets into Notional and receive fCash tokens of the associated cryptocurrency (also based on the fixed interest rate) in exchange. On the maturity date, lenders can redeem these fCash tokens for an equivalent amount of the associated cryptocurrency.

  • Notional unlocks a new class of fixed-rate use cases in DeFi, particularly for risk-averse users and longer-term obligations. Some fixed-rate lending applications being explored on Notional include funding low-risk, low-return trading strategies, sourcing early liquidity sustainably for new DeFi projects, and even using crypto holdings for personal uses, like paying off a home mortgage. 

  • Ultimately, platforming fixed-rate crypto lending is critical to DeFi capturing more of the world’s financial ecosystem. Notional Finance presents an extremely promising model for how fixed-rate debt markets can function on Ethereum, giving users the ability to borrow and lend crypto with less risk than ever before and substantially expanding the scope of DeFi. 

What is Notional Finance?

Notional Finance is a decentralized fixed-rate, fixed-term lending protocol for cryptocurrencies on Ethereum. Since its launch last fall, the protocol has accrued over 19.5 million USD in total value locked and has processed 9.5 million USD in loans. By platforming fixed-rate debt markets on Ethereum, Notional aims to introduce a new class of financial use cases, like mainstream retail lending, to the world of DeFi. 

Notional currently supports borrowing, lending, and supplying liquidity in the form of DAI and USDC stablecoins. Interest rates are fixed for the lifetime of the loan, but vary based on the size, underlying stablecoin, and length of term. For a six-month loan, the protocol generally offers a fixed APR of around 6-7%.

The Case for Fixed Rate Lending in DeFi

As of writing, the total amount of debt outstanding on DeFi lending protocols is approximately 19 billion USD. In comparison, the total size of the US debt market is estimated to be 46 trillion USD; the global debt market is estimated to be 128 trillion USD

Most debt markets outside of DeFi are driven by fixed-rate lending, which is exactly what it sounds like: loans offered at a fixed, unchanging interest rate. Fixed-rate lending generally decreases risk and enables lenders and borrowers alike to have more confidence in their financial contracts, enabling longer-term strategies and leveraged trading positions. This is why fixed-rate lending dominates a myriad of classical financial use cases, like home mortgages, corporate loans, and public bonds. 

In contrast, most lending protocols within DeFi offer variable-rate lending, where the interest rate can vary during the term of the loan. Since these lending protocols almost exclusively exchange and hold assets in crypto, the overall high volatility of the crypto market often corresponds to high volatility in interest rates, making variable rate loans extremely risky and unreliable for longer-term financial goals. Aave, one of the largest DeFi lending protocols, saw its APR for USDC loans fluctuate between 2% and 70% in APR in last December alone. These highly volatile interest rates are often undesirable for investors and everyday people seeking low-risk, reliable capital.

Fig 1. USDC Borrowing Rates on Aave for December 2020 (source)

Thus, in order for crypto to capture the full scope of debt markets, crypto lending protocols must perform fixed-rate lending to attract more traditional, often non-crypto-native use cases. 

Some projects offer fixed-rate crypto lending through a CeFi approach, where the lending institution effectively functions like a centralized bank that holds and exchanges assets in crypto instead of fiat. One of these protocols, BlockFi, manages over 15 billion USD in assets today, demonstrating the massive incumbent demand for crypto lending. Still, these CeFi crypto lending protocols have several key disadvantages, including low accessibility (like most traditional banks), poor transparency, and significant counterparty risk, which is the likelihood that any agent defaults in a financial transaction. Former crypto lender Cred famously went bankrupt in 2020 due to a series of bad bets and fraudulent transactions, leaving LPs that deposited over 100 million USD with nothing.

DeFi, in contrast, significantly reduces counterparty risk, as the entire protocol is transparent, automated, and decentralized, drawing from the liquidity of thousands of users. Lenders and borrowers have full foresight into how their money is being used, and lending rates and parameters are generally governed by a community of users, not a centralized institution. With fixed-rate debt markets on Ethereum, Notional combines the convenience and low risk of fixed-rate loans with the accessibility, efficiency, and security of DeFi. 

How Notional Works

The crux of the Notional protocol is the fCash token. Each fCash token is defined by a currency and a maturity date. Users with fCash tokens can redeem them for an identical amount of the associated currency on or after its maturity date.  

Lenders deposit assets into Notional and receive fCash tokens of the associated cryptocurrency in exchange, with a specified maturity date. The amount of fCash tokens a lender initially receives is proportional to the value of the lender’s deposit at maturity. Thus, after the maturity date has passed, the lender can redeem these fCash tokens for the original cryptocurrency at a 1:1 ratio, returning the fixed interest to them.

Borrowers withdraw assets from Notional and receive a negative fCash balance of the associated cryptocurrency in exchange, also with a specified maturity rate. As in the lender case, the size of the negative fCash balance is proportional to the total amount the borrower must pay out at maturity, given the fixed interest rate. After the maturity date, the fCash balance essentially obligates the borrower to provide an equivalent amount of the original cryptocurrency. 

Additionally, fCash is always generated in pairs: assets (tokens for lenders) and liabilities (negative balances for borrowers), keeping the assets and liabilities net zero across the entire ecosystem. 

Fig 2. Assets and Liabilities in fCash (source)

To facilitate these fixed rates and the efficient exchange of fCash tokens for their associated cryptocurrency, Notional uses several liquidity pools under the hood. Each liquidity pool holds fCash along with its associated cryptocurrency; this means each liquidity pool corresponds to a specific cryptocurrency and a specific maturity date. The share of fCash vs. the cryptocurrency in the liquidity pool changes as the maturity date approaches to match the ratio corresponding to the fixed interest-rate. To manage these pools, Notional uses its own automated market maker (AMM), with custom enhancements like dynamic curve sensitivity that help stabilize interest rates and reduce slippage (the effect that a deposit or withdrawal has on the true interest rate).

Promising Use Cases

Broadly, Notional unlocks a plethora of new lending use cases within DeFi, particularly for risk-averse users and longer-term obligations. 

Some classic fixed-rate use cases being explored in DeFi with Notional include:

  • Trading firms often prefer fixed-rate to variable-rate borrowing to fund reliable, but low-return trading strategies; given the low expected returns, highly volatile interest rates could put the firms’ profit margins at risk. 

  • Traditional lending institutions generally prefer to borrow at a fixed-rate since they pay returns to their customers also on a fixed-rate. Variable rate lending can jeopardize their profit margins and introduce significant risks into their business model. 

  • Crypto holders in need of liquid assets may prefer to borrow against their crypto holdings at a fixed rate instead of selling them and losing their position. Fixed-rate borrowing enables holders to actually use their crypto holdings to finance bigger financial decisions, since it comes at a significantly lower risk. One user even took out a fixed-rate loan on Notional to pay off their entire mortgage.

  • DeFi projects in rapid need of liquidity might look to fixed-rate loans instead of pursuing a liquidity mining approach. With liquidity mining, projects often must return massive rewards to liquidity providers in a relatively short-term, which may become unsustainable or unprofitable depending on the success of the project. Fixed-rate loans offer a guarantee on the project’s liabilities in the long-term.

What’s next?

  • Fixed-rate lending doesn’t stop at Notional’s V1. The team is hard at work building out Notional V2, with big improvements like longer dated maturities, more collateral types, better returns for liquidity providers, and more. Over the coming weeks, many of these upgrades will become public and live in the Notional Protocol. 

Final Thoughts

The past few months have seen a massive explosion of mainstream interest in DeFi, with more and more everyday people exploring how we can replace inaccessible and inefficient traditional financial products with user-oriented decentralized protocols. Given their importance in the financial world today, fixed-rate debt markets promise to be one of DeFi’s most important applications. 

Notional Finance offers one of the first fixed-rate lending protocols on Ethereum, giving users the ability to borrow and lend crypto with considerably less risk than ever before. As crypto markets continue to grow, Notional will unlock a new class of financial use cases for crypto, from home mortgages to highly-sophisticated trading strategies, paving the way for DeFi to capture an even greater share of the global financial ecosystem.

- Paul V



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Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing in blockchain companies and cryptocurrencies. I’ve been in the industry since 2014, and the firm invests in equity, early stage token projects, and liquid cryptocurrencies on exchanges. I focus on early-stage investments and share my thoughts on what’s going on in the industry in this weekly newsletter.