Unlocking the Power of Fixed Rate Returns in DeFi

No Floor, No Ceiling

The average crypto-native has a higher risk appetite relative to more traditional investors. Crypto is rightfully classified as a risk-on asset as it is the norm for most crypto tokens to fluctuate 10–20% in price within a single day, even among larger cap tokens. On the other hand, anything over a 1% daily price movement in commodities (gold, silver) or indices (the S&P500) will make for some serious news headlines.

But what if crypto didn’t have to be a risk-on asset by default?

Here’s the problem:

Nearly all yield in Web3 is variable by default because of the supply and demand economics that govern decentralization. In fact, variable yield is such a defacto setting in crypto that we often forget that even “market-neutral strategies” are built atop this foundation of variable returns.

Offering a new base layer for fixed yield in crypto will be a paradigm shift precisely because the entire space is built atop of variable yield. Fixed Yield products would accommodate the billions of dollars of liquidity that institutional investors can only delegate to risk-off assets.

Before we examine the importance of fixed yield, we first have to answer the following question:

Why is variable yield so prevalent in crypto?

The Economics of Decentralization

To understand why the variable yield is prevalent in crypto, let us examine the most commonly used yield-mechanisms in the space.

POS Staking

Staking is now a catch-all phrase to describe all instances of locking tokens up as collateral into vaults (examples: “Stake your $DAI”, “Stake your $USDC”).

However, the original definition — and purpose — of Staking was exclusively meant to define the scope of work for Proof of Stake (POS) blockchain network validators who could lock up their coins for a chance to validate the transactions.

POS validators, the original stakers, are paid out on a “block-by-block” basis. Each block would have a different number of transactions contained in it, resulting in a different payout to stakers per block. In other words, POS Validators are paid out in a variable manner, completely dictated by supply and demand (how many vs how little transactions in a single block).

Providing Liquidity to AMMs / DEXs

If you’ve swapped tokens on a DEX like Uniswap, Sushiswap, Pancakeswap or TraderJoe, then you’ve interacted with an Automated Market Maker (AMM). AMMs are liquidity pools that anyone can permissionlessly buy and sell tokens from.

In traditional finance, asset price is dictated by the supply and demand dynamic between the buy orders and sell orders of different counter-parties.

On the other hand asset price is dictated in a completely algorithmic manner within AMMs — depending entirely on the ratio between both tokens in the pool.

• Fewer tokens in the pool = higher price.
• More tokens in the pool = lower price.

So where does variable yield come into play here?

If you provide liquidity to an AMM for other people to swap from, you earn a fee from every swap transaction. Uniswap allocates 0.3% of each transaction fee to the Liquidity Providers (LPs). This 0.03% is then shared between all of the LPs.

• Fewer LPs = higher fees per individual LP.
• More LPs = lower fees per individual LP.

On top of already getting variable yield from trading volume that fluctuates, this form of yield is further distributed between LPs in a variable manner.

• Variable transaction volume + Variable participants (LPs) = Variable Yield

AMMs and POS Staking are the two foundational models that crypto yield is built atop of. These key foundational layers make up the architecture that enables crypto to be decentralized and permissionless. Moreover, nearly all yield strategies in crypto (including “market-neutral” ones) are built atop of staking and AMMs.

How do we achieve Fixed Rate returns in crypto without undermining the supply and demand factors that hold decentralization together?

Interest Rate Basics

One approach to achieving Fixed Yield returns in crypto is to tranche existing sources of variable yield like Vaults and AMMs. To better understand the significance of tranching, we have to first define investments in terms of first-principles.

Every investment is composed of:

1. A Principal — your initial deposit or collateral.
2. Interest — your yield and payout structure from your investment.

Once an investment is broken down into these two modular components, it becomes possible to trade (buy and sell) each of these components in an isolated fashion.

Let’s break this down assuming two people have invested $1,000,000 as principal in different investments:

• Investor A receives fixed returns of 1% per month on his $1,000,000 investment.
• Investor B receives variable returns of 0.02% — 2% per month on his $1,000,000 investment.

If Investor A wants variable returns and Investor B wants fixed returns: they could swap their Interest Rates (return structures) without having to swap their principal amounts ($1,000,000). This is the basic philosophy behind Interest Rate Products.

Permissionless Tranching

Tranching refers to segmenting a single investment into a Fixed Yield portion and a Variable Yield portion. These portions are called “tranches”. As an approach, Tranching is more efficient than pairing two investors with the same principal amount to swap Interest Rates. Tranches allow two different parties to look at the same investment and choose amongst themselves a fixed-rate taker and a variable-rate taker.

But how does this approach become scalable to DeFi, and how does Struct Enable Fixed rate products?

Struct lets any protocol or user permissionlessly tranche TraderJoe Liquidity Pools into fixed yield and variable yield segments!

That’s right — Struct’s Factory allows anyone to build (and use) their own Interest Rate Products on-chain by tranching yield-bearing positions (liquidity pools) using a waterfall mechanic.

Here’s how it works: Imagine a series of waterfalls that emerge from a single source of water. The waterfall closest to the source fills up first (fixed yield tranche). Any excess water then flows further downstream into secondary waterfalls (variable yield tranche).

• The Fixed Yield Tranche takes a small consistent % of the Yield generated from TradeJoe Liquidity Pools.
• The Variable Yield Tranche takes whatever yield is left over — which could be less… but could be more!

Although most crypto natives would prefer Variable Yield Tranches (high risk, high returns), most institutions in traditional finance would prefer the consistency and predictability of Fixed Yield Tranches.

Tranching essentially enables institutional liquidity and crypto degens to provide liquidity for each other. Considering Struct’s Factory allows permissionless tranching of Liquidity Pools (with some token parameters of course), Fixed Rate Returns may become commonplace enough to tame the wild and volatile returns of Web3. Once unlocked, Fixed Rate Returns have the power to pave the way for institutional liquidity to safely step into the DeFi without compromising the core tenets of decentralization.

We’re excited to have you come along with us to see what may become of this new primitive!