In the world of traditional finance, market participants can trade future interest rate payments with each other. This is often done as a way to protect against loss, manage credit risk, or speculate on whether interest rates will rise or fall based on future market conditions. These swaps can take the form of fixed-float, floating-fixed or floating-float swaps, each of which is a type of derivative contract. When an exchange takes place, the parties do not appropriate the debt of the counterparty. Instead, under the derivative contract, the interest rates are swapped while the loan value (notional principal) remains with the original party.
In what is called a “vanilla swap”, one party benefits from the risk protection of a fixed rate, while the other benefits from the possibility of profiting from a decreasing variable rate. For example, a smaller institution may want to swap its riskier floating interest rates with a larger institution, which is willing to accept the risk of interest rate fluctuations. In return, the small institution would get a fixed interest rate, allowing for better financial planning. The size of the OTC derivatives market is colossal – according to the most recent data from the Bank for International Settlements, the notional value of interest rate derivative contracts recently reached $488 trillion.
Unfortunately, the interest rate swap market has not seen significant change since the 1980s. It has since become plagued by high fees charged by banks and high settlement costs, often resulting from monopolistic institutions taking greater control over the market. For this reason, Decentralized Finance (DeFi) is seen as a clear solution to cut out the middleman with a complete and scalable solution, among them the Ethereum-based Tempus protocol.
Solving DeFi Exchanges
Tempus, which is built on the Ethereum (ETH) network, is a decentralized secondary market for returns that allows users to peg or speculate on their earnings. An essential part of the protocol is the TempusAMM smart contract, a personalized AMM that allows users to deposit their yield-bearing tokens (YBT) into a pool with a specified expiry date and earn at a fixed rate or speculate on the future return for profit. Once the YBTs are deposited, Tempus divides them into core tokens and yield tokens. Users can then exchange these tokens for each other using TempusAMM. In this way, Tempus allows parties to access a trustless version of traditional interest exchanges.
Tempus co-founder David Garai shares, “The MA serves as an indicator of the implied market return of our pools and is the counterparty to every trade. The source of the fixed return in our protocol is that users all trade their returns to principals through the MA and redeeming those principals for the underlying asset at maturity.”
In practice, these swaps are built on the stable pools of Balancer v2. Swap fees are also paid to liquidity providers, who earn rewards in two ways: through swap fees and the return on providing liquidity.
Each pool follows different rules and has a varying maturity time, all based on the underlying protocol. Tempus also offers a simplified and easily accessible user interface, so users have minimal hurdles in managing their yields.
Additionally, the platform has addressed concerns about fragmented liquidity in yield farms, where the requirement for stablecoins and other supporting tokens to create Automated Market Makers (AMMs) exists. Typically, half of these pools should be in a support token, with the other half being the yield farming asset. As a result, liquidity providers earn only half of the liquidity they could otherwise earn. Tempus takes care of this, for example, by converting ETH to stETH using Lido. From there, liquidity will be transformed into principals and returns in exchange. Core tokens provide interest at a fixed rate, while yield tokens are variable. Users can then trade between these two tokens as they wish, depending on their risk profile.
Future return for the masses
Since Tempus is an Ethereum-based protocol, the team is preparing for the upcoming Ethereum 2.0 launch.
“We have identified strong institutional demand for fixed rate ETH 2.0 staking without trust, which will be our primary focus for the next few months. Risk-averse investors want more certainty about future staking returns,” Garai shares.
Tempus launched on the Ethereum mainnet on December 15, 2021 and currently has two Lido stETH pools available. The platform will also launch its second integration with Rari Capital on January 17, with support for USDC and DAI, and with plans to release more integrations over the coming months.
As for the longevity of Tempus, the protocol recently received $1.9 million in a seed round and $4 million in a strategic funding round. The company also recently raised $28 million via a token launch auction on Copper.
In the long term, Tempus aims to eventually expand its offering to other blockchain networks outside of Ethereum and is considering opportunities on both layers one and two.
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