Interest rate swaps are one of the intriguing financial products that are used by financial institutions across the world.
Described as a type of a derivative contract through which two counterparties agree to exchange one stream of future interest payments for another, based on a specified principal amount – in most cases, interest rate swaps include the exchange of a fixed interest rate, which never changes, for a floating rate – which fluctuates over time.
Interest rate swaps occur when two parties – one of which is receiving fixed-rate interest payments and the other of which is receiving floating-rate payments – mutually agree that they would prefer the other party’s loan arrangement over their own.
Benefits of such swaps include:
Converting variable interest rates to fixed is used to protect against volatility
Institutions take up variable interest rates to retain the chance to make profits if rates go up
Given the volatile environment in decentralized finance, interest rate swaps can seemingly be a product that players can use to manuever – in particular for staking and yield farming.
However, the decentralized and trustless nature of DeFi makes it hard to enable traditional interest rate like swaps because they rely on trust between parties:
Usually there is little or no collateral among parties in interest rate swaps
Counter-parties engage in extensive negotiations to set terms
That said, we continue to see countless innovation stories – with new or old products being introduced for the DeFi space.
The concept of interest rate swaps has now found its way, thanks to Tempus, which lets DeFi lenders deposit yield-bearing tokens into a liquidity pool and enter a smart contract with a specified maturity date, but allowing them to either earn at a fixed rate or speculate on the future yield for profit.
How the mechanism works is that Tempus splits the deposited yield bearing tokens into tokenized principal and yield tokens (which accrue value during the life of a pool), and are tradeable on Tempus ‘custom’ automated market maker (AMM).
Tempus AMM is a capital efficient automated market maker built on Balancer V2.
Tempus has 3 different use cases, each of which offers a unique value proposition:
Fix your future yield using any supported Yield Bearing Token (such as stETH, cDai)
Speculate on the rate of future yield of any supported Yield Bearing Token
Provide liquidity to earn additional swap fees (on top of yield earned through yield farming protocols) by depositing any supported Yield Bearing Token
The AMM lets users trade the tokenized principal and yield tokens with each other providing liquidity so they can earn additional swap fees on top of whatever they gain through the yield farming protocol.
According to Tempus CEO, the AMM allows people to give up their exposure to an unknown future yield and swap it for more principals so they know how much they’re going to get.
Additionally, the CEO believes that such a product helps to make DeFi more attractive to risk averse traditional investors.