DeFi, there's no two sides to the loan

Author:Anthony Bowman

Other Organiser

There is real demand in the chain for fixed-rate borrowing. The obvious response was to issue loans at fixed interest rates, but there was no matching demand for fixed interest rate lending in the market。

The vast majority of the funds in the chain are pursuing gains and eager for immediate liquidity. Thus, the issuance of fixed-rate loans merely transfers interest rate risk from the borrower to the lender. An asset-liability mismatch occurs when the lender is a vault committed to immediate liquidity。

In the case of variable interest-rate lending, interest rates fluctuate with capital utilization and market conditions, and borrowers pay directly for such fluctuations. This is a real cost, but it is clear and transparent and ends when it is settled。

A LENDER IS ASSUMED TO HOLD A FIXED SIX-MONTH LOAN AT AN INTEREST RATE OF 3 PER CENT. IF INTEREST RATES RISE, THE SAME LOAN RETURNS WILL NOW REACH 5 PER CENT. THE VALUE OF OLD LOANS IS REDUCED BY MARKET VALUE (MTM). NEW LOANS WITH HIGHER RETURNS AT THE SAME RISK ARE OPTIONAL, AND NO ONE WILL PAY THE AMORTIZED VALUE OF THE OLD LOANS。

The market value loss of a single stand-alone loan remained on the books only, as the lender could hold it until its maturity and be paid in full. It becomes extremely dangerous only if it is placed in a system that requires continuous pricing。

Morpho ' s V2 Treasury is currently the most representative design open, incorporating fixed-interest-rate loans into a treasury system that promises immediate liquidity。

Extracted from: Morpho fixed interest rate market: potential for lending in the release chain

From public information, the design consists of three components:

Morpho Blue:Existing variable interest rate lending agreements. Lenders deposit funds in segregated markets, and borrowers pay interest rates that fluctuate with the utilization of funds, with positions open and flat at any time。

Morpho Midnight:Fixed interest rates through ZCBs, fixed term lending. Each loan is a bond with specific collateral, term and interest rates. These zero-interest bonds need not be licensed to support any collateral, duration and combination of parameters。

Morpho V2 Treasury:The treasury, which is managed by the developer, distributes the deposit to Blue and Midnight on the basis of the rate of return. Depositors are granted access at the share price of the treasury。

Image from the Morpho V2 Treasury document

It is envisaged that there will be two competing USDC-denominated treasury: Treasury A will allocate funds to Blue and Midnight at the same time, and Treasury B will be allocated to Blue only. Treasury A allocated 30 per cent to Blue (variable, 3 per cent) and 70 per cent to Midlight (fixed, 3 per cent)。

A single interest rate shock pushed variable interest rates up to 5 per cent and Midnight ' s position remained locked at 3 per cent. The combined return of Treasury A rose to 3.6 per cent (5 per cent x 30 per cent + 3 per cent x 70 per cent). Treasury B at pure variable interest rates rose to 5 per cent. The gap between these 140 basis points creates conditions and motivations for the vault to run。

TREASURY A DEPOSITORS ARE NOT REQUIRED TO CALCULATE MARKET VALUE LOSSES OR EVEN TO KNOW THEIR EXISTENCE. THE RATE OF RETURN GAP IS ITSELF A COORDINATION MECHANISM. FUNDS FLOW FROM A TO B TO PURSUE HIGHER INTEREST RATES AND ARE WITHDRAWN THROUGH A'S ONLY LIQUID COMPONENT (THE VARIABLE INTEREST RATE MODULE)。

THIS WOULD TAKE THE LEAD IN DRAINING THE HIGHEST PORTION OF THE BOOK INCOME, FURTHER REDUCING THE COMBINED RATE OF RETURN IN TREASURY A AND ACCELERATING THE RUN-OFF. WHAT REMAINS IS A FIXED LOAN THAT IS NOT LIQUID, IS BELOW MARKET INTEREST RATES AND IS SUFFERING FROM MATURITY。

TODAY, THE SITUATION IS REVERSED. WHEN INTEREST RATES WENT DOWN, TREASURY A HAD A FIXED POSITION ABOVE MARKET LEVELS, AND DEPOSITORS HELD UP THE MARKET VALUE GAINS BUT COULD NOT RETAIN THEM. TREASURY B DEPOSITORS CAN SMELL THE HIGHER MIXED RATE OF RETURN OF TREASURY A, AND THEY CAN POUR THEIR DEPOSITS IN TO SHARE A PIECE。

The new funds are entered at current share prices and distributed pro rata to the current books. This means that the new money has the same percentage interest as the original depositor for positions above market interest rates. This part of the proceeds is diluted。

Right and left are dead. Interest rate rises: depositors run and the vault runs. Interest rate drops: gains are diluted by newcomers

The fundamental problem is the way bonds are valued. Regardless of the differences in accounting treatments for the amortization of interest-free bonds, the real problem is that changes in external interest rates change the real value of bonds, a fact that is not reflected in the pricing based on amortization。

If bonds are valued at amortized value, then the assimilation will follow. The obvious solution was to create a secondary market, which in theory would allow the treasury to price bonds at real prices。

However, unlicensed zero-interest bonds with arbitrary collateral, duration and parameters cannot form a secondary market, as each bond is unique and lacks a liquidity benchmark that can be measured。

To take a step back, even if a secondary market was actually formed, the price of the treasury was merely a problem that masked a worse problem. Share prices will be subject to external transaction data for customized, liquid and thin bonds. Anyone who is able to influence these data can manipulate the share price and arbitrate when the vault enters and exits。

Zero-interest bonds with full expression are structurally contrary to the treasury that promises immediate liquidity. There may be some sort of solution within the architecture, but I have yet to get a description, and I am curious whether Morpho has a response。

However, I personally believe that the direct issuance of fixed loans is not a solution, at least in the current short-term outlook for over-collateral lending. If the borrower wants a fixed interest rate and the lender wants immediate liquidity, the interest rate risk must be transferred to those willing to take on such a targeted risk exposure。

If the bottom variable interest rate benchmark curve becomes more efficient and robust, the buyer of interest rate risk can provide a higher-quality fixed interest rate. As I amThis articleWhat has been explored is that we are far from touching the final shape of the market design for variable interest rates。