Abstract

Strips Finance is the world's first decentralized interest rate derivatives trading platform. Interest rate swaps (IRS) allow participants to swap variable interest rates for fixed interest rates. The IRS market is one of the most important pillars of finance. There are currently no great options to trade interest rates in decentralized finance, and Strips aims to solve this problem by building the first natively decentralized interest rate derivatives exchange on Ethereum. Strips will grow to be the premier marketplace for fixed income.

Interest rates touch every single aspect of finance. Strips finance aims to introduce interest rates trading for decentralized finance.

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Background

Market Potential

Interest rate swaps are the largest traded OTC derivatives in traditional finance. A 2020 report by JP Morgan estimates the daily volume of OTC interest rate derivatives reached a staggering $6.5trn per day (yes, Trillion). Much of the volume of interest rates derivatives has been attributed to hedging and speculators. Interest rates derivatives have consistently maintained an 80% share of the global OTC financial derivatives market, with a notional outstanding of $435.2trn as of 2018 (JPM). By comparison, FX derivatives only account for 17% of notional outstanding.

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We believe that as the DeFi market continues to grow, and attract more capital, there is an unmet demand for interest rate markets. By providing a venue to trade interest rates, we can help yield farmers, speculators, and institutional arbitrageurs to easily hedge their risk and lock in alpha.

Tradfi vs DeFi

The evolution of TradFi vs Defi

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Strips is the final missing piece of decentralised finance.

Types of Interest Rate Swaps

Fixed-to-Floating

The most common IRS contract is the fixed-to-floating model. In a fixed-to-floating contract, one party agrees to pay a fixed interest over an agreed upon term (i.e. 1.25% over 30 days) in return, they will receive a reference floating interest rate (i.e. yUSD vault yield over 30 days). In such a scenario, there is only an exchange of cash flows between the buyer and seller of the contract, and no necessary interaction with the underlying yUSD vault. Hence, it is possible ********to have a much bigger IRS market than the TVL in yUSD vault.

The Problem

The biggest unacknowledged risk in decentralised finance is the fluctuating interest rates that lenders and borrowers pay and receive. In addition, many yield farmers are familiar with project yields that collapse after gaining popularity. This is a far-reaching problem, and no satisfying solution currently exists.

Farmers can receive high APR in early farms, but yield is diluted as capital enters the yield farm. (NPV can be modelled using a poisson arrival process) $FixedRate = E\left(\sum_i^T{\frac{APR_i}{365}\times t_i}\right)$

A common problem which traders face is the volatile borrowing rates of USD. In a bull market, USD is very expensive to borrow and trade on leverage, or to capture arbitrage opportunities. As a trader, you are left with no choice but to pay whatever rate the exchange charges. During bull markets, the interest rate to borrow USD can jump from 20% to 100% overnight! However, that is precisely the time when you need dollars the most.

Likewise, if you are a USD lender at 80%, and are worried the interest rate may drop in the future, there is no easy way to lock in your interest yield for long periods of time without taking a haircut.

In addition, basis trading is one of the most common trading strategies utilized in the crypto market, yielding 20-50% returns a year. However, basis trading is simply a multi-step execution of an interest rate swap.

Furthermore, interest rate swaps allow speculators to take a view on the fluctuating interest rates in decentralized finance.

Real world example

Alice wants to enter a yield farm on Nerve.fi that is currently yielding a variable 115% APY. However, Alice is worried that the rate will drop in the future, and she would instead like to lock in 100% yield for 1 year. Alice enters strips.finance and sells the equivalent USD amount in NRV-3Pool perpetual interest rate swaps. After 1 year, regardless of where the yield on NRV-3Pool is, Alice will receive 100% in total yield, combined from her yield farming rewards and profits from her interest rate swap position.

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Perpetual Interest Rate Swap

A perpetual interest rate swap allows users to trade any type of DeFi yield.

Funding rate

The funding rate is based on the reference pool/vault yield. For example, the funding rate for the NRV-3Pool market would be the Nerve.fi 3Pool reference yield. For simplicity, we have assumed daily settlement of pnl and funding. However, funding rates will be calculated per block in actual implementation.

Example: Lock in your yield

Alice enters the Nerve.fi 3Pool yield farm, currently yielding a variable rate of 115%. To lock in 100% return for a year, Alice goes on Strips Finance and sells the equivalent USD notional amount of perpetual interest rate swaps. After 10 days, Alice has received 2.68% of yield farming rewards. Alice has received positive funding of 0.05%. In total Alice has received 2.74% (100% annualised) in 10 days.

After 365 days, regardless of where the APY of the yield farm is, Alice will still get 100% in fixed yield.