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Huobi: DeFi fixed-rate products need improvement

The DeFi industry’s existing fixed-rate products are a critical component of the derivatives market. However, their shortcomings in the form of high interest rates, stiff competition and reduced overall attractiveness for investors are obvious, and each of these points is still relevant today.

In order for DeFi’s fixed-rate products to remain attractive to investors, they need to be modernized. Modernization lies in the integration of different lending protocols that offer higher interest rates, according to analysts, Huobi Research Institute.

In a new report, “DeFi fixed-rate protocols: a bailout in a bear market?” in conjunction with Huobi Tech and EmergentX, the experts note that fixed-rate products are vital for the industry, especially during a bear market – they are what allow investors to hedge risk. However, unfavorable conditions for investors arise during periods of market fluctuation, when it is almost a foregone conclusion that one side will take advantage and the other will suffer losses. The report notes that in designing a typical DeFi product, there is an intractable problem with three variables: the balance between risk, interest rate and stability.

The report also discusses the three most commonly used fixed-rate protocols in the DeFi market: the discount (conditional) bond, principal and interest split, and tiered income.

A contingent bond is an example of a discount bond that is based on a simple supply and demand curve, where the interest is fixed at the time of borrowing, and this protocol has significant drawbacks. According to the report, among the main disadvantages: low interest rates due to insufficient turnover of funds and inflexible maturities of only three and six months, which may not be enough for both lenders and borrowers.

In the principal and interest split model, the principal token (PT) is put up for sale at a reduced price, while the yield token (YT) serves to increase yield while remaining under the liquidation line. Analysts note that pricing is a significant drawback of this protocol because of the problems associated with market forecasting.

Often used in the traditional financial market, the tiered income model divides funds into different tiers with different levels of risk appetite. In essence, it shifts additional risk from investors who prefer stable returns to those who are willing to bear increased risk.

The report notes that the contingent bond, despite its shortcomings, stands out among TVL lending protocols (the aggregate amount of funds locked into a smart contract). However, Terra’s collapse and the prospect of an impending bear market have not contributed to the popularity of these protocols. The report attributes this to three reasons: systemic risks caused by significant fluctuations in the cryptocurrency market; liquidity risks faced by credit-type fixed-rate products; and that investors will need more time to determine their investment strategies, given the variety of fixed-rate product structures available.

“Fixed-rate products face stiff competition from professional investors and large financial institutions,” said Hugo Howe, an analyst at the Huobi Research Institute and co-author of the report.

“Low interest rates remain a headache for fixed-rate DeFi and hinder further growth in the industry.”

“The only way to raise the interest rate is through fair pricing, redistributing profits among participants and increasing profits from underlying assets,” said Yeyang Wei, an analyst at the Huobi Research Institute and co-author of the report.

“We hope that innovative fixed-rate products will soon emerge.”

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