DeFi’s Interest Rate Opportunity

In this episode of [Empire]( [Mike Ippolito]( and [Jason Yanowitz]( are joined by [Simon Jones]( CEO and Co-Founder of [Voltz Protocol]( to discuss DeFi’s interest rate opportunity, TradFi vs. DeFi rates, market-driven protocols and more.


Read our notes below to learn more


**About Voltz Protocol**

* The Voltz Labs team wants to try and help DeFi become the financial system for the whole world and in doing so, completely change the way society works all around the world.
* The solution to the variable rates of return and extreme volatility is the interest rate swap market.
* They deployed the protocol on June 1 this year and the trading volume has been growing 25% week after week.


**Divergence of TradFi and DeFi rates**

* A year ago, DeFi used to be a high yield high cost borrowing and TradFi was the reverse to the point that in Europe, they had negative interest rates.
* Now, it’s completely opposite where DeFi yields and borrowing costs have come down and TradFi in reverse.
* The two different rate regimes are anti-correlated.
* DeFi rates come down before TradFi rates even start moving.
* In DeFi, the rates came down on average 12 days after the inflation data was announced whereas in TradFi, the central banks changed their rates around 100 days after the inflation data announcement.
* Programmatic market-driven protocols are a lot more efficient at converting market data and changes in market data into those markets than centralized entities that are run by human beings.
* He thinks every central bank around the world is criticized for how slow they respond to changes in inflation.
* The utilization of borrowing costs in DeFi is based on supply and demand dynamics.


**How DeFi responded quickly to changes**

* There’s a lot of retail activity in DeFi, as inflation started going up, people had less disposable income and less capital to come into the ecosystem.
* Central Banks collect loads of data and discuss it with their monetary policy committee then make a decision on what base rate should be and that has a way longer time lag from inflation changing vs. decisions being made.


**Leveraging DeFi as source of funding**

* As DeFi yield came down, a lot of DeFi projects have been destroyed as a result.
* The opportunity in DeFi right now is low cost borrowing.
* With the difference in rate regimes, people could borrow at a fixed rate of 2% in DeFi vs. borrowing a fixed rate of 6% in TradFi which gives 3x improvement on borrowing costs through DeFi.

**Importing TradFi yields onchain**

* If there’s a way to access both rates in one exchange, it opens up a huge amount of arbitrage opportunity based on the fact that those rate regimes exhibit anti-correlating behavior.
* There’s opportunity for people to take advantage of the fact that there is an observed lag in the way in which central banks react vs. DeFi reacts.
* There’s an opportunity to start creating more sophisticated and structured products which are long term interest rate cap flows, non-linear derivatives and stuff that doesn’t exist in DeFi yet.
* There’s a lot of white space that exists in DeFi on its own.


**Why institutions will use onchain products**

* The short term opportunity is low cost borrowing.
* One of the most interesting things at the moment is people are using staked $ETH.
* Having access to a diversified set of yield sources for a very sophisticated corporation can start to become pretty interesting.
* DeFi’s fundamentals of the technology and ecosystem are so strong that he thinks it’s going to end up with a stronger set of primitives that really facilitate the smart creation of financial markets.


**Centralized Institutions**

* He thinks by next cycle, a large part of it is going to be institutions.
* We had centralized institutions active as gatekeepers to the whole financial world and the issue with that is those centralized institutions are extremely opaque and have massive capacity for incentive misalignment.
* Regulation lags innovation.
* There’s an opportunity for trading infrastructure to completely displace every form of centralized exchange.


**Importance of Fixed Rates**

* The vast majority of protocols that have been built in DeFi rely on supply and demand dynamics whereas supply and demand changes the rates that are produced out of those protocols.
* The volatility of interest rates in DeFi must be solved in order for the whole ecosystem to be able to serve the financial needs of the world.


**TradFi and DeFi rates eventually changing**

* The closer the two worlds become, they start to inverse and go from being anti-correlated to being correlated.


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