In the world of traditional finance, market participants can exchange future interest payments among themselves. This is often done to hedge against losses, manage credit risk, or speculate that interest rates will rise or fall based on future market conditions. These swaps may appear as fixed-to-floating, floating-to-fixed or floating-to-floating swaps, each of which is a type of derivative contract. When a swap occurs, the parties do not take ownership of the counterparty’s debt. Instead, under the derivative contract, the interest rates are swapped while the value of the loan (notional principal) remains with the original party.
In what is known as a “vanilla swap”, one party receives the risk protection of a fixed interest rate while the other party is given the opportunity to benefit from a declining variable interest rate. For example, a smaller institution may want to trade its riskier variable rates with a larger institution that is willing to accept the risk of interest rate fluctuations. In return, the smaller institution would purchase a fixed rate, allowing for better financial planning. The size of the OTC derivatives market is colossal – according to the latest data from the Bank for International Settlements, the notional value of interest rate derivative contracts recently reached $488 trillion.
Unfortunately, the interest rate swap market has not changed much since the 1980s. Since then, it has been plagued by high bank fees and high settlement costs, often as a result of monopoly institutions taking greater control of the market. For this reason, decentralized finance (DeFi) is viewed as a clear solution to eliminate the middleman with a comprehensive and scalable solution, including the Ethereum-based Tempus protocol.
Solving DeFi Swaps
Tempus, built on the Ethereum (ETH) network, is a decentralized secondary market for returns that allows users to set or speculate on their income. A core part of the protocol is the TempusAMM smart contract, a custom AMM that allows users to deposit their high yield tokens (YBTs) into a pool with a specified maturity date and either earn at a fixed rate or speculate on the future profit. Once the YBTs are deposited, Tempus splits them into principal tokens and yield tokens. Users can then exchange these tokens for each other using the TempusAMM. In this way, Tempus allows parties to access a trusted version of traditional interest rate swaps.
David Garai, co-founder of Tempus shares: “The AMM serves as an indicator of the market implied return of our pools and is the counterparty to every trade. The source of the fixed return in our protocol is users exchanging all of their returns for principal through the AMM and repaying those principal amounts for the underlying asset at maturity.”
In practice, these swaps are based on the Balancer v2 stable pools. Swap fees are also paid to liquidity providers, who are rewarded in two ways: via swap fees and income from providing liquidity.
Each pool is governed by different rules and has a different lifetime, all based on the underlying protocol. Tempus also offers a simplified, easy-to-access interface, so users face minimal obstacles in managing their yields.
More insights into Tempus here
Additionally, the platform has addressed concerns about fragmented liquidity in yield farms, where stablecoins and other backing tokens are required to create automated market makers (AMMs). Generally, half of these pools must be in a backing token, while the other half is the yield farming asset. As a result, liquidity providers only earn half the liquidity they could otherwise earn. Tempus counters this by, for example, converting ETH to stETH with Lido. From there, liquidity is shaped in exchange for capital and returns. Principal tokens offer a fixed interest rate, while yield tokens are floating. Users can then switch between these two tokens at will, depending on their risk profile.
future earnings for the masses
As Tempus is an Ethereum-based protocol, the team is preparing for the upcoming launch of Ethereum 2.0.
“We have seen strong institutional demand for trustworthy ETH 2.0 fixed income staking, which will be our main focus over the next few months. Risk-averse investors want more certainty about future staking returns,” shares Garai.
Tempus was launched on December 15, 2021 on the Ethereum mainnet and currently has two Lido stETH pools. The platform will also launch its second integration with Rari Capital on January 17th with support for USDC and DAI and plans to release more integrations in the coming months.
As for Tempus’ longevity, the protocol recently raised $1.9 million in a seed round and $4 million in a strategic funding round. The company also recently raised $28 million via a token launch auction on Copper.
In the longer term, Tempus aims to eventually expand its offering to other blockchain networks outside of Ethereum and is considering opportunities at both tier one and tier two.
Disclaimer. Cointelegraph does not endorse any content or products on this site. While we aim to provide you with all the important information we are able to obtain, readers should do their own research before taking any action regarding the company and take full responsibility for their decisions, and this article can nor should it be considered investment advice.
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