A Protocol, which aims to Make DeFi More Like Traditional Finance in One Key Way

Decentralized finance (DeFi) has taken off in the last couple years and now has more than $190 billion of value locked in it.

Traders active in DeFi typically love to chase high interest rates from protocol to protocol — lending, borrowing, and staking their tokens in so-called liquidity pools on decentralized exchanges to be traded, etc.

The highs that DeFi enthusiasts got from “yield farming,” or earning such high returns, has spawned numerous memes and resulted in cut-throat competitive practices, such as “vampire attacking,” in which a new product will launch by incentivizing the customers of a specific product or project away to the new competitor.

But back in 2019, when Teddy Woodward, a former interest rate swap trader at Barclays, looked at the DeFi markets, he felt something obvious was missing. In traditional financial markets, fixed interest rates are the most common type of interest used in lending and borrowing. But in 2019 in DeFi, the interest rates were all or mostly all variable.

“In traditional financial markets, almost everything is fixed interest rates, because generally, it’s just what you prefer — whether you’re borrowing or lending, you want to know how much money you’re going to make,” says Woodward.

Seeing how big the first borrowing and lending protocol, Compound, was becoming, and realizing that DeFi was going to take off, he decided, to launch a decentralized fixed rate borrowing and lending protocol.

Today, he and his cofounder Jeff Wu’s creation, Notional Finance, has more than $450 million in total value locked in it, filling a niche in DeFi that at the moment is uncrowded. Depending on the amount you would want to lend or borrow as well as the maturity date, the rates currently hover roughly between 7–11%.

“Looking at traditional capital markets outside of DeFi, there’s about 25 times fixed-rate debt as floating-rate debt — treasury debt is fixed, mortgage debt is fixed, high yield bonds are fixed— so companies can plan and understand interest how much they owe,” says Ben Forman, founder and managing partner of ParaFi Capital, which invested in Notional.

At the time, ParaFi vetted about five teams working on the same problem, but found that Woodward and Wu combined finance and technology well, due to Woodward’s background as an interest rates swap trader at Barclays and Wu’s background with Ethereum smart contracts. Forman also says the opportunity is huge, with total fixed income markets at $200 trillion, and 95% of that is fixed-rate products.

“The market for borrowing dollars at fixed rates for longer periods of time than a year is an absolutely enormous market, and no one’s tapped into that yet,” he says.

How Fixed-Rate Lending and Borrowing Works on Notional

On Notional, there are lenders, borrowers, and liquidity providers. There are also the assets that can be lent/borrowed, such as the stablecoins USDC and Dai, as well as crypto assets such as ether (ETH) and wrapped bitcoin (WBTC). For someone who wants to lend, they will put, say, 100 USDC into a liquidity pool with a maturity date of three months in the future and then they’ll receive back 102 fUSDC. When the fUSDC matures, they’ll receive back 102 USDC.

The liquidity provider, meanwhile, receives trading fees every time someone lends or borrows, which is how they are able to pay the interest when, as in the example above, the fUSDC matures.

Why Traders Might Prefer Fixed-Rate Products Over Chasing High-Yield Returns

While many crypto traders and DeFi participants brag or at least talk about the yields they’re getting on various protocols, Woodward says the certainty over the returns appeals to a certain type of trader. Yield farming is “a dangerous game, risky thing. It takes a ton of time to find, evaluate, and monitor your positions, and it’s an uncertain payoff,” he says. “A fixed rate offers you certainty, and it’s not hard. You can just do it, and you know for the next year, you have this percent fixed return.”

He also noted, in a conversation before the crypto markets went south, “If we go into a bear market and prices go down, your yields will go down, but that is not the case on Notional. It’s price-independent, it’s bear market-proof.”

For that reason, the types of investors using Notional tend to be more professional and skew more toward the institutional DeFi players, including some of Notional’s own investors such as ParaFi and Nascent.

What’s Up Next for Notional

There’s a NOTE token, which will be used for governance, as the protocol progressively decentralizes, and as the NOTE holders branch out from the founding team and early VCs.

Also, due to the many hacks and exploits being found in DeFi protocols nowadays, the team will use the protocol’s revenue to incentivize users to provide liquidity with NOTE and ETH on Balancer, and if there’s a hack, they’ll use that revenue to cover any shortfall. Another next step would be to get Notional onto additional chains, as well as onto a layer 2 on top of Ethereum.

Forman says, “Right now Notional is offering three-, six- and 12-month borrowing. Mortgages are 10 years or 30 years, and corporate debt is longer than a year, so I’m looking forward to seeing the longer maturity debt get rolled out. That’s the next step.”

He believes once Notional is mature and has scaled to handle these longer debt periods, “there’s going to be a whole fixed income market that emerges, and I think there will be different types of crypto funds. Most crypto funds today are venture-like funds that research tokens and try to figure out which tokens go up but I think three will be funds that just trade interest rates on chain and will be buying 10-year notional bonds and speculating on which way market interest rates will go. I’m excited when Notional hits, I think it will unlock a whole new type of investor in the crypto market that doesn’t exist today.”