What Is The IPOR Protocol?Sponsored
IPOR incorporates TradFi primitives into DeFi to bootstrap institutional adoption and offer attractive retail yield opportunities
By: Jeremy Nation •DeFi Explainers
In the scale of large financial markets, the credit marketplace represented a $133 trillion global marketplace in 2022. Larger still is the interest rate swaps marketplace, which increased a total of 11.2% to $414.2 trillion in 2022 and accounted for 82.4% of total interest rate derivative (IRD) markets at mid-year.
A Risk Management Marketplace
With so much riding on swap marketplaces, risk management remains a critical issue. The recent collapse of the once major financial institution, Silicon Valley Bank (SVB), is a stark reminder that improper risk management around rate-based instruments can have disastrous results.
In the case of SVB, which had previously purchased a number of 10-year bonds when interest rates remained near zero, a perfect storm began to brew after The Federal Reserve hiked interest rates in April 2022. The rate changes caused SVB’s long-term bonds to fall in value in favor of the higher yields of newly issued bonds.
Bond market action caused a deficit between SVB’s short-term deposits and long-term reserves, leaving the bank strapped for cash when customers moved to withdraw funds. The bank’s long-maturity bond holdings were not properly hedged to account for this risk, and it sustained catastrophic losses after being forced to sell them.
Another reminder of the necessity of risk management occurred when the unforeseen shock of a bond selloff during last year’s fourth quarter threatened UK pensioners. The event forced the Bank of England to step in and design a rescue package; an unlimited bond repurchasing order.
Compared to other markets, the derivatives marketplace accounts for one of the largest on a global scale.
A Growing DeFi Lending Market
It’s clear that if banks don’t hedge interest rate risk properly, they could be exposed to massive losses. The same is true for DeFi lenders and borrowers. Borrowing assets in DeFi can be very risky, with rates frequently jumping into two-digit territory. For example, the AAVE borrow rate went up over 30% in February 2023, jumping two more times during the same month.
While just a sliver of the total value locked in traditional finance (TradFi) markets, DeFi lending accounts for a total of $14.25 billion spread across 248 protocols. As risk in this sector from rate variability increases, the ability to manage that risk is a growing concern.
Just as many TradFi participants mitigate the threat of rate variability by turning to interest rate swaps, it stands to reason that DeFi marketplace participants might also see the same benefits by leveraging similar tools.
The Tools Of Traditional Markets
The interest rate market encompasses a toolbox full of financial instruments, including bonds, interest rate swaps, floating rate notes, futures, collateralized debt obligations, and treasury bills. These instruments can feature varying maturities and, in some cases, fixed interest rates.
Among those financial instruments are interest rate derivatives (IRDs) which derive value from benchmark interest rates. Parties use IRDs to manage cash flow agreements based on rate movement. Properly leveraged IRDs allow market participants to hedge against rate fluctuations, and optimize risk-return profiles on yield curves.
When fixed rates are expected to remain stable, IRDs may be utilized to hedge against potential changes in floating rates or to capture the potential gains from an anticipated yield curve scenario.
Lenders with fixed-rate loans can turn to IRDs when rates are anticipated to decrease, and enter a swap to accept floating-rate payments in exchange for paying fixed-rate payments, mitigating the risk of earning low interest. If rates are anticipated to rise, lenders can decrease exposure to long-term fixed-rate securities or hedge against potential losses with interest rate futures.
Within the interest rate market, the benchmarks that guide IRDs vary from region to region, following the financial system’s nearly complete transition away from the London Interbank Offered Rate (LIBOR) after global regulators instituted systemic reforms.
IPOR: DeFi Risk Management
Short for Inter Protocol Over-block Rate, IPOR built a tech stack designed to act as the credit hub for DeFi with a number of tools, including completely transparent DeFi interest rate indices to act as an industry benchmark.
For the DeFi sector to properly utilize tools such as rate swaps for hedging, arbitrage, or speculation, IPOR’s indices act as a necessary reference point for interest rates to which instruments may correspond.
A lack of transparency and the abuse of banks through false or misleading rate submissions to favor market positions or fabricate their economic condition led regulators to do away with LIBOR, now slated for deprecation this June 30.
IPOR’s public blockchain architecture addresses LIBOR’s lack of transparency, allowing it to deliver core functionality for decentralized applications on the Ethereum layer.
In addition to the indices, IPOR also offers decentralized interest rate swaps, and will soon launch a plethora of retail-friendly products that strip away financial complexity to offer fixed-rate lending and borrowing with a click.
IPOR’s Tech Stack
The IPOR Protocol is made up of many DeFi public goods, particularly the Index. Any DeFi user or protocol can receive a transparent interest rate benchmark to map the current cost of credit or incorporate IPOR’s swaps to speculate, arbitrage, or hedge their borrowing rate or yield.
IPOR’s unique smart contracts offer DeFi participants valuable tools currently leveraged in the TradFi sector.
- The IPOR Indices - these indices cover a number of highly liquid stablecoins in the DeFi space, such as USDC, USDT, and DAI. They are public goods that inform on the current state of DeFi markets and serve as the foundation of an entire derivatives ecosystem.
- The IPOR AMM - the automated market maker is a unique request-for-quote pricing engine developed by veteran quants at IPOR Labs. The technology enables DeFi traders to open long or short interest rate swap positions, based on quantitative modeling of the historical volatility of the relevant IPOR Index.
- Asset Management - standard self-executing smart contracts that secure user ownership, transfers, returns distribution, and tracking.
IPOR Governance and Tokenomics
As detailed in the project’s Conceptual Whitepaper, IPOR is on a progressive track towards decentralization. Protocol builder IPOR Labs, a software firm based in Switzerland, will manage the platform during its initial stages.
Community growth is seeing IPOR rapidly transition into the hands of stakeholders who constitute members of the IPOR DAO, and those who hold the protocol’s similarly named native IPOR token, an ERC-20 token on the Ethereum blockchain, fully minted and capped at a total of 100,000,000 IPOR.
IPOR tokens are allocated as follows:
- 30% DAO Treasury
- 25% Liquidity Mining
- 13.15% DAO Operations
- 20% Development Team
- 11.85% Investors
The IPOR DAO currently comprises 17 IPOR Lab personnel, 15 IPORIANS who contribute to protocol development for compensation, and eight additional DAO collaborators. The coming weeks will see Snapshot voting implemented, which is expected to be the final piece of the governance architecture.
Power IPOR Tokens
Users who stake IPOR tokens receive Power IPOR (pwIPOR), the IPOR DAO’s governance token. These tokens may be used to boost liquidity mining yields across protocol liquidity pools. As the project remains on track towards a higher level of decentralization with community growth, pwIPOR token holders will make final determinations on major changes to protocol parameters.
IPOR is currently traded across decentralized and centralized exchanges.
IPOR’s Present Capabilities
IPOR currently features three stablecoin assets available for swaps, USDC, USDT, and DAI, all of which can be accessed once a web3 wallet is connected to the IPOR DApp. A potential fourth asset, staked ETH, remains in the exploration phase.
Corresponding to each of the stablecoins is an IPOR index. For example, USDC is at 3.1%.
With the emphasis on risk management surrounding interest swaps, each index allows DeFi users to create counterparty positions where IPOR’s liquidity pools act as either sending or receiving cash flow.
The IPOR AMM offers price quotes for an interest rate swap contract where payers and receivers deposit collateral, as well as contract and network fees. The above example shows the asset owner providing Judy with a floating-rate loan. Judy can hedge her interest rate risk using a swap, agreeing to make fixed payments in exchange for receiving floating-rate payments, which she passes on to the lessor.
In another example, as explained in this video, the user would pay the derivative for the entire contract’s duration, earning money if the interest rate goes above the fixed rate. At the end of the contract, the AMM calculates both down and up moves to deliver the net returns over the interest rate swap’s maximum duration of 28 days.
DeFi users may also engage in liquidity mining via classic yield farming, by providing liquidity. The protocol currently offers yields of over 15%, including liquidity mining incentives, on major stablecoins without impermanent loss.
As of June 2023, stablecoin yields are among the highest in the DeFi space.
Mining yields may also be significantly improved using pwIPOR tokens to boost returns on IPOR pools, such as USDT, USDC, and DAI, as shown above.
IPOR’s Future Improvements
Ahead of IPOR’s v2 launch slated to be released around EthCC6 in Paris, protocol developers are putting the final touches on new features, including:
- Extended interest rate swap maturities to over 3 months.
- Removal of optionality - close swaps by offsetting position.
- Revamped risk management engine for improved LP protection.
- Interest rate derivatives integration into retail-friendly products.
IPOR v2 will deploy a range of new features, from leveraged borrowing and fixed-rate markets, deposit strategies, as well as new yield-generating opportunities, including interest rate strategy vaults or TradFi/DeFi yield arbitrage vaults.
Catch the IPOR v2 reveal at EthCC6, Paris. The conference will take place between July 17–20, and be covered on IPOR’s official Twitter account.
Apply to join the exclusive reDEFIne: The Future of France side event co-hosted by IPOR Labs, LI.FI, and Swaap Finance and mingle with some of the teams pioneering DeFi adoption from credit markets infrastructure to improved DEX AMM design to powering cross-chain asset swaps.
Note: This explainer was sponsored by IPOR
This series article is intended for general guidance and information purposes only for beginners participating in cryptocurrencies and DeFi. The contents of this article are not to be construed as legal, business, investment, or tax advice. You should consult with your advisors for all legal, business, investment, and tax implications and advice. The Defiant is not responsible for any lost funds. Please use your best judgment and practice due diligence before interacting with smart contracts.