Author: nico pei
Compiled by: AididiaoJ, Foresight News
Original title: Fixed-Rate Lending, the Key to DeFi's Success in Scaling
The demand for fixed rates primarily comes from institutional borrowers and looping strategy users. While on-chain credit is expected to expand in the future, at this stage, most on-chain participants highly value the flexibility of "being able to withdraw funds at any time." Therefore, instead of forcing lenders to accept "term locking," a better approach is to build an interest rate swap layer on top of existing money markets (like Aave) to meet the demand for fixed-rate lending.
Inspiration from Traditional Finance: The Fixed-Rate Market Begins with Borrower Demand
In the private debt market, fixed rates are the mainstream not because lenders prefer them, but because borrowers need certainty.
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Borrower Perspective (corporations, private equity funds, real estate developers, etc.): Their primary concern is cash flow predictability. Fixed rates hedge against the risk of rising benchmark rates, simplify budgeting, and reduce refinancing risk. This is especially critical for highly leveraged or long-term projects, where interest rate fluctuations could directly threaten their survival.
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Lender Perspective: They generally prefer floating rates. Loan pricing is typically structured as "benchmark rate + credit risk premium." A floating structure protects profit margins when rates rise, reduces "duration risk," and allows for additional gains if benchmark rates increase. Lenders only offer fixed rates if they can hedge the interest rate risk or charge a sufficient premium.
Thus, fixed-rate products are created in response to borrower demand, not as the market's default form. A key takeaway for DeFi is: without clear and sustained borrower demand for "interest rate certainty," fixed-rate lending will struggle to gain liquidity, scale, or develop sustainably.
Who Are the Borrowers on Aave / Morpho & Euler? Why Do They Borrow?
A common misconception is: "Traders borrow from money markets to add leverage or open short positions."
In reality, directional leverage operations are almost entirely conducted through perpetual contracts due to higher capital efficiency. Money markets require over-collateralization, making them unsuitable for speculative leverage.
Yet, Aave alone has approximately $8 billion in stablecoin loans outstanding. Who are these borrowers?
They can be broadly categorized into two types:
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Long-term Holders / Whales / Project Treasuries: They collateralize their crypto assets (e.g., ETH) to borrow stablecoins for liquidity, while avoiding selling the assets (thus retaining upside potential and avoiding taxable events).
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Yield Loopers: They borrow to recursively add leverage to yield-bearing assets (e.g., Liquid Staking Tokens LST/LRT like stETH; or yield-bearing stablecoins like sUSDe). The goal is to achieve a higher net yield, not to speculate on price movements.
So, Is There Actually a Need for Fixed Rates On-Chain?
Yes. The demand mainly comes from two types of users: institutional-grade crypto-collateralized loans and looping strategies.
1. Institutional-Grade Crypto-Collateralized Loans Need Fixed Rates
Take Maple Finance as an example. It lends stablecoins to institutions through over-collateralized loans, with collateral primarily being blue-chip crypto assets like BTC and ETH. Borrowers include high-net-worth individuals, family offices, hedge funds, etc., who seek fixed-rate funding with predictable costs.
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Interest Rate Comparison: The cost to borrow USDC on Aave is around 3.5% APR, while the fixed-rate loan liquidation yield for similar collateral on Maple ranges from 5.3% to 8%. This means borrowers pay a premium of approximately 180-450 basis points to switch from floating to fixed rates.
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Market Size: Maple's Syrup pool alone manages about $2.67 billion, comparable to Aave's ~$3.75 billion in outstanding loans on Ethereum mainnet.
(Aave's ~3.5% vs. Maple's ~8%, paying a ~180-400 basis point premium for fixed-rate crypto loans.)
It's worth noting that some borrowers choose Maple to avoid (early DeFi's) smart contract risk. However, as protocols like Aave have proven their security, transparency, and liquidation mechanisms through testing, this risk perception is diminishing. If reliable fixed-rate options emerge on-chain, the premium for off-chain fixed-rate loans will likely compress.
2. Looping Strategies Need Fixed Rates
Despite generating billions in borrowing demand, looping strategies are often unprofitable due to volatile borrowing rates.
A stablecoin looping/borrowing user stated: "As a looper/borrower, the unpredictability of borrowing rates means rate fluctuations can suddenly wipe out months of accumulated yield, causing positions to become unprofitable."
Historical data also shows that borrowing rates on Aave and Morpho are extremely volatile, with annualized volatility exceeding 20%.
For loopers, they earn fixed income (e.g., via Pendle's PTs) but use floating-rate borrowing to maintain the loop, introducing "interest rate risk." A spike in borrowing rates can devour all profits. If both the borrowing rate and investment yield were fixed, the funding risk would be eliminated. The strategy becomes easier to evaluate, positions can be held with peace of mind, and capital can be deployed more efficiently.
As on-chain infrastructure (like Pendle's PTs) has been security-tested for over five years, demand for on-chain fixed-rate loans is growing rapidly.
Given the demand, why hasn't the market scaled? Look at the supply-side issues.
Flexibility is the 'Priceless Treasure' of On-Chain Participants
Here, flexibility refers to the ability to adjust or exit positions at any time, without lock-up periods—lenders can withdraw anytime, borrowers can repay and redeem collateral anytime, without penalties.
In contrast, holders of Pendle PTs sacrifice some flexibility. Even in the largest pools, Pendle's mechanism cannot allow instantaneous exit of positions exceeding ~$1 million without significant slippage.
So, how much compensation do on-chain lenders get for giving up flexibility? Taking Pendle PTs as an example, compensation is often as high as 10%+ APR, and even over 30%+ during YT points trading frenzies (e.g., usdai on Arbitrum).
Clearly, genuine borrowers (non-speculators) cannot afford a 10% fixed-rate cost. This high rate is essentially a "premium" paid for sacrificing flexibility, unsustainable without speculation on YT points.
Although PTs are riskier than base lending protocols like Aave (adding protocol and underlying asset risk), the core conclusion remains: any fixed-rate market requiring lenders to sacrifice flexibility cannot scale if borrowers cannot afford super-high rates.
Term Finance and TermMax are examples: few lenders are willing to give up flexibility for meager interest, and borrowers absolutely refuse to pay 10% to lock in rates when Aave's rate is 4%.
The Way Out: Don't Match Fixed-Rate Borrowers Directly with Fixed-Rate Lenders
Match fixed-rate borrowers with interest rate traders. Specifically:
Step 1: Protect the Lender Experience
The vast majority of on-chain capital only trusts the security of Aave, Morpho, Euler and enjoys the simple, passive experience of "depositing and earning" on Aave. They are not "sophisticated managers" who would meticulously evaluate every new protocol for a 50-100 basis point premium.
Therefore, for a fixed-rate market to scale, the lender experience must be exactly the same as using Aave now:
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Deposit anytime
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Withdraw anytime
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Almost no additional trust assumptions
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No lock-up periods
Ideally, fixed-rate protocols should be built directly on top of trusted money markets like Aave, leveraging their security and liquidity.
Step 2: Trade the 'Spread,' Not the 'Principal'
Borrowers seeking fixed rates don't need another full loan with a locked term. What they really need is capital willing to take on the spread risk between the "agreed fixed rate" and the "Aave floating rate"; the principal can still be borrowed from places like Aave.
In other words, traders are trading the expected difference between fixed and floating rates, not the entire loan principal.
An interest rate swap layer can achieve this:
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Hedgers can exchange fixed payments for floating income perfectly matched to Aave's floating rate.
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Macro traders can express views on interest rate trends with extremely high capital efficiency.
Capital Efficiency Example: A trader only posts a small amount of margin to take on the interest rate risk exposure, far less than the loan's notional principal. For example, to short the Aave borrowing rate for $10 million over 1-month term, assuming a fixed rate of 4% APR, a trader might only need to put up about $33,300 in margin—this implies ~300x capital efficiency.
Considering Aave rates often fluctuate between 3.5% and 6.5%, this implied leverage allows traders to treat the interest rate itself as a highly volatile "token" to trade (from $3.5 to $6.5), with amplitude far exceeding major cryptocurrencies, strongly correlated with overall market liquidity and prices, while avoiding the liquidation risks of explicit leverage (e.g., 40x on BTC).
Go long on rates to profit from "peaks," go short to profit from "troughs."
Long-Term Outlook: Fixed Rates are Essential for On-Chain Credit Expansion
I foresee that as on-chain credit grows, demand for fixed-rate loans will also expand. Borrowers will increasingly need predictable funding costs to support larger, longer-term positions and productive capital allocation.
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Institutional Credit Expansion: Projects like Cap Protocol are pushing on-chain institutional credit. They help restaking protocols insure institutional-grade stablecoin loans. Currently, rates are determined by utilization curves suited for short-term liquidity, but institutional borrowers value rate certainty. In the future, a dedicated interest rate swap layer will be crucial for supporting "term pricing" and risk transfer.
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On-Chain Consumer Credit: Projects like 3Jane focus on on-chain consumer credit. This field is almost entirely fixed-rate loans because consumers need certainty.
In the future, borrowers might enter different segmented rate markets based on credit grade or collateral asset type. Unlike traditional finance, on-chain rate markets could allow borrower groups to directly face market-driven rates, rather than being locked into rates set by a single lender.
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