Decentralized Finance, or DeFi for short, is an initiative that seeks to use blockchain technology to build a new financial system. DeFi relies on a network of interconnected, open-source, and non-custodial dApps (or distributed apps) to offer traditional financial instruments and create new ones that were previously unimaginable.
Exactly's goal is to develop a protocol that addresses a critical gap in the ecosystem: the ability to make fixed-rate deposits or loans for a specific period, a concept known as fixed income in traditional finance. This would give users a reliable way to hedge against interest rate volatility.
Some protocols try to achieve this through a peer-to-peer (P2P) model, where borrowers and lenders are matched on a one-to-one basis. While conceptually simple, this approach entails many inefficiencies related to matching both amount and time in each transaction. Other protocols, such as AAVE, offer a stable (but not fixed) rate if market liquidity remains within certain bounds (as measured by the Utilization Rate). While this can provide more predictability, it does not eliminate risk and may only work for some borrowers.
On the other hand, several protocols have emerged that use different approaches to achieve fixed-income functionality. Some use a single token to mimic a "Zero Coupon Bond" (e.g., Yield/Notional). In contrast, others use two tokens (one for the principal and one for the interest) like coupon stripping (e.g., Element/Pendle). These protocols attempt to determine a fixed interest rate based on the price of one or more assets with a specific expiration date, represented by one or two ERC-20 tokens.
Fixed-income protocols have yet to gain significant liquidity, with less than $1 billion in total value locked (TVL) or less than 5% of the TVL in money market protocols. This is partly due to the complexity of these protocols and the difficulties of implementing them on Ethereum and other smart contract platforms. A key metric for these protocols is the total value of loans issued, which currently stands at less than $0.4 billion (2%) compared to the over $18 billion borrowed by money market protocols.
Regarding the token approach for interest rate discovery, when there is a slippage in the price of these types of tokens, the interest rate to be discovered is indirectly affected, resulting in the protocols requiring their AMMs implementation. This poses additional challenges since these unique tokens can't be traded on AMMs like Uniswap. The constant product invariant formula x*y=k is not ideal for Yield Tokens, where time is an additional factor. Utilizing a formula that is a pure function of reserves would cause pools to suffer from unpredictable losses to arbitrage as YT maturity approaches, so all the YT protocols have developed their AMMs that can be utilized for time tokens.
Think of liquidity as water flowing down a hill. Our goal is to remove any obstructions and allow them to flow smoothly and quickly through the "river" of the financial system. To achieve this Exactly uses the first-principle approach to solve the problem of fixed income, considering all the challenges and limitations of bringing traditional finance and decentralized finance (DeFi) to blockchain technology. This is why the Exactly protocol will determine fixed interest rates directly from the supply and demand of credit in each of our fixed rate pools for each asset and maturity term. The interest rate will be a function of the supply and demand of credit in each fixed rate pool of each token based on its expiration date.
The next challenge is even more ambitious: we want to bridge the gap between decentralized finance (DeFi) and the traditional financial system. To do this, we need to offer the general public fixed rates and an excellent user experience. While we can add value to a few hundred thousand DeFi users, the world has a population of 8 billion people, and we are eager to seize this massive opportunity. We want to make fixed-income options and a seamless experience accessible to everyone.