👋Introduction to Coupon Finance
Lending, fixed.
Coupon Finance eliminates term spread in traditional lending protocols by tokenizing interest rates.
Financing perpetual borrowing with demand deposits exposes traditional lending protocols (Aave, Compound, etc) to term spread.
Financing term loans with term deposits peer-to-peer removes term spread but breaks fungibility.
Coupons, by tokenizing interest rates, match term lenders and borrowers in a peer-to-pool fashion.
As a result, lending/deposit spreads are tightened, yielding favorable rates for both depositors and borrowers.
This approach has several benefits over traditional DeFi money markets, such as Aave, that use an interest rate algorithm to manage liquidity risk.
Price discovery for interest rates without sacrificing utilization.
Borrowers need not monitor spikes in APY as rates are fixed.
Removes the need for a withdrawal buffer allowing a 100% utilization rate.
Understanding Term Spread and Cash Drag
Term spread is the difference between long-term and short-term interest rates. Since taking a loan for longer periods is a privilege, lenders charge more for longer-term loans under normal circumstances. This creates a spread where the long-term rates are higher than the short-term rates.
Traditional lending protocols, such as Aave, use demand deposits subject to short-term rates to finance perpetual borrowing subject to long-term rates. These protocols realize this spread in the form of cash drag, which is the underutilization of assets in the lending pool. The interest rate curve opted for by these protocols enables demand deposits by lowering the utilization rate of the lending pool.
Cash drag, or underutilization of the lending pool, creates a lender-borrower spread since the interest paid by borrowers is evenly spread amongst the lending pool. If 100 ETH was in the lending pool, and only 50 ETH was being lent out, the interest paid on 50 ETH will be spread amongst the 100 ETH in the pool, and the cost to borrow would be double the rewards to lend. The 50 ETH not being lent is a drag on the profitability of the pool.
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