If a merchant lends grain at interest, for one gur he shall receive one hundred sila as interest (33 percent); if he lends money at interest, for one shekel of silver he shall receive one-fifth of a shekel as interest.
Code of Hammurabi - Rule 88
Calling fixed-rate lending a “financial primitive” is an understatement - it has been around at least since the Code of Hammurabi (c.a. 1780 b.c.) where grain and currency interest rates were firmly (by firmly we, of course, are referring to capital punishment) fixed at a modest 33% and 20%, respectively.
Since then, fixed-rate lending has remained a fundamental building block of modern finance, affording enterprises and households a modicum of certainty (as to their debt service burden or rate of return) in an otherwise uncertain world. It is no surprise that debt markets remain the largest financial market in the world. In the U.S. alone, total outstanding debt in 2021 stood at $88 trillion vs just $42 trillion for U.S. equities (a large majority of which is fixed-rate debt).
Despite the importance of fixed-rate lending in both ancient and modern finance, its presence in DeFi remains elusive. Why is this?
Participants in the crypto lending market are currently required to make certain trade-offs that give rise to what we call the lending trilemma.
Crypto investors that want to access liquidity are forced to pick between stability, scalability, and transparency.
During the bull market, fixed-rate lending saw success among large centralized institutions. Institutional users turned to large CeFi platforms for fixed-rate liquidity (over $80 billion originated in a single quarter at the peak, Q2 2022). These platforms offered flexibility and the ability to customize terms, but required users to place their assets into a black box and to place their trust in opaque, centralized, third-parties - parties that charge high fees despite incredibly high counterparty risk. Perhaps a year ago, the notion of trusting a third-party in crypto was palatable, this is certainly no longer the case.
Users brave enough to venture into the world of DeFi lending gain transparency but are forced to compromise on efficiency and scalability. Existing platforms that utilize models relying on automated market makers (AMMs) suffer from significant slippage at scale while requiring large amounts of idle capital to operate. The result has been that borrowers are not able to borrow at scale without significant slippage and LPs who support those mechanisms earn subpar returns.
Floating rate DeFi protocols have managed to achieve scale within a trustless model, but are not designed for fixed-rate and fixed-term lending. While floating rate lending serves a distinct purpose in debt markets and is a necessary complement to fixed-rate lending, it is by no means a substitute. DeFi borrowers are subject to an uncertain cost of funding and suffer from volatile swings when large whales pull liquidity and lenders have no control or certainty as to their potential returns.
To achieve mass adoption and realize the vision of a transparent, equitable financial system, crypto needs a trustless, scalable, fixed-rate liquidity provider.
Enter Term Finance.
Developed by a team with deep TradFi, Big Tech and DeFi experience and backed by Electric Capital, Coinbase Ventures, Circle Ventures, Robot Ventures, MEXC Ventures with angel investment from Fernando Martinelli (Balancer), Varun (Hashflow), 0xMaha (Aura) and Shreyas (Llama).
Term is a noncustodial, scalable fixed-rate lending and borrowing protocol. With Term, users can access liquidity on fixed terms (pun intended) without compromising on fees, slippage, custody, or trust.
Like existing DeFi lending protocols, collateral is held on-chain in non-custodial smart contracts where assets can be verified in real-time and are safe from counterparty risk. What differentiates Term Finance from existing DeFi lending protocols is the novel, on-chain auction double-auction mechanism we use to determine the fixed-rates at which borrowers and lenders on the platform transact.
Term auctions are auctions where lenders submit offers to lend and borrowers submit bids to borrow to the protocol. Once the auction is closed, the protocol determines a market clearing rate where all borrowers bidding at or above the clearing rate receive a loan, and all lenders offering at or below the clearing rate make a loan, each at the market clearing rate. All other bids and offers are said to be “left on the table.” Because Term auctions clear at a single market clearing rate, users will not experience wide spreads between earn/borrow rates on the protocol common on existing DeFi lending protocols.
Term uses a tried and true auction mechanism to match borrowers and lenders in a way that leverages the virtues of DeFi without sacrificing on efficiency. The New York Stock Exchange, for example, operated solely as a modified double auction (a “call market”) from its founding in 1792 to 1865 and continues to utilize an electronic call market each morning at the 9:30am open. In government bond markets, auctions remain the preferred method of primary market issuance across the major developed economies.
Its advantages over existing AMM-based fixed-rate liquidity solutions are numerous. AMM models are capital intensive and suffer from excessive slippage that undermine their ability to scale. With the auction mechanism, on the other hand, capital only needs to be locked for the duration of the auction. Any bids or offers that aren’t filled, are immediately returned to users. Moreover, because all transactions are matched at a single market clearing rate, users will not be subject to large spreads between supply and borrower rates.
Fixed-rate lending is a cornerstone of both ancient and modern financial markets and is a necessary component of a mature DeFi ecosystem. Existing options require participants to sacrifice on stability, security or scalability. For the first time, with Term and Term auctions, users will no longer have to sacrifice to participate. Follow us on Twitter as we build toward a better and more mature DeFi ecosystem.