Onboarding to any new DeFi primitive poses challenges. On-chain auctions, market clearing rate, Term Repos, Repo Tokens…?! Term Finance can be difficult to understand at first. So today, we’re going to take a step back, and explain Term Finance in simple terms (no pun intended…).
We’re going to walk through Term Finance; Explained like I’m 5.
Term Finance enables fixed-rate, fixed-term lending and borrowing backed by digital assets.
What sets Term apart is how these loans are created. Rather than using AMMs like Compound or Aave, Term loans are created through weekly on-chain auctions.
Term Auctions are the way in which Term Loans are created. The protocol holds weekly auctions that are typically open for 1-2 days. Lenders and borrowers participate in live auctions:
When an auction closes, a clearing interest rate is determined. Loans are assigned to borrowers willing to pay above the clearing interest rate and lenders willing to lend below the clearing interest rate. Successful lenders and borrowers transact at the clearing interest rate and not at the rates they submitted in auction. Be truthful when placing bids and offers! Those assigned in auction typically do better and in no case comes out worse than what they specified in auction!
While the notion of selling loans via auctions is new to DeFi, it’s a proven CeFi mechanism. In fact, the US government has been selling treasuries through auctions for nearly a century and all other G7 countries issue debt in the first instance through regular auctions. It’s a tried and tested way to create scalable loans offering with no spread, no slippage and low fees.
Each auction sets out:
The Term Repo Token is a receipt token that enables lenders to redeem principal plus interest after the loan matures. Repo Tokens are normalized 1:1 for principal plus interest. These are ERC-20 tokens that are fully transferable and composable with other protocols.
The clearing rate is calculated by a smart contract. It finds the interest rate that maximizes the total amount matched in auction. Once a clearing rate is determined, bidders are assigned with preference given to those most willing to pay (high to low) and to lenders most willing to lend (low to high).
No. One or multiple lenders can be matched to one or multiple borrowers in a Term Auction. Term smart contracts service the loans, including monitoring individual borrowing positions.
No. Rather than a continuous order book model where parties are matched in real-time on a continuous basis, Term conducts weekly auctions to match borrowers and lenders at set times on a periodic basis. Borrowers and Lenders can submit their tenders 24-48 hours before an auction closes.
If borrowers and lenders get the same exact rate, how does Term make any money?
Term charges a one-time 0.5% annualized servicing fee upfront that is charged to the borrower and deducted from loan proceeds. Lenders do not pay any fees. Because the servicing fee is annualized, only a borrower borrowing for a year pays the full 0.5%; someone borrowing for 4 weeks pays 0.039%.
Term is starting with 4-week to 12-week auctions and will expand to longer terms depending on market response. The goal is build a liquid DeFi interest rate curve up to one year and potentially beyond.
No. Lenders cannot call their loans prior to maturity. While borrowers may repay early, early repay does not relieve them of their liability to pay interest on the full term. One benefit of noncallable loans is it prevents situations where asset-liability mismatches (as seen on CeFi lending platform, like Genesis) lead to “bank run” situations. However, because Repo Tokens (see above) are transferable, markets for those tokens may develop for lenders seeking liquidity. If a borrower obtains Repo Tokens from a specific Term Auction, the borrower can lock the tokens to reduce their outstanding debt under that specific auction.
Borrowers have a repayment window (typically 24hrs) to repay their debt at maturity. If borrowers do not repay within this window, their collateral will be liquidated to pay off their debt.
Borrowers are required to ensure that the value of their collateral remains above the maintenance margin requirement (typically 125% of debt). The market value is determined using live data obtained from Chainlink price feeds. Like the major floating rate protocols, when collateral value falls below that threshold, borrower collateral will be eligible for liquidation and subject to a liquidation incentive penalty (typically 8%). With Term, we place dynamic limits on the amount of collateral that can be liquidated to protect borrowers that adjust to return your collateral requirement back to the initial margin requirement.
Yes. Term uses Chainlink price oracles.
Term Finance’s mission is to be an institutional-grade, secure lending protocol. Lenders can earn stable yields while preserving capital and borrowers can secure funding at predictable costs without liquidating their high-quality assets. With this in mind, Term plans to focus on assets with deep on-chain liquidity, in particular blue chips (ETH, wBTC), high-quality liquid staking tokens (wsETH), and stablecoins (USDC, USDT). The assets in parentheses are those that will be supported initially.
Term has been audited by Sigma Prime, Runtime, and Dedaub. Full audit reports are available on GitBook.
Term has run a successful testnet since March 2023, and has been live to the public on Mainnet since August 2023.
This is an introduction geared towards beginners interested in Term. Please check out our documentation located here to learn more, as well as for important legal information.