Why DeFi interest rate swaps may be finance’s next frontier

This year, more than one-fifth of American adults have traded or used cryptocurrency, an astronomical increase since 2009, when Bitcoin broke onto the scene. This trend also introduced millions of people to a new iteration of finance, accelerating and popularizing new technologies that are making global financial services more equitable and accessible than ever before. 

Decentralized finance (DeFi) is quickly expanding access to an array of financial services, including interest rate swaps (IRS), a derivative instrument for exchanging fixed and variable interest rates, which account for more than US$1 quadrillion in exchanged value per annum in traditional finance. 

Just as the rise of smartphones and cloud computing changed banking and finance forever, DeFi is the next leap forward in global finance, reimagining a range of financial products for today’s investors. 

This leap means centralized incumbent corporate gatekeepers of financial products and services are being replaced with decentralized, open and permissionless protocols. Interest rate swaps in DeFi serve as the tip of the spear aiming to disrupt TradFi’s dominance of global financial markets.

Interest rates swaps in global finance 

Interest rate swaps are critical to the global financial system, helping governments, businesses and investors exchange a fixed payment for a floating payment, or visa-versa. These swaps are typically connected to a specific interest rate like Sterling Overnight Index Average (SONIA) or Secured Overnight Financing Rate (SOFR). 

An interest rate swap can help companies operating in a global economy take advantage of better interest rates in different countries and help firms guard against interest rate exposure by revisiting or revising their debt conditions to account for shifting economic realities. Interest rate swaps are an essential tool for speculation, risk management and structured investment product generation as well as retail-focused investment products like mortgages and fixed-rate savings accounts. 

The quadrillion dollars in notional value exchanged each year demonstrates the importance of this derivative instrument. However, interest rate swap products have only made limited inroads among DeFi platforms as the technological challenges and fundamental requirements have, to date, limited platforms’ ability to offer this service at scale. 

Bringing interest rate swaps to DeFi

Automated market makers (AMMs) are one of the most foundational aspects of the cryptocurrency ecosystem and DeFi platforms, allowing users to exchange tokens and tokenized assets without locating a counterparty. 

These autonomous protocols powered by smart contracts have allowed decentralized exchanges (DEXs) to thrive, eliminating intermediaries and unlocking new investment methodologies for DeFi users. 

Unfortunately, efforts to leverage AMMs to facilitate interest rate swaps have generally been unsuccessful. This challenge is exacerbated by the fact that most DeFi…