Who Uses IPOR and for What?
IPOR as a transparent public good
First, the IPOR rates are meant to be a public good. The rate data may be freely viewed on the ipor.io website, the index rates are published on-chain via an oracle construction, and different data providers and services report the IPOR rates so the general public can have a transparent view of the benchmark interest rates in DeFi.
The on-chain components are meant for other protocols to build upon. If a third party protocol developer would like to reference the on-chain index rates, they are free to do so in their smart contracts. One thing to note is that the on-chain publication of the indices are subsidized by the IPOR DAO as well as derivative contract takers. In case a protocol should want to subsidize publishing of the IPOR rates as well to provide more granular rates on chain (published more frequently) this is a welcome prospect! Please contact the development teams using the links indicated on ipor.io and see Public Request to Publish IPOR.
Hedging Interest Rates (Fixing Your Rates) IPOR is a composite of the interest rates from multiple credit markets. Therefore if you want to hedge your loans and cover basis risk you would need to distribute your loans between multiple markets to closely follow the IPOR. Or alternatively use products that use IPOR as an interest rate. You may also hedge the position on a single market however the index may move differently than the rates on a single market. Example: Let’s say you’re taking USDC loan using floating / adjustable rate. If the rate goes up, you will have to pay more interest on your loan. You will need a product that will earn you interest if the rate will go up. Hence you want to be “long“ interest rates or in other words you want to “pay fixed and receive floating“. This way if the interest rate goes up - you will pay more in interest on your loan, but this will be offset by the earnings on interest rate swap. Should the interest rates go down, your swap will lose but those losses will be offset by the lower interest on your loan. This way your interest rate is fixed and you don't need to worry about it changing. If you want to hedge a deposit then you reverse this structure: go “short“ interest rates or in other words “receive fixed and pay floating“. This behavior might be typical for a lender who does not want to lose potential income in case the rate of return drops.
NB: This will be tied to the term of the swap, and the initial IRS will be a maximum of 28 days.
The IPOR treats each stablecoin as a different currency given their highly divergent rate behaviors. As the rate behaviors vary, there are often times when rates between stables may offer an opportunity to arbitrage between rates.
Let us take an example. If one were to assume that they could redeem any two stables for the same value this would represent an opportunity to capture the different rates between divergent stablecoins.
Stablecoin A currently has an IPOR rate of 2.5% and Stablecoin B an IPOR rate of 5.5%. The borrow and lend rates between markets may vary but let's simplify the example using the IPOR rates only.
Step 1: A trader could borrow Stablecoin A and take a "pay fixed" contract to lock in the borrowing cost.
Step 2: Trader exchanges Stablecoin A for Stablecoin B.
Step 3: Trader lends Stablecoin B and locks in the lending rate with a "receive fixed" contract.
Through the use of interest rate derivatives the trader is able to capture a risk free arbitrage between two stablecoins.
Speculators are able to also long or short interest rates. With IPOR Interest Rate Derivatives this will be possible with leverage.
Leverage on IPOR is not the same leverage you can find when trading equities. Although it shares a similar function of giving you exposure to a larger capital position than you could be exposed to if you were not leveraged, it is not exactly the same.
IPOR leverage could be better described as collateralization. You simply put down a collateral deposit that will be used to settle your derivative at maturity. In traditional financial markets, when 2 parties enter an Interest Rate Swap they agree between each other on the “Notional“ amount. Because they are bound by the contract and they are both non-anonymous entities they can allow themselves to forego putting any money in custody (they trust each other and are bound by a legal contract). In crypto, to allow a trust-less transactions it is important to collect some form of collateral as a guarantee of payment at the smart contract level. The ratio between collateral and notional amount is what we call on our smart contracts “collateralizationFactor“ also known as leverage. In the v1 IRS the IPOR protocol limits your possible losses and profits to the amount equal to your deposit, this would be the only reason to use lower leverage than the maximum. If you’re not expecting high volatility in interest rates, it is rational to use maximum leverage for cash efficiency reasons.