Interest rates power global finance. Economic growth and activity, the rate of inflation and asset prices and overall health of the global economy can be measured by their markets. As institutional investors begin to ramp up their adoption of crypto investment vehicles, we’re thrilled to announce our seed investment in Rho Labs, the developer of Rho Protocol, the world’s first cryptonative rates exchange. By bringing the rates market onchain, Rho Labs brings all of the utility and risk management capabilities of interest rate swaps to crypto.
The history of interest rate derivative markets
In their natural state, interest or yield rates are variable or “floating,” making them susceptible to market forces. In the early 1980s, interest rate swaps — where counterparties exchange fixed versus floating payments — enabled the transfer of interest rate risk for the first time. Today, interest rate swaps are crucial financial instruments that play an important role in the global economy by helping businesses, governments, financial institutions, and even individuals (e.g. those with fixed rate mortgages) manage interest rate risk and optimize their debt structures.
The utility of interest rate derivatives cannot be understated. They are one of the most widely used types of derivatives, where two parties exchange (swap) future interest rate payments based on a notional amount. For institutions and individuals looking to lock in their assets or liabilities, executing a fixed versus floating interest rate swap allows them to hedge. Like other derivatives markets, swaps also let market participants speculate on the direction of rates. In this capacity, they are used by institutional investors, traders, or hedge funds to speculate on future movements in interest rates or to exploit arbitrage opportunities. For example, if an investor believes that interest rates will rise, they might enter into a swap where they pay a fixed rate and receive a floating rate, expecting to profit from the increased floating rate. While this speculative use adds risk, it also contributes to liquidity in the swap markets. Together, hedgers and speculators make interest rate swaps some of the most liquid markets in the world, and they are supported by robust electronic trading and clearing infrastructure. It is no surprise that interest rate derivatives are, by far, the largest notional derivatives market with nearly $600 trillion in notional as of June 2024.
While interest rate markets are ubiquitous across traditional finance, these markets remain underdeveloped in the crypto space. However, rates are ubiquitous across the crypto economy, too. Examples include staking yield rates for proof of stake blockchain like Ethereum and Solana, and perpetual swap funding rates. But with few onchain tools to hedge risk, these markets have historically remained within the bounds of traditional finance, depriving crypto market participants of this fundamental risk management tool.
Building an onchain rates market
Rho Labs is constructing a non-custodial, institutional-grade interest rate derivatives market on Arbitrum, fostering secure and transparent onchain trading for crypto-specific rates such as staking and perpetual funding rates. The platform was founded in 2022 by former traditional finance veteran and Chief Product Officer of Copper Alex Ryvkin, who has spent recent years entrenched in building out the institutional infrastructure for web3. With a desire to build this highly attractive market for fixed and floating rates onchain, he has assembled a world class team of technologists and engineers to bring this market to crypto investors.
The protocol delivers the well-trodden utility of interest rates swaps to the cryptonative space, allowing end users to swap fixed for floating rates. Two examples below:
Rho Protocol’s support for fixed rate staking is critical for cryptonative rates markets, as it enables validators to stabilize their revenue streams enabling them to drive sustainable business operations. Traditionally, validators take a percentage of earned rewards for their clients, but volatile variable protocol rewards make it impossible to predict future revenue and thus plan and manage budgets. The utility of fixed staking rates, made possible through fixed versus floating swaps, helps bring this traditional finance-native stability to validators. Recognizing the utility of this product, the market recently witnessed the launch of the first staking rate swaps that were executed over the counter (OTC). This proof of concept is an important step forward for crypto markets, as fixed income markets enter the scene. As this nascent industry matures, electronic markets like Rho Protocol and other infrastructure will be inevitably needed by market participants.
In crypto, perpetual swaps dominate derivatives trading, with cumulative trading since 2020 surpassing $60 trillion. One of the cornerstones of perpetual swaps are funding rates, which ensure that the price of the perpetual contract stays close to the spot (market) price of the underlying asset. Recently, tokenized basis trades allow users to benefit from positive funding rates to drive yield to their end users. However, funding rates are variable and, prior to Rho Protocol’s fixed versus floating funding rate contracts, those seeking to benefit from basis trading had no tools to hedge this volatility and fix their rates. Rho Protocol’s perpetual futures funding rates open up new opportunities for leveraged trading, basis trading, and enhanced yield strategies, and are attractive to institutions including ETF and stablecoin issuers.
Nascent fixed income markets are expected to be an area of exponential growth as regulatory normalization catalyzes institutional adoption of the crypto markets. Bringing the obvious utility of fixed versus floating swaps to crypto markets unlock new opportunities for risk management, structured products and even speculation. Deep, liquid crypto rates markets, facilitated by Rho Protocol, will further close the gap between traditional and crypto markets.
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