Weekly Interest Rate Roundup: Sep 20 - Sep 27

The merge has come and gone, and it's left the crypto community struggling to come up with a new narrative. Where do we go from here? What's next for DeFi rates? On Ethereum L1, probably not much. I think we'll continue to see low levels of stablecoin activity and a gradual deterioration in liquidity that will consolidate the position of leading protocols and squeeze out smaller and undifferentiated players. We've entered the depressive phase of the market cycle - protocols will die off with a whimper now, not a bang.

Protocols are increasingly turning to things like undercollateralized lending to generate yield for their users. For example, Ribbon recently announced a product which will see it funnel user cash to trading firms like Wintermute on an uncollateralized basis. There's clearly a market for this. Borrowers are willing to pay very high rates to borrow uncollateralized, and the collapse of half the crypto CeFi lenders has opened up space for new lenders to take their place.

In some ways I think this makes sense, protocols like Maple and Ribbon replace the BlockFis of the world and change the market structure in good ways. In this model, lenders know exactly who they're lending to and the lender's liquidity profile matches the actual loans that the protocol makes. This means that you don't have middlemen promising depositors free redeemability which they are unable to honor during a bank run.

But I also wonder why you really need a protocol in the middle taking a cut if lenders know who they're lending to and they aren't getting any liquidity benefit by going through an intermediary. Why doesn't Wintermute and Alameda and co just go direct to the end lender? Just deploy a smart contract and say "put your USDC here, and we'll give it back to you a year from now + 7%".

I guess these protocols will go sue Wintermute if they don't pay up at maturity, whereas you would find that difficult to do yourself. But if a protocol's only job is to arbitrate potential legal disputes and to navigate the legal and regulatory system more generally, it doesn't really sound like DeFi to me. But for now, that's where the money is! So until we see growth in on-chain economic activity, we're going to see more of this.

Teddy