This week on Flywheel, we were lucky to have on Julian Traversa from Swivel Finance, a protocol for trading tokenized cash flows a.k.a. interest rate swaps. This is a fancy way of saying “selling your future yield.” Which swivel is doing has been tried before many times, but never really taken off. However, with the launch of staked Ethereum LSDs like frxETH, there is now a base yield for all of DeFi to play with.
Swivel aims to provide a solution for effective portfolio/risk management and market participation through tokenized cash-flows.
Okay, I know that might sound like a mouthful, so let me break it down for you. Swivel allows lenders to split an interest-generating token into two separate cash-flow tokens. The first is called nTokens, which are yield-generating tokens that represent the future yield generated. The second is zcTokens, which are tokens redeemable at maturity and represent ownership of an underlying token.
What does this mean for you? Well, this yield tokenization allows for fixed-yield lending, yield boosting, and fixed-maturity rehypothecation. In simpler terms, Swivel Protocol enables wider market participation by providing a capital-efficient infrastructure and professional trading interface necessary for trading tokenized cash-flows.
Swivel divides an LSD into two parts, the principle and the yield. Either token can then be sold off. By selling the yield you lock in a fixed rate. Conversely, if you buy the yield you are betting on a floating rate. It’s a classic interest rate swap. What's cool about Ethereum now is that we have a very clear and permanent form of yield that can go into these systems.
What sets swivel apart is that it has built a professional trading exchange for these fixed and floating yields. The interface is robust and allows for limit orders to be placed. Order books are much more efficient than AMMs. The primary benefits are as follows: there is an increased general capital efficiency similar to spot markets, LPs can manage their inventory with respect to underlying rates, time-decay (Theta), sensitivity to rate variance (Delta), and underlying rate volatility (Vega), there are combined Principal Token and Yield Token liquidity pools resulting in over 100% capital efficiency, and finally, there are free limit orders and the ability to cancel orders.
In professional know, there are three options for frxETH, you can lend, sell the principle or the premium. Each market has its own limit orders set by market participants.
It's definitely worth playing around with swivel to see how the trading engine works, and how interest rate swaps could change the face of DeFi.
Not financial or tax advice. This article is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This post is not tax advice. Talk to your accountant. Do your own research.