🌳 Hedging against interest rate fluctuations

Scenario: Stabilizing borrowing costs

In DeFi, borrowing and lending are common practices that facilitate leverage and liquidity. However, borrowers face interest rate variability that can impact profitability and payment schedules. Interest Rate Derivatives (IRDs), such as swaps or futures, can help borrowers stabilize their borrowing costs by locking in current interest rates, even in volatile markets. This is particularly useful for crypto businesses that prioritize predictable financial planning over fluctuating gains.

Example:

A decentralized lending platform is concerned about the variability in interest rates for loans issued under variable-rate agreements. To hedge against this risk and offer borrowers more stability, the platform enters into an interest rate swap. In this swap, it agrees to pay a counterparty a fixed interest rate while receiving a floating rate tied to a crypto lending index. By locking in a fixed rate through this swap, the lending platform can offer its borrowers stable interest rates, improving its competitiveness and providing borrowers with predictable payment terms.