The crypto story over the past decade has been a continuous downshift in risk and reward. We started with thousand-fold returns on speculative assets a decade ago, and have arrived at single digit percent returns today.

At every step, protocols and platforms emerged to give users access to appropriate investment opportunities.

We began with ICO’s in 2017, which were the original DeFi platform. They let investors bet their money on future tokens with the expectation of 100x returns, or more. The huge risk on these investments meant that most of them failed, and doubling your money was considered a bad bet. ICO’s are the purest form of speculation on future value.

Decentralized exchanges emerged years later, and represented a step down in risk and reward. They let users buy tokens on launched products with price history and liquidity. These tokens were unlikely to go to zero, but that also meant they were unlikely to give 100x returns. “Just” doubling your money on a token from Uniswap is considered a win.

As DeFi matured, we have seen another step down in risk and reward. Yield bearing protocols let investors stake their tokens looking for stable returns. Typical rates are in the ballpark of 20% APY or less, a completely different risk and reward profile than what we’ve seen before.

These boring yield investments would make your grandpa proud, and they’re the next frontier of DeFi.

The yield swap opportunity

To get a sense of the yield swap opportunity, let's look at the closest analogs we have in TradFi: equities and corporate bonds.

Equity investments are similar to tokens. They represent a speculation on future value. When a VC invests in Juicero or Uber, they are expecting huge future returns, not a stable series of coupon payments. Even public stock market purchases are made seeking outsized returns.

Meanwhile, corporate bonds are similar to yield. They are purchased from established companies, and going from 5.6% to 6.3% is significant. No one wants bonds from a young startup. The best bonds are from the most reliable names with billion dollar market caps.

TradFi markets show rough parity between equities and corporate bonds. The global markets for each are valued roughly around $40 trillion.

This makes sense from first principles: there is a tradeoff between the two styles of financing, and the free market should reach an equilibrium point at maturity.

Meanwhile, the DeFi analogs of these two markets are far from equilibrium. Token swap protocols are valued over 30x more than yield swap protocols, as measured by token value.

The gap between yield swaps and token swaps represents a $3 billion opportunity, and Delorean.exchange is targeting that opportunity.

Delorean.exchange is a next generation yield swap

The gap between token swaps and existing yield swaps is due to two factors. We’ve talked about the first, which is market timing. But there’s a second factor that’s holding back the existing yield swaps: inefficient or flawed protocol design.

Delorean.exchange is not the first yield swap, but we’re the first ones to get it right. Our protocol takes concepts from TradFi, but we adapt and update them to match the unique requirements of DeFi. Let's look at a few key aspects that separate Delorean.exchange from others in the category.

1) No pre-defined terms

In TradFi, all bond instruments have a predefined expiry and a fixed coupon payment schedule. This is due to the history and limitations of TradFi, which cannot track payments with second-by-second precision like you can on a blockchain. It works in TradFi because they deal in billion dollars of liquidity and trillion dollar companies. The DeFi landscape is different. The market caps and liquidity are comparatively tiny. We have to use blockchain’s strengths, like precision accounting, to balance out its weakness in limited liquidity and market maturity.

This is why having pre-defined terms is a flaw in any DeFi protocol, yield swaps included. Whereas some other yield swaps operate with specific, protocol defined terms, Delorean.exchange does not. We enable each user to determine the term of his yield swap. All these terms are asynchronously issued, but nevertheless draw on the same pool of liquidity.

We expect this distinction to have a large impact. As one datapoint, consider that the volume on crypto perpetuals is 10x higher than the volume of all fixed expiry futures combined.

2) Capped terms

Although Delorean.exchange lets users define the terms of each yield swap, those terms are capped. This means they buy and sell specific slices of yield from a token, not the entire future yield of that token. This is different from some other yield swaps, which create derivatives representing all the future yield of a particular underlying.

We chose this approach for a couple reasons. First, outside select assets like bitcoin, the vast majority of a token’s value is on the yield side. Creating a token that represents all the future yield of that token is simply a duplicate of the token itself. We believe that in the long term, “governance utilities” will have very limited value. This is observable in TradFi markets where no-governance assets like GOOG have price parity with their governance-bearing counterparts.

Second, yield swaps are meant to be a step down in the risk and reward ladder. Assets representing value way off in the future are very risky, and therefore not appropriate for a boring, low risk protocol like a yield swap.

3) Market based pricing

Delorean.exchange does not employ strategies or algorithms to price yield. Instead, we combine price discovery with a fixed discount rate. This results in a market based pricing of future yield.

This is important because the protocol cannot price dozens or hundreds of yield sources from a huge variety of tokens. Just as Uniswap does not use oracles or algorithms for any of its pools, we cannot use fixed algorithms to price yield. Instead, we rely on the wisdom of the market and arbitrageurs to create equilibrium points.

How it works

We’ve talked about the “why” of Delorean.exchange. Now, let's look at a simple example to understand how it works.

Suppose Alice holds 50,000 GLP tokens, a yield generating token, which is paying 20% APY on average. Over the next year this position will pay Alice 10 ETH, a good return, but a year is a long time. Alice wants her money now.

She uses Delorean.exchange to get access to that future yield. She performs a swap which does two steps at once. First, it locks 50,000 GLP into an escrow, promising 10 ETH of future yield in exchange for minting 9 yGLP. You may notice that 10 ETH of future yield only mints 9 yGLP. This is because that 9 yGLP represents the net present value of future yield from the locked GLP.

Second, she goes to Uniswap and exchanges 9 yGLP for 9 ETH. This swap takes place at the market price for the future yield, which in this case was 1:1.

At this point. Alice has 9 ETH, and the liquidity pool has 9 yGLP. We can think of the 9 ETH she received as a loan, and that loan will be paid off by the yield from the underlying GLP tokens.

What happens next?

A buyer, Bob, comes along and pays 9 ETH to buy the 9 yGLP. Then, he takes those 9 yGLP, and swaps them for a slice of yield. This slice entitles him to the yield from the 50,000 GLP that are locked into escrow. If all goes well, he’ll likely get around 10 ETH of yield out of the transaction, giving him a 1 ETH profit.

Now, let’s get into a little more detail on the 1 ETH discrepancy. How is it calculated?

The basic premise is that money today is worth more than money tomorrow, and money tomorrow is worth more than money further in the future. Therefore, when calculating the yield owed to the buyer, a discount rate is applied. The more time passes, the bigger the discount.

Delorean.exchange looks at historical yield rates for the token being locked up and plugs this data into an exponential decay function which gives us a projected APY of the underlying tokens. This projection is combined with a fixed discount rate to give the future yield’s net present value. That net present value number is used to mint yGLP tokens.

The market pricing is on those yGLP tokens. If the projection and discount rate match market preferences, 1 yGLP is worth 1 ETH. But what if the discount rate is too low? Or what if the market thinks GLP’s yield will go down? In that case, the price of yGLP will drop, representing a further discount on the yield.

About Delorean.exchange

Delorean.exchange is a yield swap marketplace which simplifies the process of buying and selling future yield. We are starting on Arbitrum, and plan to be multichain. We will be adding more yield sources to our platform. We aim to become DeFi’s premier yield swap marketplace. Learn more about how Delorean.exchange works on our Gitbook.

To join us on our quest of transforming the DeFi landscape, follow us on Twitter and join the community Discord.