Reading this only means one thing: you are one of the few left reading amidst the celebrity meme storm ravaging crypto right now.

There’s no trophy for this, but there’s some succor to it all—we can definitely refer to you as an outlier. If you look right into where all this meme mania fits in, it’s right in the outlier narrative. The crux of this is that outliers always stand out!

Like you, we can refer to a couple of decentralized protocols as outliers within the larger DeFi landscape. Despite what seems to be a bull market, the performance of DeFi protocols has been quite underwhelming, with waning mindshare.

One outlier that we’ve consistently come to enjoy reminding you of (check articles one and two) is Term finance.

Term finance, as an on-chain lending protocol, offers a platform for fixed-rate auctions, a system quite different from the plethora of variable-rate lending protocols, with fixed-rate AMMs predominant across DeFi as we know it.

We’ve previously discussed fixed-rate lending and how Term functions in our previous articles, but are we happy to review it again? Yeah! However, let’s give you a quick rundown this time. For the real deal, see the previous articles.

What is on-chain fixed-rate lending

In layman's terms, this is the crypto version of lending, where rates are affixed throughout the loan period.

Unlike variable rates, which are characterized by fluctuations and uncertainty, the borrower and lender in on-chain fixed-rate lending are both aware of the rates from the onset, and the rate is consistent throughout the loan period.

How does Term Finance enable fixed-rate lending on-chain

Term finance is a DeFi lending protocol that enables on-chain collateralized fixed-rate lending and borrowing through an auction process where the interest rate on the loan is determined by the borrowers and lenders that participate in the auction.

Lenders submit supply offers at a specific minimum lending rate, waiting to be matched with borrowers who, in turn, submit bids that specify the amount they are willing to borrow, the maximum rate they are willing to pay, and the collateral amount they are willing to put up to back their loan.

Term’s process requires that bids and offers be sealed at both ends, and at the end of the auction, a clearing rate is determined, with lenders and borrowers matched.

Term, as a decentralized lending protocol, emulates the features of a Tri-party repurchase agreement, in which three parties are involved: the lender, the borrower, and a clearing agent.

However, this time, the middleman or clearing agent role is replaced by an on-chain non-custodial smart contract called Term Repo lockers that lock collateral specific to each loan term.

How’s Term different from everything else?

To truly understand what Term offers, we must juxtapose it vis-a-vis variable-rate lending protocols and fixed-rate notional AMM protocols.

Versus Variable-rate lending protocols

Lending protocols exist on-chain for the sake of facilitating one of the oldest financial primitives known to man — providing an avenue for lenders to lend and borrowers to borrow (yes, it really is this obvious).

Also, the foremost protocols that have pioneered on-chain lending offer variable rates due to the approach to facilitating the service (via lending pools) with open-ended terms.

Protocols like Aave and its forks, Compound, etc, offer passive variable-rate lending products through an algorithm wherein utilization of the (supply and demand) lending pool determines the interest rate.

Flexibility vs. Stability

While the open-ended nature of loans on the variable rate protocols offers significant flexibility, it doesn’t come without significant cost.

One drawback of allowing open-ended loans is that borrowers are subject to an unpredictable and fluctuating cost of borrowing (no one would agree to an indefinite loan at a fixed rate, would they?).

At the same time, lenders cannot rely on their current income stream nor adequately plan their finances due to the uncertain nature of variable interest rates.

By fixing loan terms/maturities, Term Finance offers fixed-rate lending, where borrowers and lenders lock in a fixed rate for a predetermined period of time. This allows for certainty in borrowing and lending, which translates into the luxury of adequate financial planning and predictability.

Due to the extreme volatility often associated with variable interest rates in DeFi, Term’s fixed rate solution offers a hedge and safe harbor against periods of elevated interest rate volatility.

Passive vs. Active

The ability to passively lend is a major benefit of the variable rate (“lazy lending”) model, but again, this comes with significant drawbacks.

All lenders in this model expect to be compensated for the liquidity they supply, regardless of whether their liquidity is being utilized.

Underutilization of available supply leads to periods of extremely inordinate spread between borrowing and lending rates, resulting in underwhelming returns for lenders.

Overutilization of available supply, on the other hand, leads to periods of extreme volatility and exposes users to liquidity risk.

On Term Finance, borrowers and lenders in the auction are matched at a “single price,” eliminating the inordinate spreads between lending and borrowing rates. Borrowers save, and lenders earn more!

Because unmatched funds are promptly returned to users after an auction, utilization is always at full capacity, avoiding the need to dilute active lenders, as is the case in the “lazy lending” model.  

Versus fixed-rate AMMs

Term’s auction model for stabilizing interest rates isn't the only method. Fixed-rate AMMs provide another option.

With these, lenders lock in their capital for a set period at a fixed rate, and borrowers can take out loans from this pool at that same locked-in rate. Notional Finance is a great example of a platform using this approach to offer fixed-rate loans.

While this method achieves the goal of fixed-rate borrowing and lending, there are quite a few downsides to the AMM model. The capital inefficiency of AMM models is well documented (see this article by Chainlink, for example).

Only a small fraction of total value locked (TVL) is available to trade at any rate along the pricing curve. This means that even with millions of TVL in each pool, only a small fraction of this liquidity is available to borrow or lend before slippage causes a borrower’s rate to rise significantly.

Because loans with various maturity dates are not fungible, this model requires the seeding of multiple AMMs, one for each maturity. This leads to significant liquidity fragmentation and further exacerbates the slippage problem.

To avoid this, AMM-based fixed-rate protocols are forced to limit their users' options.

These technical difficulties with AMMs (specifically as it applies to fixed-rate lending) make it difficult to meaningfully scale lending as it constrains the amount and types of loans that can be facilitated at a point in time.

However, the case is different for Term Finance, as it functions through an on-chain auction process that efficiently matches borrowers with lenders without the need for third-party AMM liquidity providers (the middle-man), ensuring a constant flow of liquidity directly from lender to borrower without any worry about slippage.

Moreover, because Term Finance’s method of creating fixed-rate loans is not constrained by the need to minimize AMM liquidity fragmentation, it allows the Protocol to offer as many terms (loan periods) and collateral types as its users desire.

Risk Management

A focus on risk management is a crucial element of the mission to bring predictability and stability to the DeFi lending space.

Leading variable-rate protocols pursue a commingled collateral pool model wherein pools are not isolated.  They put all their eggs in one basket, which increases the risk of systemic failures and pool contagion if any single collateral type is compromised.

All the collateral is held in a single smart contract, making it an attractive honeypot for potential hackers and significantly increasing the risk of a large-scale breach.

And boy! How many times have we seen that happen before, especially with Aave and Compound forks. —both of which have the most researched codebase in DeFi lending. thereby making the forks an easy target for compromise.  

Term Finance diversifies or reduces pool contagion risks by separating pools via collateral and term. Lenders are only ever exposed to the collateral they specifically choose to lend against, and each lending market has its own isolated smart contract to serve as its collateral locker.

Collateral is never rehypothecated (lent out) nor leaves the system unless a loan is repaid or liquidated.

Another area where Term Finance stands out is in its approach to liquidations. Unlike the leading variable-rate lending protocols, Term Finance’s liquidation procedure is designed to be borrower-friendly. It liquidates only the minimum amount necessary to restore the borrower's position to the initial margin or bring it back to health with a reasonable buffer.

This targeted liquidation strategy minimizes the amount of collateral that needs to be sold, reducing the impact on borrowers and helping them maintain more assets. This approach can make Term Finance more attractive to borrowers, as it offers a more precise and less punitive liquidation process compared to the often more aggressive liquidations seen in other protocols.

Final thoughts

With over $80 million in loans cleared, Term continues to demonstrate that on-chain lending can thrive not just through the amount of locked capital but by prioritizing usability and flexibility for end users—both lenders and borrowers.

This approach highlights that an efficient system is more about user experience and active loans than sheer capital volume and (often underutilized) TVL.

Term’s approach to lending also further reflects the need for a stable system in DeFi lending that brings predictability and certainty to the space.

By offering fixed interest rates, Term ensures that lenders and borrowers can find common ground without being affected by bullish or bearish market sentiment fluctuations.

This stability eliminates the nuances and uncertainties typically associated with variable interest rates, providing a more reliable and secure lending environment.