Audio and transcript from the January 28th, 2022 installment of “Conversations with the Coop” with Teddy Woodward, the co-founder of Notional Finance.
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Crypto Texan: Hello everyone, welcome to Conversations with the Co-op. This is where we source questions from the Index Co-op community to gain insights from today's leaders in crypto and DeFi. I'm your host Crypto Texan, and on this week's episode we have Teddy Woodward from Notional Finance with us here today. Thanks for being here with us today Teddy, how's everything going?
Teddy: Everything is going great. Thanks for having me.
Crypto Texan: Yeah, absolutely excited to have you on. So we usually just like to start off with your background, and how did you get into crypto and decentralized finance?
Teddy: Yes, sure. So I started my career as an interest rate swap trader at Barclays Investment Bank. So I started my career in very traditional finance. I worked in London, in Canary Wharf, if anybody's familiar with that. I worked there for about four years before leaving, I think early 2018 so basically right around the peak of the last cycle, I left that job because, you know, to be honest, I didn't really like working for a bank. I liked trading and doing all that stuff, but I didn't really like working for a bank, so I left that job to trade crypto for a family office in LA in 2018 and then stuck around there for about 18 months.
And while I was doing that, I think DeFi was basically just starting. So, you know, I don't think Compound was even live yet at that time. And I was really interested in DeFi right away. Like right from the beginning, I thought it was, you know, it seemed to me that it was the actual realization of what crypto can do, because at the time, I was trading on centralized exchanges like Binance and BitMEX and all that stuff. And you know, basically as far as I could tell, it was the same as what we do in traditional finance, it was just a lot worse.
It was effectively exactly the same, except the exchanges, like technology was just way worse. The market was a lot less efficient, and the exchanges just were super risky from just a counterparty perspective, like the Bitfinex kind of situation and obviously Quadriga and all that stuff. So it seemed to me that like, okay what I was doing was crypto, but not really, I felt, and it seemed to me that DeFi was how crypto is actually going to change finance.
And so I was interested in DeFi from very early on, but at that time, the space was so small that there was no way that I felt I could get involved on a professional basis just because it was too small. And then kind of towards the end of 2019, Compound was really starting to show some success, which was cool because I think at that time it was basically Compound and Maker were basically like the only two things in all of crypto that showed any success at all. And it seemed to me that it proved that DeFi could do something. And I wanted to stay in crypto and I always wanted to start a company, and the success of Compound felt to me like it was the real start of an interest rate market, and I thought it was really cool.
And basically, I thought, you know, the next logical step for the space was going to be the ability to lend and borrow at fixed rates of interest. So it just seemed to me like DeFi is going to be a big thing. This is a big opportunity in DeFi, and it's completely non-existent at that time, and so, basically I left my job and moved to San Francisco, where I met my co-founder at a hackathon, and then we started Notional together full-time in January 2020. Yes, and that's how it started.
Crypto Texan: Yeah and you bring up a lot of good points there. I remember back in the 2017 ICO craze, you know, I was aping into a bunch of ICOs that I didn't do any research on back then, but that's when I first got into the space. And yeah, you had to go to Binance to find these tokens, if they were available and if they just happened to be listed on Binance. And then it was like, you got to send your ether to Binance and then do the trade, you might not even be able to withdraw those new tokens to your wallet. And yeah, that's not really decentralized finance.
I mean, you can basically back then, it was like you could send bitcoin to another address, that's decentralized, you can send ether to another address, that's decentralized. And then, yeah, once Uniswap came around and it's like, oh, I can just do this swap on chain using a smart contract and not have to worry about having Binance custody my assets, which like you said, is a huge counterparty risk, which is one of the main things that we're trying to get away from in DeFi, is that counterparty risk. And saying all this, reiterating this because I think we want to touch on this a little bit more when we talk a little bit more about Notional.
But yeah, so you met your co-founder and y'all decided that you're going to start a fixed rate borrowing and lending protocol platform. I guess, where did you see a need for that in the market? And I guess what kind of inspired the founding of this protocol?
Teddy: Yeah, that's a good question, so I would say that, you know what inspired the founding was just kind of like... So actually, both Jeff and I both had the same idea. So I think about it from my perspective, as you know, I had the idea, but also actually, incidentally, so did Jeff. When we met each other, we met at a hackathon and we both came with the same idea, which is pretty cool. But I think, you know, when I say, when you talk about was there a need, I think it was at that time it was very much like a gut level decision that, like it was a big bet on DeFi and just a bet that fixed rates were going to be important because I think if you're honest, at that time DeFi was like max $200 million in assets, you know, max like through all of DeFi. So it's like, was there really a need for anything? Based on that amount of traction, it's not clear.
So, you know, I think every– if you're doing something in DeFi at that time, you were really taking a risk that anybody was going to care about DeFi at all beyond this very, very small group of people that did. So yes, I mean, I just felt that, coming from my background I just felt it was inevitable because, you know, in general, like when you look at lending markets, whether it's in centralized crypto markets or it's in traditional finance, you're almost always getting fixed rates of interest.
And that's just generally because in the absence of technological constraints, people choose fixed rates because they just generally prefer fixed rates, because they want to know exactly how much interest they're going to earn or exactly how much they'll have to pay. Like if you just say, you know, if you have both options available to you in general, what you see is that people generally prefer fixed rates. And so I felt that if there was going to be a DeFi space at all, there was going to be a need for this. So yes, that's kind of how I thought about it.
Crypto Texan: Yeah, that makes sense, and yeah, I think another reason that people do want fixed rates, it's just like from a forecasting and budgeting standpoint, right? Like if I'm going to borrow to purchase a house, I'm going to want that to be a fixed rate because that little movement in that interest rate, in a variable rate on a mortgage can affect your loan payment, sometimes hundreds of dollars, which could affect your budgeting. And I think a lot of companies and retail individuals like that aspect, but I think, and there's other interest rate types of protocols that are popping up or fixed interest types of features that we're seeing in DeFi. So I guess my next question is, you know, how does Notional work and how does Notional differentiate itself from some of the other fixed rate actors that are out there?
Teddy: Yeah, that's a good question. So I'll give you a quick technical overview here. So the core concept in Notional is what we call fcash, and fcash is a lot like a zero coupon bond in that it is defined by a currency type and a maturity date. So for example, March 1st, 2022, USDC. That is an fcash token, and it is redeemable for one USDC, on its maturity date, March 1st, 2022. So you can think about that as representing USDC at a specific point in the future. And the way we enable fixed rate lending and borrowing is by allowing you to trade between USDC today and USDC in the future. And you think as a lender, what you're doing is you are selling your USDC today and you're buying a fixed amount of USDC in the future. And the exchange rate at which you trade between USDC today and USDC on March 1st implies a fixed interest rate over that period of time.
So just to give you an example, if you're a lender, you want to lend 100 USDC, let's say you come to Notional, you sell your 100 USDC and you get back 101 March USDC in return. So what that means is that you know on March 1st, you're going to have 101 USDC. So you will have made 1 USDC in interest over two months, so that's a six percent annual return. Does that make sense?
Crypto Texan: Yeah, that does make sense, okay and so basically, if I take my 100 USDC and I lend it on the Notional platform, I then receive a 101 March 1st, 2022 USDC, which at that point I can claim on that date for 101 USDC, or I could trade that on the open market. And is there a secondary market already for this fcash?
Teddy: Yeah, yeah. So first of all, that's absolutely right. You did a good job of explaining that. So what I would say is that Notional operates liquidity pools where there's one liquidity pool for each maturity. So we'll have a liquidity pool that's kind of like a Uniswap pool where we have USDC on one side and March 1st USDC on the other side. So actually, when you're lending, what you're doing is you're putting your USDC into this liquidity pool and you're taking out March USDC in return. And then any time prior to maturity, you can go do the opposite. You can take your March first USDC and go put it back into that pool and get some USDC back in return. Yeah so that's kind of like, you know, a mental model of how it actually works.
Crypto Texan: Yeah, that definitely makes sense. And so why the name fcash? Is there any significance behind the "f" before the cash?
Teddy: Yeah, so actually, we started out by calling it future cash. We started calling it future cash, and then our lawyers advised us to not call it future cash because they felt that the word future was just too much. Like, I don't know, it was risky because they thought maybe it might look like a future or something, so we changed it to fcash.
Crypto Texan: Okay yeah, that makes sense. And so who are your target users? Are you looking for retail users to utilize this protocol? Are you looking for DAOs or more crypto native institutions, like who are y'all targeting here?
Teddy: Yeah that's a good question, so I would say that it depends. On Ethereum L1, we are not looking for retail users to use Notional directly because of its high fees. So if you want to use Notional with a relatively small dollar amount, right now because Notional currently only exists on Ethereum, it doesn't really make financial sense for you to do that. Now having said that, we are pursuing an L2 strategy where we're going to have instances of Notional on different L2s and I think that pain point will be eased significantly. So I would say that the users kind of depend on what chain we're talking about.
I think that on Ethereum L1, a lot of the users are basically, so basically right now it's very high dollar amounts on average. So I think the last time I checked, the average dollar amount per active account on Notional was something like, you know, a million dollars, maybe maybe $800k. So it's a pretty large dollar amount. And I think a lot of these people are, it's pretty whale heavy, so we have funds and just people with a lot of crypto. And I think that we are, so we launched Notional V2 in November and after going through the initial work that was related to the launch, we really tried to focus on protocol partnerships because I think that is, in my opinion, it's the future of being a DeFi protocol on Ethereum L1.
I think that ultimately what you're going to see is that the users on Ethereum L1 are going to be high dollar value accounts, so like big funds for one, it's going to be DAOs for two, although I think that to date that is more promising than reality. And then number three, it's going to be protocol partnerships, right? So something like what we're building with Index, right, with this fixed product where the idea is that there's one big product that interacts with Notional directly, and then, you know, the end users enter that product in a much cheaper and more passive fashion. And all the complexity, all the management is pushed on to the protocol.
And I think we're seeing that, you know, Index is one example of that. Another example of that is our upcoming integration with Yearn. So Yearn is going to be lending on Notional in their USDC and DAI vaults, and we're really excited to get that going. But it's just another example of the protocol being the main interaction with Notional on Ethereum L1 and then the users interacting with this partner protocol. Does that make sense?
Crypto Texan: Yeah, that definitely does. It sounds like you've got a lot of irons in the fire, too, which is exciting from a business development standpoint as well. I want to touch on something you said related to your average wallet size, or the average user is utilizing about 800,000 or million dollars and if that's your average, I mean, it definitely feels like more of a whale or institutional related protocol. But do you feel that way? And I guess the other question I have is what is your TVL right now with those types of averages?
Teddy: Yeah sure man, so I think, you know I haven't looked at that average figure lately, and it might not be correct, but the last time somebody brought this up and threw out that number and it feels directionally correct. And right now we have something on the order of $350 million in TVL and I think we have something like 600 or 650 active users. So I guess that works out to, you know, maybe half a million dollars. So it's gone down a little bit, but it's still quite large. As for an average capital per user. I think, and you know to be honest with you, I think it makes sense, just from the fact that like Ethereum gas fees are so large and in the context of a lending protocol, you really need to be using large dollar amounts or it just doesn't make sense.
I think it's slightly different if you're talking about a trading protocol. Let's say you want to buy $10,000 worth of ether, a $100 or $200 fee to do that isn't that much, right? Because you know, you're probably buying your ether and you're expecting to make 3x or something on it, right? But if you're talking about, you want to lend your $10000 for six months at a 9% interest rate, your total expected profit is like $450 right? So that gas fee is a huge pain. And so as a lending protocol, I think that the necessary dollar amount for it to make sense on Ethereum L1 is really quite high.
Crypto Texan: Yeah, I understand that, and another thing you touched on was you felt like DAOs getting involved with Notional is probably more of a promise than a reality. And I think we've felt that as well from the Index Co-op. You know, I think we're starting to develop more products that are maybe DAO treasury oriented, like this fixed product that we'll get into in this partnership with Notional. But also there's PAY that we're working on, which is like a DeFi aggregated stablecoin yield product, and we're hoping that that might attract more DAO treasuries. But why do you feel like it's been more promise than execution, like why do you feel like DAOs would rather hold their native token in their treasury, which seems crazy to me.
Teddy: Yeah, you know, that's a good question. I think just the number one thing here is that people sometimes get-- alright so I think lately there have been people that are talking a lot about this, but I think a lot of people still don't know that most DAOs hold almost all of their assets in their native token. So I think that the number of DAOs that hold stablecoins is really quite small. And even the DAOs that do hold stablecoins, the amount of stablecoins they hold is also very small relative to their total assets. So I think like, you know, the reality is that there just actually isn't very much stablecoin capital in DAOS, so there's not a lot of stuff to actually manage. That's the reality here.
And there won't be, I guess, until these DAOs decide to raise money. And I think like, as for why people haven't done that or that these DAOs haven't done that, it's hard for me to speculate. I could imagine that maybe their token holders don't want them to raise money because if they raise money, then they're selling a bunch of tokens. I could, you know, I would say that after having our token live now for three months and experiencing what a lot of people in DeFi are like from a governance standpoint, I could see that very easily being the reason why DAOs have decided not to diversify. I can see there being a lot of grassroots backlash from the idea of dumping a whole bunch of supply on the market. You know, maybe that's it, I don't know.
Crypto Texan: Yeah I think you're right, at the Index Co-op we did diversify our treasury. We've got, I think, a few, well this happened like, I think three and then six months back, but we ended up getting about $8 million in USDC. So we've got that in our treasury. And we feel pretty safe and secure having that in there, and I feel like we're pretty lucky that we were able to implement at least some sort of treasury diversification strategy just to assist in this bear market, at least. And maybe that's part of it. Maybe it's because I mean, DAOs are, when it comes to it the majority of DAOs have only come to fruition, like in the past few months or a year during the bull market, right.
And so maybe I don't know, everyone's just so used to token number going up in treasury, getting bigger because of that. And I think now maybe that we've experienced these highs and lows in the bear markets that maybe we'll start to see future implementation of more strategic DAO treasury management in the future. Or at least, I hope so. And that's kind of what the Index Co-op and I think y'all are betting on a little bit too. But another thing, let's talk about the governance of the Notional Finance protocol. How is it governed? I know that you have a token. How involved is the community? Are you governed through token governance? How does all of that work?
Teddy: Yeah so first of all, you know, well done on the diversification and as you're saying, you guys are one of the few. So, you know, well done. And I think you are probably right, you know, there's a lot of bias. Like everybody sees the number going up, nobody wants to sell because everybody thinks it's going to infinity. But I think you're right, that as we go forward and as like, these DAOs need cash to continue operating, we'll probably see more treasury diversification, I think it'll probably just take time, as you might expect.
So then Notional governance. So Notional has a governance token, a native token, the NOTE and right now, we're in the process of decentralizing. So again, we launched Notional V2 along with our NOTE token a little under three months ago. So we're kind of in the process of decentralizing right now. Notional is owned by a multi-sig at the moment, so it is not actually owned by the governance contract on chain, although we are in the process of moving to that. And you know, we want to involve the community as much as we can. And so far that's been via votes on Snapshot that we execute. So that's been kind of how we've done it so far.
Another thing with the NOTE token, we're actually pretty soon here going to be implementing a staking module and that is based off the feedback of the community the first couple of months since launch. And what that's going to do is it's going to give us both additional insurance for users on the platform. So kind of like Aave's safety module, if you're familiar with that. People are going to be able to stake their NOTE, provide insurance to the users on the protocol. So in the event of any hack, their funds will be used to recapitalize the protocol, but in return they will get an explicit share of the Notional protocol revenue, so Notional protocol is to use the revenue that it generates or use, you know, a portion of the revenue that it generates to buy back NOTEs and give that NOTE directly to those who have staked NOTE. So it's basically a way for token holders to directly experience the upside of the protocol success while also strengthening the protocol by providing insurance to users on the platform. Yeah so we're hoping to push that, have that live running next month.
Crypto Texan: Okay that's really interesting, and did you say Aave does this as well?
Teddy: Yeah that's right, so Aave, it's called the safety module, and it's pretty similar in design to us. The way it works is like you take your Aave and you can stake it into the safety module and you stake it as like an 80/20 Balancer LP liquidity. So it's also actually providing liquidity at the same time. And basically the safety module is like a first line, or maybe it's the last line of defense, but it is some line of defense against a hacking or an insolvency. So, you know, I think Aave has some sort of protocol reserves just like Notional. And the idea is that, you know, in the event of a hack or in the event of a protocol insolvency, Notional is going to use its own reserves to make sure that lenders are whole. But in the event that our reserves aren't good enough, the people that stake in this module provide an extra layer of backstopping to users who have put their capital on the platform.
Crypto Texan: And is there a timeframe for the lockup period for the NOTE token in that safety module?
Teddy: Yeah so you can redeem whenever you want, but you'll be subject to a cool down period of, we haven't finalized it, I think it's going to be 14 days.
Crypto Texan: Okay yeah, that's really interesting, yeah. It's always, you know, everyone wants staking, everyone who wants to use their token to generate additional yield. And that's something that the Index Co-op kind of prides itself on is that, you know, we have a lot of un-incentivized TVL. And I think that can say a lot about your protocol as well. And it's hard and we're working with the tokenomics of the Index token as well. It's difficult to create an incentive structure that aligns both holders, users, contributors, all the stakeholders of the protocol, DAO, organization however you want to call it.
So yeah, that's really interesting. I kind of like that model that y'all are looking at there. So let's talk about the treasury a little bit more. What revenue drivers do y'all have to the treasury? Do y'all charge a fee against, you know, people who are borrowing at a fixed rate? Or how does, or do you take a little bit of interest on top? How are y'all generating revenue for the protocol?
Teddy: Yeah so first of all, to your comment about the staking module and tokenomics more generally, I totally understand what you're talking about. I think it's very hard to design a tokenomics plan that really works well. And a lot of the reason I think it's difficult is that oftentimes the people that are the loudest are, you know, I don't want to say they're the ones you should listen to the least. But like, if you're just listening to the people in the community, you might not be hearing all sides, you know?
And so I think it's something we really wanted to stress. We wanted to make sure that when you're staking your NOTE, you're providing value. You know, it's not just a way of earning more NOTE. We really wanted to make sure that it was providing more value to the system as a whole. We really wanted to make that true. Yeah so that was just one thing.
And then as for Notional protocol revenue, basically we generate revenue in two ways. So the first is a straight up transaction fee on any time someone borrows or lends. We take a small fee on any of those transactions, so that's one revenue stream. The other revenue stream comes from Notional's integration with Compound. So basically right now, it was a big upgrade in Notional V2, we are integrated with Compound so that basically liquidity providers on Notional put in C tokens instead of the underlying token. So that enables them to earn compound interest at the same time as they're earning liquidity fees on Notional. So it really increases their returns, which is really important for Notional. And an effect of that is that Notional earns a lot of comp incentives because essentially right now, our entire TVL is sitting on Compound. So Notional the protocol is earning a lot of comp incentives because of that, we are actually, if you look at Compound, Notional is the single largest lender on Compound, which is kind of an interesting statistic, but it's true.
Crypto Texan: Yeah, that is interesting. And have y'all looked at maybe diversifying the protocols you'll use for the composability? I mean, have you looked at Aave as well, in almost like an aggregator sort of way, look to see where, I don't know, which interest rate benefits the borrower and the user best?
Teddy: Yeah yeah we have I mean, we started out with Compound because what we wanted to prioritize more than anything was security. And we felt at the time we designed Notional V2, that Compound was the gold standard in terms of protocol security. We felt confident that they weren't going to list the collateral assets that we would think is too risky, and we just like, you know, Compound doesn't change a lot, which in some ways makes it really good to build on because you can just be very confident that it's going to be stable. So that's why we selected Compound.
Now, having said that, we are currently in the process of upgrading the system to allow, or to support Aave as well. So we're going to be able to integrate with Aave in the same way that we integrate with Compound, and that's going to be really important because it's going to allow us to go to L2. So because one of the things about Compound is that it is only on Ethereum L1, so it's not on Polygon, it's not on Arbitrum, it's not anywhere else. So integrating with Aave is going to allow us to be on L2, which is really important. And then going forward, we might also at some point look at integrating Yearn in a similar way, although we have not decided whether or not we're going to do that. But we're considering it.
Crypto Texan: Yeah that's always puzzled me a little bit about Compound, is to just why it's only on mainnet, and I guess they do have the Compound Treasury, which is for institutions, and maybe that's becoming more of a focus for them now. And then just comparing that to Aave, Aave is almost on, you know, they're on Avalanche and Polygon, and they're I think they're working on Arbitrum or Optimism as well, don't quote me on that. I don't know, it's just interesting to see those two different sides. And obviously, Compound has less assets listed from an interest rate market standpoint on their protocol. Okay, something I'm trying to get my head around here. Well, I don't know, did you have something you wanted to say right there?
Teddy: Oh yeah I just want to like, I think it's actually just kind of interesting. So we started designing Notional V2 like a long time ago because everything in crypto, it's like the time between when you start designing it and when it's launched in production is so long, because it takes a long time to figure out the design and then build it and then test it and then audit it like just the whole process takes so long. So when we started designing it, Compound was firmly in the lead, and then by the time we launched and kind of to your point, like Compound hasn't been very aggressive in growing beyond Ethereum or enlisting other assets. And you know, I think we really, you've really seen Aave just grabbing market share and and it's like we were, it was too late for us to change until now. So I don't know, it's just kind of an interesting thing.
Crypto Texan: Yeah, it really is. But like you said, you know, Compound rarely changes, it doesn't have a lot of assets, which also makes it less risky and it's still well-respected from a security standpoint. But yeah like you said, that's what you want. If you're building your protocol to call functions on the Compound protocol, that's kind of what you're looking for though, right? So it makes perfect sense. But yeah, anyway, we'll move on.
So something I'm trying to get my head around is that when the users, when the people who are borrowing right, the borrowers on the Notional protocol, they're borrowing at a fixed rate and that fixed rate is going to have a maturity date or that loan is going to have a maturity date. Does it automatically pay back, or what happens if a borrower doesn't pay back their debt by the maturity date?
Teddy: Yeah, that's a good question, so what happens is that the borrower can, so once they hit maturity, the debt is going to start accruing interest at a variable rate. So if you haven't paid back by maturity, your debt will start accruing interest at a variable rate, which is actually equal to the Compound supply rate.
Now what can also happen after maturity is that you can be rolled forward okay, so this is a little bit of a tricky concept. So what's going to happen is, you know, let's say you've taken out a loan and it's due on March 25th. Okay so March 25th rolls around, you owe $100 to the protocol on March 25th, but you haven't paid it back. And then on March 25th, you still owe $100. What can happen now is once you're past maturity, you can become eligible for settlement. So what that means is that a third party can forcibly extend your loan to the next maturity. So essentially, a third party can force you to extend your loan to June, right.
So now your debt has been rolled forward to the next maturity at a small penalty to the market rate for that maturity. So if after your debt has matured, let's say the June interest rate is 7%, somebody can roll you forward and your loan will be extended at a 2.5% penalty to that rate. So you will be paying 9.5% until June. So basically, if you don't do anything, you can get rolled forward, and that's fine. But there's like a little penalty that, it's an incentive for the person to roll you forward and kind of a deterrent so that, you know, to try and get you to roll forward yourself.
Crypto Texan: Okay yeah, and that's something that's always kind of difficult for me, at least to wrap my head around is actually having maturity dates where, you know, the user actually has to go in, pay back the loan themselves. I mean, what happens if someone just never pays back the loan that they borrowed?
Teddy: Eventually, you'll get liquidated.
Crypto Texan: Ah that's right, because there's collateral, right, this isn't unsecured. Of course.
Teddy: Yeah, so basically, you just keep on accruing interest. It's the same as like, it's the same as Compound, right? It's like if you put in $200 dollars of Ethereum and you borrow $100, eventually you're going to keep paying interest on that hundred dollars. And then eventually, the amount you owe is going to be more than the minimum collateralization and you can be liquidated.
Crypto Texan: Are these partial liquidations or is it just a full liquidation of the collateral?
Teddy: So it's going to be a partial liquidation, the way it works in Notional is that if you are eligible for liquidation, a liquidator can purchase 40% of your collateral and they can purchase more if you're super underwater. But the default amount of your collateral that they can purchase is 40%.
Crypto Texan: Okay, and is there a second rate for or is there like a secondary market for, I guess, debt that has extended past the maturity? Well, I guess it all is owed back to the protocol. But you did mention a third party could execute the extension, so who would these third parties be in that case?
Teddy: Yeah so the third party, basically the way the settlement action works is it's kind of like a liquidation. So the way it works is that, you know, again so it's March, you haven't paid your debt. The next liquidity pool now matures in June. Okay, so there's an active liquidity pool for June. So what the settler can do is the settler can lend to you at a penalty rate to the market rate on that liquidity pool. So basically, what happens and sorry if this is too complicated, but the settler will give you cash and then it's going to take positive fcash from you. And then it's going to lend to you at like 9.5% and then it will execute an arbitrage trade against the June maturity.
So the way it works in practice is that the settler, you know, flash loans, so borrows a bunch of USDC, lends to you and then immediately goes and sells that fcash on the June maturity and pockets are spread. So that 250 basis point penalty is the incentive for the settler to do that. So it works kind of like a liquidation.
Crypto Texan: That makes perfect sense to me, actually. And this is a fascinating protocol, I love this. And so what I want to talk about now is that there was a recent post in the Index Co-op's governance forum about launching a fixed income product suite with the ticker symbol fixed. And that is a partnership, a potential partnership should it be approved through governance between the Index Co-op and Notional. So I'm wondering if we can dig in a little bit and if you could provide a little background on what this potential new product could be through this partnership?
Teddy: Yeah so I think fixed is going to be really interesting, you know, the first thing I'd say is that as you can see in this discussion, Notional is a pretty sophisticated protocol, right? Like, I think having these maturity dates just introduces a layer of complexity and sophistication that is just more complicated than something like a Compound, right. So for people to use Notional, it requires a lot of engagement, right, in a couple of ways.
So one, you have to understand how this new way of borrowing and lending works, right? Things are just different with fixed rates, and then you also have to periodically roll your loan right in the same way that, you know what we were just talking about with borrowers getting their debt rolled forward. So if you're a lender, you know, let's say you lend to March. Well, then once March happens, you're going to want to continue to earn interest, right? So you'd want to roll your loan forward, but the problem with that is that it costs gas to roll your loan forward. And you also have to remember to do it, so it takes a lot of engagement from the user. And I think what's really, really cool about fixed is that it just abstracts all that away.
So basically for the end user, all they have to do is just buy a token on Uniswap, which is now the easiest thing you could possibly do. And they don't have to roll their loan forward, they don't have to pay the gas cost of maintaining this position, it all happens for them. So it just makes it really, really easy and it gives them a really easy way to access the high and stable returns that exist on Notional. And I think that's really cool because basically right now, Notional has really high interest rates relative to other DeFi protocols. So right now, our interest rates are in the 9.5% range, which is really, really attractive for lenders in the context of something like 2.5% or 3% on Aave right?
But the tricky part is that you've got to figure out how this works on Notional and you've got to do all the stuff that I just talked about. So I think that fixed products give people a super easy way to access that return without having to, you know, understand all the nuances and remember to come back every three months and all that stuff. So I think it's going to be a really cool product, and I'm really excited.
Crypto Texan: Yeah, so the way I'm understanding it is that this proposed product basically outsources the expertise that you would need to manage these fixed rate positions on your own and just tokenizes them. And that is managed by the smart contract and the methodologists behind that, is that correct?
Teddy: Yep, that's right. And I think that that is really the model that's going to be successful here in DeFi going forward. You know, it's like you have the protocol to handle all the sophistication because again Notional is kind of a sophisticated protocol and like Index Coop and the methodologists at Index Coop, you can manage all that complexity and make sure that you get the most out of it. And so you don't have to do any of that yourself.
Crypto Texan: Yeah wow this is really fascinating. So on the Notional protocol, I mean, what we're looking at from this fixed product suite standpoint, we're looking at USDC short term or long term, DAI short term or long term. Same thing with WBTC and Ethereum, short term or long term. Like what would be the difference between these products outside of the base asset? You know, what benefits would someone have from purchasing a USDC short term fixed product versus a USDC long term fixed product?
Teddy: Well, that's a good question. So I think, you know, right now there is the difference in the base asset, like what you talked about. Now as for the difference between short term or long term, I think the idea is that we're going to start with the short term just because it's the simplest one to bring to market. But I think that as we go forward, what I would expect to see is, now this might not necessarily be true, but what I expect to see is that the longer term product would actually have a higher yield than the shorter term product right?
And that's basically because in general in finance, and this isn't true yet in Notional, I think Notional still needs to mature a little bit, but in general in finance, you see what's called an upward sloping yield curve. And what that means is that the interest rate for a shorter maturity is usually less than the interest rate for a longer maturity. So for example, if you're lending for six months, you might expect to receive a lower interest rate than if you're lending for a year. And that's usually how it works, and the reason for that is because as a lender, you're giving out more optionality when you lend for a longer period of time.
And so usually people require a higher return to lend for longer periods of time. And so what I would expect to see going forward is that the longer term fund would have a higher yield than the shorter term fund. That's what I would expect to see. Now it's crypto, so reality doesn't always meet expectations, but that would be the reason why you'd buy one maturity term over the other.
Crypto Texan: Right, yeah, we are kind of in a very unique interest rate environment where, you know, we have this inverted yield curve and we have for the past several years, right? But I mean, I think it's starting to flatten out and maybe curve back to some normalcy, kind of like you said. But I could also foresee a situation where possibly in the crypto space, maybe it remains inverted because there is, you know, uncertainty can play a factor in interest rates as well, and there is a lot of regulatory uncertainty as well as uncertainty around volatility that, maybe I don't know, it's possible in my mind at least that yield curve could continue to stay inverted in the crypto space versus the traditional finance space. Do you foresee anything like that or am I just completely wrong in thinking that that could happen?
Teddy: So first of all, you're definitely not wrong. And what you've seen so far at Notional is that, so our yield curves are inverted right now. So the shorter term maturities are higher than the longer term ones. So that's already true. Now maybe it'll stay that way, maybe it'll change, I don't know. But so far the reason that that's been true is generally because the people that have borrowed on Notional have preferred a shorter term, and they've been willing to pay higher interest rates at shorter terms than they have in the longer term. So, you know, that means an inverted yield curve, which is kind of interesting.
And I think that as Notional kind of gets more adoption and as we see these integrations that we're talking about come online, I think that could change things because I think that, from some of the integrating partners that we're speaking to, their lending interest is more on a short term basis. So I think what you could see is that again, as these integrations come online, we get more short term lending interest, which pushes the short term part of the curve down. But that might not necessarily happen, so yeah, I think it's totally possible that the yield curve stays inverted and like the best opportunities for lenders are on the short end of the curve. That's definitely possible, yeah.
Crypto Texan: Yeah and just one other question, because we're kind of running up on time here. What other assets do y'all, I mean right now, it's my understanding you have USDC, DAI, BTC and ETH available to borrow and lend. Are there any others that I'm missing and do you foresee a future where you have additional assets to borrow and lend? Or are you looking for more of the highly liquid, safe, secure from a crypto standpoint, types of assets?
Teddy: Yeah so I think that a big goal of ours in the next couple of months is going to be to increase the assets on Notional. So as you said, right now we've got four assets in total, we've got ETH, Bitcoin, USDC, and DAI. And yeah, we are going to onboard more collateral types and also different lendable and borrowable currencies. So I think that what I'm excited about is listing other stablecoins to lend and borrow. So I think that, you know, something like DEI or RAI, I think it'd be really interesting stuff.
And, you know, we've spoken with those two teams and think that there could be some cool use cases to come out of that. So I think that we're just looking forward to broadening the scope of Notional to just encompass more users and use cases and all that stuff. But to be honest, we've been working really hard on what we have to do right now and so we haven't been able to add additional assets at this time, but that's definitely coming.
Crypto Texan: Awesome, well Teddy, this has been a fascinating conversation for me, and I have a traditional finance background as well, and I've done my fair share of interest rate swaps back in the day or recently, actually. So yeah, this has been a great conversation. Before we let you go, why don't you just let the audience in those who are listening to the recording know where we can go to find out more about you, Teddy, and Notional Finance.
Teddy: If you want to learn more about Notional, you can visit our website. That's Notional (dot) finance. You can also follow us on Twitter @NotionalFinance, or you can follow me on Twitter, I am @teddywoodward.
Crypto Texan: Alright, thanks to everyone who's listening live in the audience, this is being recorded, so we'll get the transcript up and going and we will publish this next week. Everyone have a great weekend. And Teddy, thanks again for coming on the show and talking to us today.
Teddy: Yeah, thanks a lot for having me. Great questions, it was fun.
Crypto Texan: Yeah, absolutely. Alright have a good weekend, everyone, bye.
Teddy: Bye.
Host: @Crypto_Texan
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Transcript: @qjuniperus
Conversations with the Coop - Teddy Woodward - Notional Finance