The interest rate swap market, which is a $341 trillion industry, was bound to make an entry into the crypto sector as well. Delta Exchange is now bringing the feature to crypto markets as well.
Decentralized finance takes a leap
The most recent push in the crypto industry is towards decentralized finance (DeFi). One such application of DeFi could be in interest rate swaps which allow users to hedge the risks they face from fluctuations in interest rate payments via perpetual contracts. Singapore-based Delta Exchange is taking steps in this direction. On recently introduced the interest rate swaps (IRS) which are contractual agreements between two parties that help them exchange interest rate payments over a predefined period of time.
An IRS will involve the exchange of fixed and floating rate obligations where they do not exchange the principal amount. The floating interest rate will go up and down depending on the reference rate. Traditionally, an interbank interest rate such as Libor is used as a reference rate for swaps.
How does Delta create its unique offering?
Delta’s IRS offering is different. It will use the perpetual Bitcoin (XBT/USD) funding rate on crypto exchange BitMEX as a reference rate. This will help in connecting the price of the contract with the spot price of the currency. The funding rate will become positive when the perpetuals trade at a premium compared to the spot price. This would mean strong buying pressures in the market and longs are paying funding to shorts.
As soon as the perpetual trade at a discount to the spot market, the funding rate will be considered negative and shorts will start paying funding to longs. Funding will occur every eight hours or thrice in 24 hours at 04:00 UTC, 12:00 UTC, and 20:00 UTC. Traders will be receiving funding only if they are holding positions at any one of those times.
Usually, the BitMEX funding rate is considered positive and is usually launching in the 15%-20% range in annualized terms. The rate has previously been known to rise and fall very sharply when Bitcoin experience sudden crashes or rallies.
The traders may end up losing a lot of their profits they hold a position for too long. The risk could then be hedged with an interest rate swap. If we assume that the funding rate remains positive on BitMEX, like it historically has, a trader holding a long position could turn his floating funding rate to fixed by buying a floating-for-fixed contract. Traders will a short position can do the opposite.