Voltz Protocol | ALPHA LEAK with Simon Jones

What that does off the back of that is it actually unlocks a whole bunch of new products and services which weren't possible until now.

Welcome, Bankless Nation, to this Alpha Leak episode where we cover Voltz protocol. Voltz is an interest rate swap AMM. It's got Uniswap V3 code in it, and it helps us arbitrage interest rates across DeFi. Inside of one side of the Volts protocol can go in variable interest rates, and out on the other side comes out stable interest rates. And Voltz is really a market maker, a coordinator between these two types of market actors in DeFi. Some people are willing to take the risk of volatile interest rates, and some people are willing to pay for that risk being reduced and get stable interest rates. And Voltz is an AMM that allows these two market participants to come together and meet in the middle and allows one person to get stable interest rates and one person to get variable interest rates and perhaps a bunch more yield. There's also the conversation of liquidity providing, since this is using Uniswap V3 code, but instead of with assets with interest rates, there's of course the possibility of being a liquidity provider and gaining a ton of yield. And Volks really is trying to position itself as like the curve of DeFi for interest rates, where curve is where you go. It's the epicenter of stablecoin liquidity or like kind asset liquidity. Volks is going to be or trying to position itself to be the epicenter of interest rates liquidity in DeFi. And we don't really have a single central point of interest rate liquidity. While the

Interest rate swap market in TradFi is like a quadrillion dollars, and I didn't just make that up. There is literally a queue. This is a line from Simon in the show. There's literally a Q in front of the volume and yearly interest rate swap market volume in TradFi. And if there's one thing that we know that DeFi produces, it's yield. DeFi is really good at producing yield. And Ave produces some yield for some assets, Compound produces some yield from some other assets. We have the ETH stake rate, we have the USDC lending rate, we got the urine yield rate. We have all of these yield rates that are different from each other. And volts can be a coupler, a center point of liquidity between all of these different yield rates, allowing people to arbitrage them in a leveraged fashion, because that's what Uniswap 3. The reason why I'm so bullish on volts is that like it allows DeFi to set the market, the interest rate dynamics of the Ethereum economy, right? The mark the interest rates of crypto are set by the market rather than the Fed, right? And so in the TradFire world, interest rates are set by like 12 dudes in a closed room. There's no input, it's just like it's whatever they say. Under like a Volts paradigm, or really like, and this is why I'm again I really am bullish on the future of Volts, is that Volts allows the market to determine the interest rate. And so it just kind of like how Uniswap V3 is an oracle for prices organically. Like there uh you put uh in die into one pool, ether into one pool, and the market balance these things out and naturally prices die versus ETH. Uh Volts can naturally price the interest rates of all of DeFi. Uh and so you know, this is bullish for just a bankless, permissionless money and finance system where we don't have 12 dudes in a closed room determining the cost of money. Uh instead, we have a protocol determining the cost of money, and that protocol could be volts. At least that is the bull case for volts. Of course, I ask Simon, is there a token coming? What about the token? When token? Uh that question comes at some point during the show, so you'll have to stick around to hear about that. Just as a disclaimer, both Ryan and I have invested in the uh as angel investors in volts in previous rounds. Uh, so we are uh upside access to the upside there, so that's the disclaimer there. Uh so I want to get right into the show with Simon right after we talk about some of these fantastic sponsors that make the show possible.

Welcome Bankless Nation to this episode of Alpha Leak. On today's episode, I'm talking to Simon Jones, co-founder and CEO of the Volts Protocol. And Voltz uh recently just went to mainnet. So Simon, congratulations on that.

No, thanks. It's uh super exciting.

Simon, for the listeners that haven't heard of Volts Protocol or what that is, can you just explain the high-level explain like I'm five? What is the the early explanation for Volts Protocol?

Yeah, sure. So the the really high level is that we have built out a protocol that effectively brings interest rate swaps to DeFi.

Um, and I guess to talk to the significance of that first. So

If we just look at traditional finance as an example, interest rate swaps, they're just a core pillar to a well-functioning financial system. And to put that in context, there is a kind of almost cartoonishly large quadrillion of notional exchange each year in TradFi interest rate swaps. I mean, it literally starts with a Q. And it's that large because it supports such a wide spectrum of use cases, both across risk management, across speculation, but then also across the construction of a whole bunch of different products, both for corporates and for retail.

And at the moment in DeFi, we don't have this piece of infrastructure. And what that does is uh it kind of through it not existing, is it limits the amount of products that we can actually build in order for DeFi to be able to become the financial system for the whole of the world. Um so by us bringing this to DeFi, uh that is what we ultimately really hope starts to happen.

So let's keep things really basic here. What is an interest rate swap market? What what is that?

Yeah, so it there's there's basically a number of different actors that exist on the protocol. Um so we have LPs because it's an AM, but just to ignore that for a second and talk about the traders, um, you are either what we describe as a fixed taker, where you are selling a variable rate of return in exchange for a fixed rate.

Or you're what we describe as a variable taker, where you are selling a fixed rate of return in exchange for a variable rate.

And if I just talk about two kind of really simple use cases for that, so if you're a fixed taker and you have an asset that produces a variable rate of return, like CDI, for example, and you don't want that variable rate.

What you can do with Vault's protocol is you can deposit CDI as margin, which effectively enables you to sell a variable rate into the protocol.

And in return, you are then converting that into a fixed rate asset. So you are selling variable and exchanging that for a fixed rate.

Which, if we just look at that very simple use case, like an interest rate swap market actually opens up a very wide spectrum of use cases. But if you just look at that really simple one, what's really interesting is for the first time in DeFi, that has actually removed the silos between fixed and variable rates. You have a variable rate asset with a click, you convert it into a fixed rate asset.

If we look at the other side and again take a really simple use case, so in this instance, you're a variable taker, you are selling fixed in exchange for variable. The fixed rate of return that you're selling away, if you're essentially wanting to go along the variable rate, so for example, if you believe there's another bull market around the corner and the rates on CDA are going to increase, you can actually get levered exposure

to that variable rate as it increases over time.

So the idea here is that there are some market participants that desire a fixed rate and they will pay some amount of cost in order to access that risk-reduced rate. And so if you like lock in 4%, you have removed a lot of risk because you've removed the volatility of the fluctuations of the interest rate. And then there are people who are willing to be paid for taking that risk who are willing to take the variable rates because being paid to take the variable rates comes with a higher yield, although you just don't know what that yield is because it's variable, but you also don't really care because you're willing to take the variance and the risk and collect what is like a not a direct payment of a fee, but a backdoor fee in the sense that you get to charge higher interest rates if you are the one taking the risk of the variance, and you are charging people who are de risking what the the yield is by getting a fixed fee. Am I on track here?

Yeah, kind of vaguely. I mean there's there's there's um there's a bunch of different actors that will exist on the protocol. Um uh but it at its highest level, there are people who are more risk averse and therefore they are willing to sell away a variable rate in exchange for fixed. And there's people who are uh kind of on that use case more kind of risk loving, who are basically able to take advantage of the fact that there are these more risk averse actors in the market.

Keeping things again high level uh can we talk about why this market is so big in TradFi? Like uh a quadrillion, people don't know how to think about the word quadrillion. That's a very large number. Why why is it so big in the traditional markets?

Yeah, it's really big because it supports such a wide spectrum of use cases, which exists across uh kind of three main buckets. So there's there's risk management, uh, there's uh speculation, and then there's also the construction of a whole bunch of different products, uh both for corporates and for retail. And actually,

in traditional finance, right, like so if you had to go to your normal person on the street and say, hey, have you heard of an interest rate swab, chances are they probably said no. But if if you sit go to them and say, have you heard of a fixed rate mortgage, the chances are they'll probably say yes. And what's actually happening is in the background that in traditional finance, that bank which is constructing, or typically that bank which is constructing that mortgage for a consumer, they're actually using super low level capital markets infrastructure, i.e., an interest rate swab, in order to package up that product.

So when we kind of think about this in the context of DeFi, you know, if we want these types of products to exist and if we want to increase like this the spectrum of uh kind of utility that DeFi can provide.

To people around the world, such that DeFi can become the globe's financial system, right? We need these core pillar to exist such that we can start building these products and services.

Can you illustrate what DeFi looks before and after a s like sophisticated, robust interest rate swaps market? Like what what is the current state of DeFi and then what is DeFi going to be once we have all of this interest f infrastructure around interest rate swaps built out? What how what changes?

Yeah, so there's actually, if we if we look at DeFi today, there's there's almost a uh structural problem where DeFi is structurally variable. And this exists all the way across the stack. So if you go right to the bottom of the stack uh to uh your kind of proof of state mechanics, obviously where kind of vast majority change converging, uh, you know, on a block by block basis, uh, due to supply and demand dynamics, the rates of emissions which miners are able to generate change, right? So you have right at the lowest level, you have variable rates of return coming out of the ecosystem.

On top of that, you've got protocols. So if you think of say Ave and Compound just as examples, again, supply-demand dynamics mean that the rates of return change on a block-by-block basis.

And then on top of that,

if you're a trading firm or you're trying to build products or kind of that you distribute to retail or whatever,

um

Even if you deploy some sort of market neutral strategy, you are doing that on top of an ecosystem that's structurally variable.

And what interest rate swaps unlock at the most macro level is it enables us to build a system where we have structural stability for those that want it.

And that it kind of opens up this whole spectrum of different use cases and products and services that can be built.

Which kind of span across different retail use cases. So that could be stuff which is on one end of the kind of complexity spectrum, stuff that's relatively simple, like fixed rate vaults, all the way through to actually the other end of the spectrum, you can start building, for example, fixed rate mortgages on chain. And there are teams that have reached out to us since we've gone live, kind of exploring that as an idea.

And then on the corporate side, you actually have stuff where

You can do stuff around risk management and you can also do stuff around speculation. So if we talk to risk management as an example, you may have a CFI lending business, for example, which is kind of promising, say fixed rates of return on one side, but then are kind of lending out variable rates on the other. And actually, what they have at a balance sheet level when you aggregate that up

is they have a rate liability and they have no way of hedging that risk on chain. And all of a sudden, with Vault, you can do that, which enables them to be more stable as an entity and therefore start to expand the products and services that they can offer.

And then on the speculation side, what's actually really interesting is you can build because it's a derivative and you can trade rates just like you can speculate with kind of like crypto assets, you can actually build a whole bunch of really interesting trading strategies that take advantage of kind of different rate markets and the way in which those rates are produced, and the fact that they kind of at times, for example, may diverge and you believe they're going to converge.

And because you can do that and trade that exposure on volts with leverage, all of a sudden it's 100 basis points with 1% kind of like change. Actually, if you're doing that with 100x leverage, it becomes really attractive. Um, so there's there's a much wider spectrum of use cases which then get opened up off the back of it.

And crypto has this branding of being this like chaotic, volatile, unstable Wild West. And perhaps it's because we don't have some infrastructure like this which really creates like solid foundations for people to make like longer-term plans. Uh and so if some like big institution with a bunch of capital comes in, they need solutions to lock in their interest rates so that they can think in the long term, right? And like, you know, the my model for this is that the crypto industry starts extremely degenerate, extremely speculative, extremely unstable, extremely volatile. Uh but as it grows and grows and grows, both in just like amount of capital, a number of users, but then also like sophistication of financial primitives, all of a sudden we come up with tools to turn what is a chaotic, unstable place into an orderly, uh orderly markets with solid foundations. And like the cool thing, the cool thing that I'm seeing here with this is that you have two parties, one that is the volatile party and one that is the uh the non-volatile, the stable party. And like the stability cunt can come on the backs of degenerates, right? Like people that are trading with like a thousand X leverage on interest rate uh variants, uh, and if they are right, they get a bunch of money. And the the people that are looking for the orderly institutions can ride off of the liquidity of like the DGENs who are uh taking a bunch of leverage with with interest rates. Uh, would you would you how do you like that take? Is that a a good take, or what would you change?

No, I think that I think there's definitely parts of that which I like completely agree with. I mean, I mean it's it's completely fine for elements of uh like I have absolutely no issue. I think it's amazing that there's parts of DeFi that are uh are kind of volatile, it's like lots of speculation, it's a completely legitimate thing to do with your money. But there's also

If we really want DeFi to become the financial system for the whole of the world, there's also a whole bunch of other people who don't want that. And actually, the existence of an interest rate swap market enables DeFi to exist for both sides of the market and actually, frankly, enables those different types of kind of actors with different risk appetites to almost be able to kind of play off the fact that

there are different people with different risk appetites, and you can effectively exchange that difference in risk appetite with one another.

Yeah, right. This uh Volt s seems like it can be a coordination tool between the risky and the risk averse, right? It allows the risk averse to find the uh their other half to balance each other out to create a stable foundation.

In many ways, yes. And then what that does off the back of that is it actually unlocks a whole bunch of new products and services which weren't possible until now.

So um a question about how Volts actually works under the hood. Like we already have like stable interest rate options. Like Aave has stable interest rates in its protocol. When you borrow like USDC or DAI or anything really, uh I think you you can get a variable interest rate and pay a lower fee than what is offered for a stable interest rate. So like either you can lock in like a 3% uh USDC borrow fee, or you can get a variable interest rate, which will be something like 2.5% or 2%, but then there's the chance that that variable interest rate goes up to like 5% or perhaps even down to 1%. Like, but we already have this option in in Ave and in Notional as well. Uh and so like other DeFi applications already provide this service. So what's different about volts?

Yeah, I think the key thing is that Volts is generalizable and composable such that you can build a whole bunch of different products and services off the back of it. So it and and alongside that, the other thing which is extremely different is that it's so capital efficient. So actually, when I kind of go back to when Archer and I, Arch is my co founder, when he and I were going through a process of just figuring out how on earth you build this type of market in DeFi, um where the constraints are frankly just fundamentally different to say traditional finance, if you're trying to look at that as an example.

The kind of two things that we're really optimizing for was number one, capital efficiency, which has kind of led to a bunch of architectural decisions that we made in the protocol. And I guess the headline there is it is around 3,000 times more capital efficient than alternative structures.

But then the other that we're really solving for is to try and make the protocol as composable as possible, which meant that we figured out a mechanic where everything exists on chain such that people can start using Volts as a very low level building block to build all these products and services that kind of we feel it is going to unlock through the next few years.

Right, so Ave and its variable or fixed interest rates is like a money market, but it only has so it only goes so far in providing like the actual tooling for all yield-bearing assets to be able to access both fixed and variable interest rate markets. But then also like another big difference is that with leverage, right? And so you can only you can only arbitrage the differences between variable and fixed interest rate markets on Ave to so like it only goes so far because of like the capital intensivity, and Ave is just not really meant for that. Volt is specifically meant for arbitraging the differences between variable and fixed interest rates, and you are able to do it with leverage. Uh, how does the leverage happen? Uh how how do we get like leverage interest rate market swaps? Like, where does that key unlock come from?

Yeah, so the the way that we've built the protocol is is we deliberately split out the AMM from what we describe as the margin engine. And the AMM, what that now does is we describe it as a virtual AMM because it essentially only acts as a pricing oracle, where we essentially mint and burn fixed and variable tokens as trading activity takes place, and that obviously drives the price. That then acts as a pricing oracle into the margin engine.

And the margin engine, we often describe it as the beating heart of the protocol because it's responsible for defining the leverage that you can take as a trader. It deals with settlements, it deals with liquidation events, it collects fees for LPs.

It basically does everything except at the pricing oracle, which the virtual AMM does.

And then in terms of like specifically how it creates leverage, so if I just walk through a kind of a really simple use case, if you've got uh a pool which has got a one year term, and say you're a variable taker, so you're selling a fixed rate, and imagine the price of the fixed is 10%, right? If I'm doing 100 of notional, a really simple uh kind of model uh would assume that I need to deposit 10 of margin, right? So I've got 100, 10% for a year, 10 of margin.

And so at in that instance you are already trading with 10x leverage. But what's actually very naive about that model is it would assume that the variable rate would just drop to zero and stay at zero through the entire course of the term.

Which actually, when you start to run a whole bunch of modeling around that, is it just extremely unlikely to happen. So, what we have instead is we have a margin engine which computes predictions into the future of what your likely upper and lower bounds are going to be for a rate. And then that defines uh kind of within a safety measure, it defines the amount of leverage that you can take as a trader, which actually, in some instances, particularly as rates actually start to come down. So if you go from 10 to 1%, you know, you you could theoretically be fully covered and only be depositing one instead of 10 for a year term. As rates start to come down, it means that actually you're able to take more leverage as a user. So the the actual kind of underlying number associated to the rate is not what matters because it's offset by the fact that you're able to take more leverage.

And this is where, yeah, we're definitely taking a peek under the the complexities of the Volts protocol and what really powers the Volts protocol to make it different than all the other fixed versus variable interest rates markets. Can we actually just zoom out and like start from the very beginning about the technical details behind Volts? You talked about how it's a virtual AMM uh and like I kind of can wrap my head around that. Uh but like can we just like go and do uh just a walkthrough of like all the details of the Volts protocol under the hood? I know you already just did it, but like let's start from the beginning and like go through it like step by step.

To explain the architecture, it's actually easier to just explain the different actors first. So we've got we've got three different actors. So you've got liquidity providers, you've got fixed takers, and you've got variable takers. If you are providing liquidity, we actually borrowed concepts from Uniswap V3, where we have tick kind of spacing within the AMM. So as a liquidity provider, you choose your tick range that you want to deposit liquidity within. But that requires you via the margin engine tick.