Why do DeFi users reject fixed interest rates?

12월 21, 2025 22:09:25

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Original Title: Why fixed-rate lending never took off in crypto

Original Author: Prince

Original Compilation: Golem, Odaily Planet Daily

The failure of fixed-rate lending in the crypto space is not solely due to DeFi users rejecting it. Another reason for its failure is that DeFi protocols adopted money market assumptions when designing credit products and then deployed them in a liquidity-driven ecosystem; the mismatch between user assumptions and actual capital behavior has kept fixed-rate lending in a niche market.

Fixed-rate products are unpopular in the crypto space

Today, almost all mainstream lending protocols are building fixed-rate products, largely driven by RWA. This trend is understandable, as once credit is closer to the real world, fixed terms and predictable payment methods become crucial. In this context, fixed-rate lending seems like the obvious choice.

Borrowers crave certainty: fixed payment methods, known terms, and no unexpected repricing. If DeFi is to operate like real finance, then fixed-rate lending should play a core role.

However, each cycle has been quite the opposite. The floating-rate money market is vast, while the fixed-rate market remains sluggish. Most "fixed" products ultimately perform like niche bonds held to maturity.

This is not coincidental; it reflects the composition of market participants and the way these markets are designed.

TradFi has credit markets, DeFi relies on money markets

Fixed-rate loans work effectively in the traditional financial system because that system is built around time. The yield curve anchors prices, and changes in benchmark rates are relatively slow. Some institutions have clear responsibilities to hold duration, manage mismatches, and maintain solvency when funds flow in one direction.

Banks issue long-term loans (mortgages being the most obvious example) and fund them with liabilities that do not belong to "profit-driven capital." When interest rates change, they do not need to liquidate assets immediately. Duration management is achieved through balance sheet construction, hedging, securitization, and a deep intermediary layer specifically for risk-sharing.

The key is not the existence of fixed-rate loans, but that there will always be someone to absorb mismatches when the terms of the borrowing parties do not align perfectly.

DeFi has never built such a system.

DeFi is more like an on-demand money market. Most fund providers have a simple expectation: to earn returns on idle funds while maintaining liquidity. This preference quietly determines which products can scale.

When lenders behave like cash managers, the market will clear around products that feel like cash rather than those that feel like credit.

How DeFi lenders understand the meaning of "lending"

The most important distinction is not between fixed and floating rates, but in the promise of withdrawal.

In floating-rate pools like Aave, providers receive a token that is essentially a liquidity inventory. They can withdraw funds at any time, rotate funds when better investment opportunities arise, and often use their positions as collateral for other purposes. This optionality is a product in itself.

Lenders accept slightly lower yields for this. But they are not foolish; they are paying for liquidity, composability, and the ability to reprice without additional costs.

Using a fixed rate disrupts this relationship. To gain a duration premium, lenders must forgo flexibility and accept that funds will be locked for a period. This trade-off can sometimes be reasonable, but only if the compensation is also reasonable. In reality, most fixed-rate schemes offer compensation that is insufficient to offset the loss of optionality.

Why does highly liquid collateral pull rates toward floating rates?

Today, most large-scale cryptocurrency lending is not credit in the traditional sense. It is essentially margin and repo lending backed by highly liquid collateral, and such markets naturally adopt floating rates.

In traditional finance, repos and margin financing also undergo continuous repricing. Collateral is liquid, and risks are marked to market. Both parties expect this relationship to adjust at any time, and the same goes for cryptocurrency lending.

This also explains a problem that lenders often overlook.

To gain liquidity, lenders have effectively accepted economic benefits far below what the nominal rate implies.

On the Aave platform, there is a significant spread between the amount borrowers pay and the returns lenders receive. Part of this is protocol fees, but a large portion is due to the necessity of keeping account utilization below a certain level to ensure smooth withdrawals under stress.

Aave one-year supply and demand comparison

This spread manifests as reduced yields, which is the cost lenders pay to ensure smooth withdrawals.

Thus, when a fixed-rate product appears and offers a moderate premium for locking up funds, it is not competing with a neutral benchmark product but with a product that deliberately suppresses yields while being highly liquid and secure.

Winning is far more complex than just offering a slightly higher annual interest rate.

Why do borrowers still tolerate floating-rate markets?

Generally speaking, borrowers prefer certainty, but most on-chain lending is not like a home mortgage. It involves leverage, basis trading, avoiding liquidation, collateral looping, and tactical balance sheet management.

As shown in @SilvioBusonero's analysis of Aave borrowers, most on-chain debt relies on revolving credit and basis strategies rather than long-term financing.

These borrowers do not want to pay a high premium for long-term loans because they do not intend to hold them long-term. They want to lock in rates when convenient and refinance when inconvenient. If rates are favorable, they will continue to hold. If issues arise, they will quickly close their positions.

Thus, a market emerges where lenders need a premium to lock up funds, but borrowers are unwilling to pay that cost.

This is why the fixed-rate market continually evolves into a one-sided market.

The fixed-rate market is a one-sided market problem

The failure of fixed rates in the crypto space is often attributed to implementation issues. Comparisons of auction mechanisms with AMMs (automated market makers), comparisons of tranches with liquidity pools, better yield curves, better user experiences, etc.

Many different mechanisms have been tried. Term Finance conducted auctions, Notional built explicit term tools, Yield experimented with term-based automated market-making (AMM), and Aave even attempted to simulate fixed-rate lending within a liquidity pool system.

The designs vary, but the outcomes converge; the deeper issue lies in the underlying mindset.

The debate ultimately shifts to market structure. Some argue that most fixed-rate protocols attempt to make credit feel like a variant of a money market. They retain liquidity pools, passive deposits, and liquidity commitments while merely changing the way rates are quoted. On the surface, this makes fixed rates more palatable, but it also forces credit to inherit the constraints of money markets.

Fixed rates are not just a different interest rate; they are a different product.

At the same time, the notion that these products are designed for future user bases is only partially correct. There is an expectation that institutions, long-term depositors, and credit-native borrowers will flood in and become the pillars of these markets. However, the funds that actually flow in resemble active capital more closely.

Institutional investors appear as asset allocators, strategists, and traders, long-term depositors have never reached meaningful scale, and while credit-native borrowers do exist, they are not the anchors of the lending market; lenders are.

Thus, the limiting factors have never been purely allocation issues but rather the result of the interaction between capital behavior and flawed market structures.

For fixed-rate mechanisms to operate at scale, one of the following conditions must be met:

Lenders are willing to accept funds being locked up;
There exists a deep secondary market where lenders can exit at reasonable prices;
Someone accumulates duration capital, allowing lenders to pretend they have liquidity.

DeFi lenders largely reject the first condition, the secondary market for term risk remains weak, and the third condition quietly reshapes balance sheets, which is precisely what most protocols are trying to avoid.

This is why fixed-rate mechanisms are always cornered, barely able to exist, yet never becoming the default repository for funds.

Term segmentation leads to liquidity fragmentation, and the secondary market remains weak

Fixed-rate products create term segmentation, and term segmentation leads to liquidity fragmentation.

Each maturity date is a different financial instrument with varying risks. A claim maturing next week is entirely different from one maturing three months later. If lenders want to exit early, they need someone to buy that claim at that specific point in time.

This means either:

There are multiple independent liquidity pools (one for each maturity date)
There is a real order book with genuine market makers quoting across the yield curve

DeFi has yet to provide a lasting version of the second option for the credit space, at least not on a large scale.

What we see instead is a familiar phenomenon: liquidity deteriorates, and price shocks increase. "Early exit" turns into "you can exit, but at a discount," and sometimes this discount can consume a significant portion of the expected returns for lenders.

Once lenders experience this, the position no longer feels like a deposit but becomes an asset that needs to be managed. After that, most funds will quietly flow out.

A specific comparison: Aave vs. Term Finance

Let’s take a look at the actual flow of funds.

Aave operates on a massive scale, with lending amounts reaching billions of dollars, while Term Finance is well-designed to meet the needs of fixed-rate supporters but remains small compared to money markets. This gap is not due to brand effects but reflects the actual preferences of lenders.

On the Ethereum Aave v3 platform, USDC providers can earn about 3% annualized returns while maintaining instant liquidity and highly composable positions. Borrowers pay an interest rate of about 5% during the same period.

In contrast, Term Finance typically completes 4-week fixed-rate USDC auctions at mid-single-digit rates, sometimes even higher, depending on collateral and conditions. On the surface, this seems better.

But the key is from the lender's perspective.

If you are a lender considering the following two options:

About 3.5% yield, similar to cash (withdraw anytime, rotate anytime, can use the position for other purposes);
About 5% yield, similar to bonds (hold to maturity, limited liquidity unless someone takes over).

Comparison of annualized yields (APY) between Aave and Term Finance

Many DeFi lenders choose the former, even though the latter is numerically higher. Because numbers do not represent total yield; total yield includes optionality.

The fixed-rate market requires DeFi lenders to become bond buyers, while in this ecosystem, most capital has been trained to be profit-driven liquidity providers.

This preference explains why liquidity concentrates in specific areas. Once liquidity becomes insufficient, borrowers immediately feel the impact of decreased execution efficiency and limited financing ability, prompting them to revert to floating rates.

Why fixed rates may never become the default option in cryptocurrency

Fixed rates can exist; they can even be healthy.

But they will not become the default place for DeFi lenders to store funds, at least not until the base of lenders changes.

As long as most lenders expect to receive parity liquidity, value composability is as important as yield, and they prefer positions that can adapt automatically, fixed rates remain structurally disadvantaged.

The floating-rate market wins because it aligns with the actual behavior of participants. They are money markets for liquid funds, not credit markets for long-term assets.

What needs to change for fixed-rate products?

For fixed rates to work, they must be viewed as credit rather than disguised as savings accounts.

Early exits must be priced, not just promised; term risk must also be explicit; when the direction of capital flow is inconsistent, someone must be willing to take on the other party's responsibility.

The most viable solution is a hybrid model. Floating rates serve as the foundational layer for capital storage, while fixed rates act as an optional tool for those explicitly looking to buy and sell duration products.

A more realistic approach is not to forcibly introduce fixed rates into money markets but to maintain the flexibility of liquidity while providing a pathway for those seeking certainty to opt-in.