Borrow Short Lend Long

Banks primarily derive income through their net interest margin, a strategy encapsulated by the phrase "borrow short, lend long." This approach entails borrowing an asset for a brief period, typically at a low interest rate—for instance, over a span of 20 days—and subsequently lending out the same asset at a higher interest rate for an extended duration, such as 100 days. The borrowing process is rolled over into the next 20-day period. Short duration fixed rates are crucial here. This straightforward yet effective method of generating profit is notably absent from DeFi.

Yield Curve Trade

A simple way for a trader to express whether the curve according to them should be steeper or flatter. Say the 2 month ETH bond yields 3.5%; the 3mo yields 3.8%; 5mo yields 4.3%; and the 10mo yields 5.2%. Implying that the 2’s - 10’s curve is trading at 5.2% - 3.5% = 170 bps.

The trader might feel based on analysis that this is too flat and expect the curve to steepen. They can express this view by buying the 2mo ETH bond and shorting the corresponding 10mo bond. To remain at the current risk level, this will be done in PV01-equal amounts. For completeness let’s say the PV01 of 10mo ETH bond is 7.15 and the PV01 of 2mo ETH bond is 1.49 – the trader would buy 4.79 units of 2mo ETH for each unit of 10mo ETH that is shorted.

These are popular and cost efficient ways for market participants to express their views on the yield curve and actually drive yield behavior. These trades/activities make sure that the curve is reflective of on-ground market reality, and consequently DeFi markets are representative of the underlying asset

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