Why fixed interest rate lending has never really To da moon in the encryption field

Author: Prince, Translated by: Block unicorn

Abstract: The reason fixed-rate lending has not succeeded is not solely because DeFi users rejected it. Another reason for its failure is that protocols designed credit products based on assumptions from money markets and then deployed them into an ecosystem optimized for liquidity. The mismatch between assumed user behavior and actual capital behavior has structurally kept fixed rates in a niche position.

Today, almost all mainstream lending protocols are building fixed-rate products, primarily driven by real-world assets (RWA). This is understandable. As we get closer to real-world credit, fixed terms and predictable payment methods become crucial.

Fixed-rate lending sounds like a no-brainer. Borrowers need certainty: fixed payments, known terms, and no surprises with repricing. If DeFi is to operate like real finance, then fixed-rate lending seems to play a core role.

However, each cycle ultimately ends in the same way. The floating rate currency market is vast, while the fixed rate market remains sluggish. The performance of most “fixed” products ultimately resembles that of niche bonds held to maturity.

This is not a coincidence. It reflects the composition of the participants and the way these markets are designed.

Traditional finance (TradFi) has credit markets, while decentralized finance (DeFi) mostly has only currency markets.

Fixed-rate lending is effective in traditional financial systems because these systems are built around time. The yield curve anchors prices, and changes in benchmark interest rates are relatively slow. Some institutions have a clear mandate to hold durations, manage mismatches, and maintain solvency when funds flow in one direction.

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

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

DeFi has never built such a system.

The system built on DeFi resembles an on-demand money market. The expectations of most suppliers are simple: to earn returns on idle funds while maintaining liquidity. This preference quietly determines which products can scale.

When the behavior of the borrower resembles cash management, the market will settle around products that feel like cash rather than products that feel like credit.

How DeFi Lenders Understand the Meaning of “Borrowing”

The most important difference lies not in fixed rates versus floating rates, but in the withdrawal commitment.

In floating rate liquidity pools like Aave, suppliers receive a token that is essentially a liquidity inventory. They can withdraw funds at any time, rotate their capital when better investment opportunities arise, and typically use their holdings as collateral for other assets. This option itself is the product.

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

Fixed interest rates disrupt this relationship. To obtain a term premium, lenders must forfeit flexibility and accept that their funds will be locked in for a period of time. This trade-off is sometimes reasonable, but only if the compensation is significant. In reality, the returns offered by most fixed-rate schemes are insufficient to compensate for the loss of optionality.

Why do liquid collateral pull interest rates towards floating rates?

Today, most large-scale cryptocurrency lending is not traditional credit in the conventional sense. They are essentially margin and repo lending supported by highly liquid collateral. Such markets naturally adopt floating interest rates for settlement.

In traditional finance, repurchase and guaranteed financing will also continue to be repriced. Collateral is liquid. Risk is valued at market price. Both parties expect this relationship to be adjustable at any time. The same applies to cryptocurrency lending.

This also explains a problem that lenders often overlook.

To obtain liquidity, lenders have essentially accepted economic benefits that are far below what the nominal interest rate implies.

On Aave, there is a significant disparity between the interest rates paid by borrowers and the income earned by lenders. Part of this is due to protocol fees, but a large portion is because the account utilization rate must be kept below a certain level to ensure smooth withdrawals under pressure.

Aave One-Year Supply and Demand Comparison

This difference is reflected in a reduced yield. This is the cost that lending institutions incur to ensure a smooth exit process.

Therefore, when a fixed-rate product emerges and locks in funds at a moderate premium, it is not competing with a neutral benchmark product, but rather competing with a product that intentionally lowers yield while maintaining high liquidity and safety.

It's far more than just providing a slightly higher annual interest rate.

Why do borrowers still tolerate floating rate markets?

Borrowers do appreciate certainty, but most on-chain lending is not like a home mortgage; it involves leverage, basis trading, avoiding liquidation, collateral cycling, and strategic balance sheet management.

As Silvio Busonero demonstrated in his analysis of Aave borrowers, most of the on-chain debt is related to looping and basis strategies, rather than long-term financing.

These borrowers are unwilling to pay a high premium for the term because they do not intend to hold the term. They wish to lock in the term at their convenience and refinance when it is inconvenient. If the interest rates are favorable to them, they will extend the term. If problems arise, they will quickly close their positions.

Therefore, a market will ultimately form where lenders require a premium to lock in funds, but borrowers are fundamentally unwilling to pay this fee.

This is why the fixed interest rate market continues to evolve into a one-sided market.

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

The failure of fixed rates in the cryptocurrency space is often attributed to the implementation level. For example, the comparison between auctions and automated market makers (AMM); the comparison between series contracts and liquidity pools; better yield curves; and improved user experience.

Many different mechanisms have been tried. Term Finance runs auctions; Notional has built explicit term tools; Yield has experimented with an automated market maker (AMM) based on expiration dates. Aave even attempted to simulate fixed-rate lending within a liquidity pool system.

The designs are different, but the results ultimately converge. The deeper issue lies in the thinking patterns behind them.

This is often where the debate shifts towards market structure. Some believe that most fixed-rate agreements attempt to make credit feel like a variant of the money market. They retain funding pools, passive deposits, and liquidity commitments, while only changing the way interest rates are quoted. On the surface, this makes fixed rates easier to accept, but it also forces credit to inherit the various limitations of the money market.

A fixed interest rate is not just a different rate; it is a different product.

At the same time, the notion that these products are designed for future user groups is only partially correct. People expect that institutions, long-term holders, and native credit borrowers will flood in and become the pillars of these markets.

But what actually flows in is more like active capital rather than a balance sheet.

Institutions appear as asset allocators, strategists, and traders. However, long-term depositors have never reached meaningful scale. Native credit borrowers do exist, but borrowers are not the anchors of the lending market; lenders are.

Therefore, the limiting factors have never been purely a distribution issue, but rather the result of the interaction between capital behavior and flawed market structures.

To enable the fixed interest rate mechanism to operate on a large scale, one of the following conditions must be met:

1. The lender is willing to accept the funds being locked.
2. There exists a sufficiently deep secondary market where lenders can exit at a reasonable price, or
3. Some hold term assets, allowing lenders to pretend to have liquidity.

Most DeFi lenders reject the first condition. The secondary market for term risk remains weak. The third condition quietly reshapes the balance sheet, which is exactly what most protocols are trying to avoid.

This is why fixed interest rate mechanisms are always cornered, barely able to exist, yet can never become the default way to store funds.

The division of time limits leads to fragmented liquidity, and the secondary market remains weak.

Fixed-rate products create terms. The division of terms leads to fragmentation.

Each term is a different instrument with varying risks. A bond maturing next week is entirely different from one maturing three months later. If a lender wants to exit early, they need someone to buy that bond at that specific point in time.

This means either:

• Multiple independent fund pools (one for each maturity date), either
• A real order book with real market makers willing to quote across curves.

DeFi has not yet provided a lasting version of a second solution for the credit sector, at least not on a large scale.

What we see is a familiar phenomenon: liquidity deteriorates, and price shocks increase. “Early exit” has turned into “you can exit, but you have to accept a discount,” and sometimes this discount can swallow up most of the expected gains of the lenders.

Once the lender experiences this situation, the position no longer resembles a deposit, but rather becomes an asset that needs to be managed. After that, most of the funds will quietly flow out.

A Specific Comparison: Aave vs Term Finance

See the actual flow of funds.

Aave operates on a large scale, involving billions of dollars in lending. Term Finance is well-designed and fully meets the needs of fixed-rate supporters, but its scale is still relatively small compared to the money market. This gap is not a brand effect, but rather reflects the actual preferences of lenders.

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

In comparison, Term Finance can usually conduct 4-week fixed-rate USDC auctions at mid-single-digit interest rates, sometimes even higher, depending on the collateral and conditions. On the surface, this seems more attractive.

But the key lies in the perspective of the lender.

If you are a lender, choose between the following two options:

• Approximately 3.5% return, similar to cash (can exit anytime, rotate anytime, and positions can be used for other purposes), and
• Approximately 5% yield, similar to bonds (held to maturity, unless other borrowers appear, otherwise liquidity is limited for exit)

Comparison of APY between Aave and Term Finance

Many DeFi lenders choose the former, even though the latter has a higher numerical value. Because numerical value is not the whole return. The whole return includes optionality.

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

This preference explains why liquidity is concentrated in specific areas. Once liquidity is insufficient, borrowers will immediately feel the impact of decreased execution efficiency and limited capacity. They will reselect floating interest rates.

Why Fixed Interest Rates May Never Become the Default Option for Cryptocurrencies

Fixed interest rates can exist. They can even be healthy.

But it will not become the default choice for DeFi lenders to deposit funds, at least not before the lender demographic changes.

As long as the majority of lenders expect to obtain par liquidity, value composability is prioritized over yield, and positions that can be automatically adjusted are preferred, fixed rates remain structurally disadvantaged.

The reason floating rate markets prevail is that they align with the actual behavior of participants. They cater to the money market seeking liquidity rather than the credit market focused on long-term balance sheets.

What changes need to be made?

If fixed interest rates are to work, they must be regarded as credit rather than disguised as savings accounts.

Early exit must be priced, not promised. Duration risk must be clear. When the direction of fund flows is inconsistent, there must be someone willing to take on the responsibility of the other party.

The most feasible solution is a hybrid model. Floating rates serve as the foundational layer for capital storage. Fixed rates act as an optional tool for those who explicitly wish to trade duration.

A more realistic solution is not to forcibly introduce fixed interest rates into the money market, but to maintain the flexibility of liquidity while providing an opt-in path for those seeking certainty.