SOFR: why this rate is important for all market participants

Where does this mysterious letter combination come from

SOFR stands for Secured Overnight Financing Rate (. Sounds complicated? In fact, it's just a number that shows how much it costs banks and large financial players to borrow money overnight secured by U.S. Treasury securities.

Imagine the REPO market as a huge corridor where transactions worth over ) trillion take place daily. People lend and borrow money, using government securities as collateral. The Federal Reserve Bank of New York analyzes all these transactions, calculates the average $1 considering the volume of each transaction ( and publishes the result — this is SOFR.

Data comes from three types of operations in the secured financing market:

• REPO through an intermediary ), for example, a bank ( that facilitates the exchange of money and collateral.
• REPO with total collateral financing )GCF( through the clearing house
• Bilateral REPOs between two participants that have cleared.

The rate is published every day at 08:00 Eastern Time, reflecting data from the previous business day.

Why SOFR Replaced LIBOR

Until 2008, the financial world relied on LIBOR — a rate that was based on what banks said they would pay each other. The problem? It was not a real rate, but just an assumption. When the financial crisis struck, it became clear that LIBOR could be manipulated. Banks lied about their rates to appear more stable — it was a scandal.

SOFR emerged as an alternative based on actual, recorded transactions. There is no subjectivity, no room for deception. By 2023, LIBOR was almost completely phased out, and SOFR became the main benchmark for dollar-denominated financial operations worldwide.

Why Averages and Indexes Are Needed

The overnight SOFR rate is great for short-term operations, but what if you need a rate for a month, three months, or a year? This is where averages and the SOFR index come into play.

The average values ) for 30, 90, or 180 days ( smooth out the fluctuations of the daily rate, providing a more stable indicator for mortgages and long-term loans. The SOFR index, launched in 2018, tracks the cumulative value of the rate over time — this simplifies calculations for complex financial transactions.

Where SOFR is Used in Real Life

Today, the rate underlies many financial instruments:

Loans and Mortgages — from small business loans to mortgages with a floating interest rate.

Complex derivatives — swaps, futures, and other contracts that institutional investors trade to manage risks or for speculation.

Securities — mortgage-backed securities and bonds often use SOFR as a benchmark.

Consumer loans — some student loans and auto loans are also tied to SOFR.

SOFR Futures: a tool for hedging and speculation

At the Chicago Mercantile Exchange )CME(, futures on SOFR are traded — standardized contracts based on the expected average rate. They allow market participants to either hedge against risk or bet on future rate fluctuations.

There are two main types:

Monthly futures track the average value of SOFR for the month. One basis point )0.01% change( is worth $25.

Three-Month Futures - are based on a three-month average. One basis point is worth $12.50.

How do they work? Contract price = 100 minus the expected SOFR rate. As market expectations change, the value of the futures contract also moves. CME makes daily adjustments to ensure that no one finds themselves in a losing position due to sharp market movements.

What are they needed for?

• Banks hedge credit risks based on SOFR
• Investors receive information about future interest rates
• Futures support the development of SOFR forward rates, which are necessary for replacing LIBOR in contracts.

Comparison of SOFR with Other Rates

SOFR vs LIBOR: SOFR is based on actual transactions, while LIBOR is based on subjective assessments. SOFR has a broader scope and is more resistant to manipulation.

SOFR vs Federal Funds Rate: SOFR covers secured borrowings in the REPO market, while the federal funds rate reflects unsecured interbank loans. SOFR is considered safer due to the collateral.

SOFR and global rates: €STR ) for euros ( and SONIA ) for British pounds ( play a similar role in their currency zones. SOFR remains the standard for dollar transactions due to its linkage to US Treasury bonds.

SOFR and Cryptocurrency Markets: The Invisible Link

Although SOFR is not directly traded on cryptocurrency exchanges, it has an indirect influence on the crypto markets. This rate reflects the conditions in the money market and overall liquidity in traditional finance.

When SOFR rises, it is a signal: borrowing becomes more expensive, and investors seek less risky assets. At such a moment, demand for cryptocurrency may decrease as people are attracted to bonds and other conservative instruments.

If the Federal Reserve tightens monetary policy and SOFR spikes sharply, cryptocurrency prices often fall. Investors choose proven assets with guaranteed returns.

The opposite situation: low SOFR = abundance of cheap money. Speculative assets, including cryptocurrencies, become more attractive.

Futures prices for SOFR on CME serve as an indicator of the expectations of major market players regarding future interest rates. This indirectly influences the sentiments of participants and cryptocurrency trading.

Main Advantages of SOFR

• Reality over fiction — the stake is based on actual transactions, not assumptions.
• Stability — with a daily volume of over ) trillion, even extreme trades cannot artificially distort the result.
• Minimal risk — the collateral in the form of US Treasury bonds ensures reliability
• Global recognition — approved by the Alternative Reference Rates Committee $1 ARRC( and complies with international standards.

Where SOFR Falls Short

• Overnight only — this indicator is only for one-day funding; average calculations are required for longer periods.
• Transition costs — migrating from LIBOR required updating thousands of contracts and systems.
• Volatility during stressful periods — SOFR may rise sharply if there is tension in the market, although it remains more reliable than alternatives.

Withdrawal

SOFR is a revolution in the field of financial benchmarks. The transition from the subjective LIBOR to an objective rate based on actual transactions did not happen by chance, but as a result of the need to restore trust in the financial system after the 2008 crisis.

Today, SOFR is the standard for loans, bonds, derivatives, and many other instruments. SOFR futures provide participants with the flexibility to manage risks. The indirect influence on cryptocurrency markets shows that even traditional financial rates shape sentiments in the decentralized world of assets.

Thanks to the transparency, reliability of collateral, and support from the largest financial regulators, SOFR will remain the primary benchmark for dollar-denominated debt transactions for many years.