Skip to main content

Interest Rate Tranches

Our first primitive, Interest Rate Tranches, serves as a settlement layer for the tranching of yield-bearing positions to create a fixed-income and variable-yield instrument.

info

Tranching‚Äč

Tranching is a mechanism that changes the risk profile of investments by prioritizing the way in which the cash flows from these assets are returned to investors. Investors in the fixed tranche receive a prioritized return in the form of fixed cashflow. While investors in the variable tranche are offered an opportunity for amplified returns through leveraged exposure to the performance of the underlying assets.

Tranching an underlying yield-bearing position changes how the yield is distributed. This distribution follows a waterfall mechanic, which orders how the yield from a position is returned.

At the end of the investment period, the principle and fixed rate is returned to investors who subscribe to the fixed-income tranche before the remainder is passed on to investors who subscribe to the variable tranche.

Structured investments typically involve exposure to fixed income markets/derivatives. The fixed income market has the potential to be significant, but at this time, in DeFi, the market is immature. Its current status is that:

  • Many of the parameters available on different derivative instruments are static in nature. These instruments are predominantly set by the developers of protocols, leaving investors with no choice but to take it or leave it.
  • Many of the protocols offering these instruments experience fragmented liquidity as a result of having multiple maturity dates. Despite this, they continue to utilize conservation functions that cause high slippage if larger volumes are transacted under low market depth.

At Struct, we believe a tranching structure will overcome these challenges. Tranching an underlying yield-bearing position changes how the yield is distributed. This distribution follows a waterfall mechanic, which orders how the yield from a position is returned. At the end of the investment period, the principle and fixed rate is returned to investors who subscribed to the fixed-income tranche before the remainder is then passed on to investors that subscribed to the variable tranche. This distribution ultimately splits an investment position into slices, with financial terms suitable for specific investors. It also benefits the ecosystem by creating financial instruments with comparatively less risk than the underlying yield-bearing position.

Fixed rates are challenging algorithmically since they are ultimately derivatives of an underlying yield-bearing position that varies with market conditions. For this reason, our Interest Rate Tranches will expire after a specified maturity period.

When the smart contract is created, a subscription period for investors to deposit into the tranche they want exposure to will begin, and the deposit will be queued. Deposits within tranches will be invested into the underlying yield-bearing position every Friday at a specified time. These funds will stay in the position until the predetermined maturity period.

The expected returns from a variable tranche are a function of the returns of the yield-bearing position and the fixed rate set for the fixed-income tranche, and they are calculated based on the following methodology.