Voltz: Interest Rate Swaps for Volatile Yields

The current interest rate derivatives market size in traditional finance in terms of notional amount outstanding is currently $500 trillion, and any protocol that is able to bring even a portion of that on-chain will stand to benefit greatly. Voltz is a non-custodial automated market maker for Interest Rate Swaps (IRS). Voltz uses a concentrated liquidity virtual AMM (CL-vAMM) for price discovery, with a margin engine handling the settlement of these trades.

Concentrated Liquidity Virtual AMMs

First popularized by Perpetual Protocol, a vAMM means that no real assets are stored inside the AMM or its liquidity pools. Instead, the assets being traded are stored in another smart contract that manages the collateral that backs the vAMM. As a result of this, vAMMs are simply a price discovery mechanism and not for spot trading.

When a vAMM pool is initialized, the amount of liquidity in the pool is defined by the protocol. The protocol sets k, the liquidity constant within the x*y=k function, that determines slippage when a given trade is executed. Thus, liquidity providers are not required for a vAMM, and instead any realized PnL will come from the collateral of traders trading against each other. Simply put, the traders provide liquidity to each other. Given that liquidity within the pool is virtual and traders open trades based on their collateral, traders are able to open leveraged positions in a vAMM in comparison to a normal spot AMM.

In order to incentivize the price of a vAMM to trade closely to the price of the underlying asset, most vAMMs have a funding rate mechanism similar to a perpetual futures exchange. In order to mimic the liquidity of various markets, a vAMM may opt to dynamically change the value of k based on various factors such as volume, open interest, funding payments, and volatility. A higher value of k will result in less slippage while a smaller value of k will result in larger slippage. It is important to note that the k constant is fairly arbitrary and can be changed at any time depending on a protocol’s contract configuration or governance process.

Most AMMs we are familiar with are for users to trade spot tokens such as ETH and USDC. In order for users to trade interest rates, Voltz introduces two tokens to represent fixed and variable rates.

1. 1% virtual fixed tokens: These tokens represent 1% of the fixed rate on an underlying token. Thus, if a user holds one hundred 1% virtual fixed tokens, then assuming the expiry of the IRS pool is exactly one year, the user can claim exactly 1 token of the underlying fixed rate.