Element Finance – The Latest “fixed interest rate” DeFi Protocol

Element Finance (https://www.element.fi/) is the latest entrant to the fixed-interest space that seems to draw many DeFi entrepreneurs recently. Its modus of operation is fairly simple: users deposit LP tokens (most of the currently offered options are based on Curve, however other LP venues can be supported in the future) to Element pools who yield farm on Yearn vaults in the background. The innovation here (that justifies the additional middleman between users and Yearn) is that Element mints two separate tokens for depositors: a Y token (interest token) and  a P token (principal token). 

 

When users deposit their Curve LPs they get to choose from an existing list of Tranches. Each tranche represents a specific Yearn vault/Curve pool, as well as a specific timeframe for maturity (i.e. a tranche can be based on CurveTriCrypto pool, maturing on September 31st). The Y and P tokens minted for depositors to this tranche, can be redeemed for the underlying curve LP token only at maturity. They can however, be freely traded for their underlying token on specially designed Balancer pools, for a price determined by the balancer pools AMMs. 

 

Principal tokens are typically traded at a discount (in relation to the amount of LPs to be redeemed at maturity), thus forming a sort of a fixed-rate interest for buyers, who earn the diff between what they paid and what they can redeem at maturity. Sellers can then take the underlying LP token and re-deposit to Element, thus creating a sort of leverage to their initial investment. This process can be repeated by risk-prone investors to achieve up to 10x leverage according to the documentation. Y tokens can be traded too. In the case of the Y tokens, the current price can represent the currently expected interest to be collected at maturity (based on the current yearn vault APY for example) with a certain discount compensating for the risk of the vaults performance decreasing before maturity time. 

 

The principle behind Element.fi is not new and quite common among the fixed interest DeFi protocols: Risk averse investors are expected to buy in to the opportunity for a fixed rate, less risky investment stream (buying principal tokens) while the more adventurous investors are subsidizing these fixed rates for the chance of a higher profit.

 

How is started, how it’s going

 

If the current trading volume on Element.fi’s first 5-6 initial tranches is any indication, it’s not going extremely well. It could be that Element’s lack of ‘to the moon’ token (which I personally view as a positive indicator) denied it an initial devoted community of active users. Whatever the reason may be, trading volume is low and sporadic, indicating that most likely the current minters/liquidity providers and either of the team or affiliated with it. 

 

Are DeFi users truly looking for safe, conservative interest?

 

That seems to be a basic assumption with everyone trying to create a low risk fixed interest DeFi venue. That, plus the ever prolonging wait for institutional/tradFi users to enter the DeFi market are the premise behind the business assumption that fixed rate has a market on DeFi. However, it does seem that the current DeFi user market attracts the exact opposite: risk prone investors looking for x100’s opportunities and willing to take enormous risks for it. We may be years away from those risk averse moms and pops showing up at the doors of DeFi looking for a safe 10% APR investment channel for their retirement funds. Part of the reason is that: A. the base assets on which said interest is accrued are still highly volatile, making these “safe” investment tracks not so safe at all. B. Protocols such as Element entail huge amounts of risk unrelated to the underlying tokens. They are all based on new, untested technology, and are brought to market in the true spirit of DeFi innovation, that is, hastingly, and with a “let’s see what happens” attitude. While these inherent risk are seldom mentioned in DeFi circles and are swept under the rug in the marketing collateral of projects such as Element, they are nonetheless present and real. This contradicts “safe investor” use cases and my conclusion is that at least in the near 2-3 year future, we’ll only see true traction with DeFi projects that offer at least a hope of life changing upsides. 

 

The days of the conservative investor will arrive at DeFi’s gates eventually, however DeFi still has a long way to go before they do.