DeFi Second Half: Institutional Lending on the Chain and the Rise of the Interest Rate Market

Original Text: 《 Why Institutions Aren’t Coming On-Chain 》

Translation:

Original: 《 Why Institutions Aren’t Coming On-Chain 》

Translation:

Introduction: Current money market protocols (such as Aave, Morpho, Kamino, Euler) serve lenders well, but due to the lack of fixed borrowing costs, they have failed to serve a broader group of borrowers, especially institutional borrowers. Since only lenders are well served, market growth has stagnated.

From the perspective of money market protocols, P2P fixed interest rates are a natural solution, while the interest rate market offers an alternative with capital efficiency 240-500 times higher.

P2P fixed interest rates and the interest rate market are complementary, and both are vital for each other’s prosperity.

Insights from Leading Protocols: Everyone Wants to Offer Fixed Rates to Borrowers

Early-year roadmaps from various teams often set the tone for upcoming developments.

Morpho, Kamino, and Euler Finance are leading on-chain money markets with a total locked value of $10 billion. Browsing their 2026 roadmaps, one clear theme stands out: fixed interest rates.

Morpho:

[1] Morpho V2 Briefing

Kamino:

[2] Kamino’s 2026 Plan

Euler:

[3] Euler’s 2026 Roadmap

The terms “fixed interest rate” or “predictable interest rate” appear 37 times in the 2026 announcements from Morpho, Kamino, and Euler Finance. Excluding irrelevant words, this is the most frequently mentioned term in the announcements, and it appears as a top priority in all three roadmaps.

Other keywords include: institutions, real-world assets, and credit.

What’s going on here?

Early Decentralized Finance: Borrowers’ Fixed Interest Rates Are “Not Really Important”

Early DeFi was fun and experimental for builders. But for users, early DeFi can be summarized in two words: absurd speculation and terrible hacks.

Absurd speculation

From 2018 to 2024, DeFi was like a “Mars casino” disconnected from the real world. Liquidity was mainly driven by early retail investors and speculative behavior. Everyone was chasing four-figure annual yields. No one cared about borrowing at fixed interest rates.

Market volatility was intense and unpredictable. Liquidity lacked stickiness. Total collateralization ratios fluctuated wildly with market sentiment. Since demand for fixed-rate borrowing was minimal, demand for fixed-rate lending was even less.

Lenders preferred the flexibility to withdraw funds at any time. No one wanted their funds locked up for a month — because in a nascent, rapidly changing market, a month felt like a lifetime.

Terrible Hacks

Between 2020 and 2022, hacks were frequent. Even blue-chip protocols were not immune: Compound experienced a major governance vulnerability in 2021, resulting in losses of tens of millions of dollars. Overall, DeFi vulnerabilities during this period caused losses amounting to billions, deepening institutional doubts about smart contract risks.

Institutions and high-net-worth capital had limited trust in smart contract security. As a result, participation from more conservative funds remained very low.

Instead, institutions and high-net-worth individuals borrowed from off-chain platforms like Celsius, BlockFi, Genesis, and Maple Finance to avoid smart contract risks.

At that time, the phrase “just use Aave” didn’t exist, because Aave’s position as the safest DeFi protocol had not yet been established.

Catalysts for Change

I’m not sure if this was intentional or coincidental, but we often refer to platforms like Aave and Morpho as “lending protocols” — even though both lenders and borrowers are using them, there’s definitely something noteworthy here.

The term “lending protocol” is actually very fitting: these platforms excel at serving lenders but are clearly lacking in serving borrowers.

Borrowers seek fixed borrowing costs, while lenders want the flexibility to withdraw funds at any time and earn floating rates. Current protocols serve lenders well but fail borrowers. Without fixed-rate borrowing options, institutions won’t borrow on-chain, and bilateral market growth stalls — which is why these platforms are actively working on building fixed-rate features.

Even if this structure is extremely favorable to lenders, change often stems from user pain points or product improvements. Over the past year and a half, DeFi has accumulated significant experience in both areas.

Regarding pain points, fixed-income cyclic strategies are repeatedly hurt by fluctuations in borrowing costs, and the spread between off-chain fixed rates and on-chain floating rates continues to widen.

User Pain Point 1: Fixed Income Cyclic Strategies

Traditional finance offers a rich array of fixed-income products. DeFi only started to have such products around 2024, when Pendle and liquidity staking protocols began splitting ETH staking yields.

When looping fixed-income tokens, the pain caused by interest rate fluctuations becomes obvious — the 30-50% APY promised by cyclic strategies is often wiped out by rate volatility.

I personally tried to automate opening and closing positions based on rate movements, but each adjustment incurred multiple costs: underlying yield sources, Pendle, money markets, and Gas fees. It’s clear that volatile lending rates are unsustainable — they often turn my returns negative. Pricing borrowing costs based on on-chain liquidity dynamics introduces volatility far beyond acceptable levels.

This pain is just the beginning of private credit on-chain. Most private credit prefers fixed rates because real-world business activities require certainty. If DeFi wants to evolve beyond a “Mars casino” disconnected from real economic activity and truly support meaningful commercial activities (like GPU collateralized loans and credit for trading firms), fixed rates are inevitable.

User Pain Point 2: Widening Spread Between Fixed and Floating Rates

Because lending protocols provide excellent service to lenders — flexible withdrawals, no KYC, and easy programmable operations — on-chain lending liquidity has steadily grown.

[5] Aave TVL historical chart. The growth rate of this chart is about twice the increase in Bitcoin price.

As lending liquidity increases, floating borrowing rates on these protocols decline. While this seems beneficial for borrowers, it’s largely irrelevant for institutional borrowers — who prefer fixed-rate loans and are obtaining them through off-chain channels.

The real market pain is the ever-widening gap between off-chain fixed borrowing costs and on-chain floating rates. This gap is substantial. The average premium paid by institutions for fixed-rate borrowing is 250 basis points (bps), and for blue-chip altcoins collateral, the premium can reach up to 400 bps. Based on a 4% Aave baseline rate, this represents a 60-100% premium.

[6] Aave ~3.5% vs Maple ~8%: Fixed-rate loans collateralized with crypto assets carry an approximately 180-400 bps premium.

The flip side of this gap is the compression of on-chain yields. Because the current lending market structurally favors lenders, more lenders are attracted than borrowers — ultimately harming lender returns and capping protocol growth.

Product Progress: DeFi Becomes the Default for Lending

In terms of development, Morpho has integrated into Coinbase as a major revenue source, while Aave has become a pillar for protocol treasury management, retail stablecoin savings, and new stablecoin banking. DeFi lending protocols provide the most convenient way to earn stablecoin yields, with liquidity continuously flowing on-chain.

As TVL increases and yields decrease, these protocols are actively iterating, thinking about how to also become excellent “borrowing protocols” to serve borrowers and balance the bilateral market.

Meanwhile, DeFi protocols are becoming increasingly modular — a natural evolution from Aave’s “all-in-one” liquidity pool model (note: I believe the pool model will still have long-term, ongoing demand — that’s a topic for future articles). With Morpho, Kamino, and Euler leading modular lending markets, loans can now be more precisely tailored based on collateral types, LTV (Loan-to-Value), and other parameters. The concept of independent credit markets has emerged. Even Aave v4 is upgrading to a hub-and-spoke modular market structure.

This modular market structure paves the way for new collateral types (Pendle PTs, fixed-income products, private credit, RWA), further amplifying the demand for fixed-rate borrowing.

Mature DeFi: Money Markets Thrive Through Interest Rate Markets

Market Gap:

Borrowers strongly prefer fixed rates (off-chain services are good) > Lenders strongly prefer floating rates and flexible withdrawals (on-chain services are good)

If this gap isn’t bridged, on-chain money markets will remain at their current scale and won’t expand into broader money and credit markets. Bridging this gap has two clear paths, which are not mutually exclusive but highly complementary and even symbiotic.

Path 1: Managed P2P Fixed Rates

The P2P fixed-rate model is straightforward: for every fixed-rate borrowing demand, an equal amount of funds is locked for fixed-rate lending. While elegant, this model requires 1:1 liquidity matching.

According to the 2026 announcement, all major lending protocols are building toward P2P fixed-rate solutions. However, retail users won’t lend directly to these P2P fixed-rate markets for two main reasons:

2. They value withdrawal flexibility;

3. They face too many independent markets to evaluate and choose from.

Therefore, only liquidity currently deployed in risk management vaults can be lent to these fixed-rate markets — and even then, only a portion. Risk management vaults must retain sufficient liquidity to meet depositors’ immediate withdrawal needs.

This creates a tricky dynamic game for risk management vaults that need to meet instant withdrawal demands:

When deposits surge and vault liquidity is insufficient due to funds being locked in fixed-rate loans, the vault lacks mechanisms to curb withdrawals or encourage deposits. Unlike money markets with utilization curves, vaults are not designed to maintain withdrawal liquidity. More withdrawals do not generate higher yields for the vault. If the vault is forced to sell its fixed-rate loans on the secondary market, those loans are likely to trade at a discount — potentially leading to insolvency (similar to the Silicon Valley Bank dynamics in March 2023).

To mitigate this tricky dynamic, risk management vaults prefer to do what traditional lending institutions do: swap fixed-rate loans for floating rates via interest rate swaps.

They pay fixed rates into the swap market and receive floating rates in return, avoiding the risk of being locked into low fixed rates when floating rates rise and withdrawals increase.

In this scenario, institutional lenders and risk management vaults use the interest rate market to better provide fixed-rate liquidity.

Path 2: Interest Rate Market Based on Money Markets

The interest rate market does not directly match fixed-rate lenders and borrowers. Instead, it matches borrowers with funds willing to compensate the spread between “agreed fixed rate” and the “floating rate generated by the money market utilization curve.” This approach offers capital efficiency 240-400 times higher than the 1:1 liquidity match required by P2P.

The logic of capital efficiency:

Borrow 100 million (USD) at floating rates from existing Aave liquidity; the borrower wants to convert this floating rate into a one-month fixed rate loan. Assuming a fixed rate priced at 5% APR; 100m * 5% / 12 = 416k; interest rate swaps achieve an inherent leverage of about 240x (100m / 416k).

Morpho

Interest rate exchanges help hedgers and traders price and swap fixed and floating rates.

A money-market-based interest rate exchange cannot offer pure fixed-rate loans like P2P — if rates spike tenfold and stay high long-term, hedgers might face automatic deleveraging (ADL) risk.

However, this scenario is extremely unlikely and has never happened in Aave or Morpho’s three-year history. Interest rate exchanges can never fully eliminate ADL risk, but they can implement multiple layers of protection — such as conservative margin requirements, insurance funds, and other safeguards — to reduce it to negligible levels. This trade-off is very attractive: borrowers can access fixed-rate loans from proven, high TVL money markets like Aave, Morpho, Euler, and Kamino, benefiting from 240-500 times higher capital efficiency than P2P markets.

Path 2 reflects traditional finance — daily $180 trillion in interest rate swap trading fuels credit, fixed-income products, and real economy activities.

This combination of proven money market safety, $30 billion in existing protocol liquidity, appropriate risk mitigation, and excellent capital efficiency makes interest rate exchanges a pragmatic path for expanding fixed-rate lending on-chain.

Exciting Future: Connecting Markets and Expanding Credit

If you’ve read through the dry mechanisms and market microstructure above, I hope this section sparks your imagination about future development paths!

Some predictions:

1. Interest rate markets will become as important as existing lending protocols

Since borrowing mainly occurs off-chain and lending mainly on-chain, the market remains incomplete. Interest rate markets connect borrowing and lending by catering to different preferences, greatly expanding the potential of existing money market protocols and becoming an indispensable part of on-chain money markets.

In traditional finance, interest rate markets and money markets are highly complementary. We will see the same dynamic play out on-chain.

2. Institutional credit: interest rate markets will become the backbone of credit expansion

Disclaimer: Here, “credit” refers to unsecured or undercollateralized money market lending, not overcollateralized modular markets (like Morpho Blue).

The dependence of credit markets on interest rate markets is even greater than on overcollateralized loans. When institutions finance real-world activities (like GPU clusters, acquisitions, or trading operations) via credit, predictable funding costs are crucial. Therefore, as off-chain private credit and RWA expand, interest rate markets will also develop.

To connect off-chain real-world yield opportunities with on-chain stablecoin capital, interest rate markets are a more critical pillar of on-chain credit expansion. @capmoney_ leads in institutional credit lending, and I am closely watching their team to understand the future direction of this industry. If you’re interested, I recommend following them too.

3. Consumer credit: everyone will have “borrow-to-consume” privileges

Selling assets triggers capital gains tax, which is why ultra-high-net-worth individuals almost never sell assets; they prefer to borrow to consume. I can imagine that in the near future, everyone will have the privilege of “borrowing to consume” instead of “selling to consume” — a privilege currently reserved for the super-rich.

Asset issuers, custodians, and exchanges will be highly motivated to issue credit cards that allow people to collateralize assets for borrowing and direct spending. For this system to operate on a fully self-custodied stack, decentralized interest rate markets are essential.

@EtherFi’s credit card has pioneered collateralized consumer credit, growing 525% last year, with a peak daily transaction volume of $1.2 million. If you haven’t tried EtherFi’s card yet, I highly recommend exploring “borrow-to-consume”!

Finally, I want to point out that fixed interest rates are not the only catalyst for money market growth. Many issues can only be solved by money markets — such as supporting off-chain collateral and RWA-based redemption mechanisms for oracles used in cyclic strategies, etc. Challenges lie ahead, and I am genuinely curious and hopeful to contribute to the evolution of this market.

If you’ve read this far, thank you for exploring the details of this fascinating market with me!

At @SupernovaLabs_, we are obsessed daily with the subtle nuances of this market’s evolution. We aim to be a pillar supporting existing lending protocols, helping them better serve the borrowing side of the market. We believe this will unlock borrowing demand, drive credit expansion, and become an integral part of the on-chain economy. The opportunity is right in front of us, and the time is now. Next week, we will have more announcements about product launches.

[1] Morpho v2:_

[_2] Kamino The Next Chapter:

[_3] Euler’s 2026 Roadmap:

[_4] Casino on Mars:

[_5] DefiLlama: Aave TVL

[_6] Maple Finance Yield:__https://maple.finance/app