Diving into Fixed Interest Rates Protocol with Teddy Woodward, CEO and Co-founder of Notional Finance - Ep. 41

Bobby Ong [00:00:00]: 
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Benjamin Hor [00:00:35]:
Hello everyone, my name is Ben. I'm an analyst from CoinGecko and welcome to the CoinGecko podcast. Today, we are having Teddy Woodward, co-founder and CEO of Notional Finance. If you are watching this on YouTube, we at CoinGecko really appreciate if you hit the like and subscribe button below. So before we start the podcast episode, here's a little bit about Teddy Woodward. Teddy, is a former interest rate swap trader at Barclay's in London, but his interest shifted to crypto after realizing that there wasn't much innovation happening in the traditional banking sector. The success of Compound in 2019, Teddy saw an opportunity to build a DeFi yield curve and bring the hundred trillion dollar fixed rate lending market to DeFi. So you set about doing just that with his co-founder Jeff Wu, who he met at the 2019 SF hackathon, where they won first price with a fixed rate concept. Welcome to the CoinGecko podcast, Teddy. 

Teddy Woodward  [00:01:30]: 
Thanks for having me Ben, excited to be here. 

Benjamin Hor [00:01:33]: 
Yeah, that's great. So let's just get into it, right. Without getting too technical, can you give us a simple explanation of what Notional Finance is?

Teddy Woodward [00:01:41]: 
Sure. So, so Notional is a decentralized protocol built on Ethereum that enables users to borrow and lend crypto assets at fixed rates of interest. So you can think about it, it's kind of like Compound, but if Compound had fixed rates. 

Benjamin Hor [00:02:01]: 
All right. How does Notional ensure that its products achieve fixed interest rates? Cause I think that Steve differentiated crux of the lending system, right?

Teddy Woodward  [00:02:10]: 
Yeah, that's right. That's right. So, okay. So basically the core concept here in notional is, is what we call F cash F cash is, it's kind of like a zero coupon bond. A lot of people like to think about it that way. So it is defined by a currency type and a maturity date. So for example, December 1st, 2021 USDC is an F cash token. Now that F cash token is transferrable. You can trade it, you can transfer it, you can do anything. And on maturity, so on December 1st, 2021, you can redeem it for one USDC on Notional. You can think about that as representing USDC at a specific point in the future, so on its maturity. Basically the way we achieve fixed rates, is by allowing users to trade between USDC today, and USDC in the future. The rate at which you trade USDC today for USDC on December 1st implies a fixed interest rate over that period of time. So, for example, if you sell 99 USDC today in order to purchase a hundred USDC on December 1st, that's about a 6% annualized interest rate.

Benjamin Hor [00:03:30]: 
All right. So just to add on a little bit you mentioned all this dates, maturity dates, who comes out all of these maturity dates for now, right? Who sets the date?

Teddy Woodward [00:03:38]: 
Basically like, it's a governance function. So like the way notion would be to works is, we have three month, six month and one year pools at launch. And I'll just preface this a little bit by saying that Notional V2 we expect to launch in, in early November. So it's quite possible that if you're listening to this podcast, Notional V2 is already live. So I'm going to, I'm going to talk about Notional V2 as opposed to Notional V1. So in Notional V2 we have three month, six month, and one year pools at launch and every three months, you know, those pools mature and they roll forward. So it's basically like the, the way the maturity dates are governance decided essentially. 

Benjamin Hor [00:04:19]: 
Okay, interesting. I guess this brings me to the next question right? You mentioned a little bit of V2. Could you elaborate more about what else can we expect with a Notional Finance V2? 

Teddy Woodward  [00:04:29]: 
Yeah. Yeah. So I think there's a lot that's different and a lot that's better in Notional V2 than Notional V1. So the first thing is that users will be able to borrow and lend for up to one year. So as I said, we're going to launch with three month, six month and one year maturity. Which is a big upgrade to notional V1, where we only had three month and six month maturities. And so we decided to extend that maturity horizon, because we got overwhelming interest in Notional V1 for longer maturity date. People were much more interested in the six month maturity than they were in the three month maturity. And you know, something that's really cool about Notional V2 is that, you know, while we're only launching with three months, six month and one year pools, we have designed it such that it can support maturity dates out to as far as 20 years. So like it's a long-term ambition here. Now we, of course, we're not going to get to 20 years immediately, but we do expect to activate, two year, five year and maybe even 10 year maturities, like before too long. Yeah. So what kind of act turn those on as we see end user demand for longer dated maturities. So, so that's one thing that's new in Notional V2. And another thing that's new is the Notional V2 provides a much better and, and I think very, very attractive experience for liquidity providers Notional V2 introduces these things called N tokens. So what end tokens do, it's Notional's liquidity token, and what it does is it gives liquidity providers a high yielding, freely redeemable, and totally passive way of providing liquidity to notional, which if you're familiar with Notional V1, is a really, really big improvement because in notional V1, liquidity providers had to select a particular maturity that they wanted to provide liquidity into. And then upon maturity, they had to go roll their liquidity forward into a new maturity, and it was a real hassle. Now Notional V2 we've integrated with Compounds, so liquidity providers are automatically earning the compound interest rate on top of liquidity fees, so they're earning more yields and tokens automatically, so they don't have to do any engagement with the individual liquidity pools at all. They just deposit their capital receive N tokens, and don't have to do anything else. And another thing is that end tokens are incentivized by our liquidity mining program with our governance token. So basically like liquidity providers of Notional V2 and have an awesome time because they earn higher yields from a Compound integration, get an ERC-20 assets that is totally passive. They earn governance, token incentives, and they can borrow against their N tokens on Notional because it's natively eligible as collateral. That's like a really big improvement and I think that that's going to drive a major sort of increase in, in Notional's TVL.

Benjamin Hor [00:07:22]: 
Yeah, I guess that's like a part of a larger trend now where everyone is trying to expand capital efficiency. And this is one of the other ways that, you know, we are going deep in the capital efficiency hole. Really cool. So, all right. I guess my next question is, are there any interesting stats or data that you can share for Notional maybe for the past year or so, or since V1?

Teddy Woodward [00:07:40]: 
Yeah, so I, I can share a really, an interesting anecdote. Which I think is like a,a really cool thing about Notional V1. So we actually executed, you know, people call it the first DeFi mortgage. And basically what happened is, is one of our users had, so he lives in Australia. And he had a mortgage with the Commonwealth bank of Australia. And now he's really interested in DeFi, but he didn't want to borrow on Compound or AAVE because the rates were so variable. And so what he did was he borrowed about 500,000 USDC against his ETH on Notional, took that USDC and paid off his mortgage with the Commonwealth bank of Australia. Yeah, yeah so basically he took his debt in the regular financial system and transferred it onto Notional, which is really cool. And you know, hopefully is I think in Notional V2, you know, we could see a lot more of that. So I'm, I'm very excited. 

Benjamin Hor [00:08:36]: 
I mean, yeah, that's really cool. It's one, you know, for a lot of people that they think, oh, DeFi's in their own world, but this is like a first real use case. You know, where people from the trad-fi or real world per se, come into crypto. I guess then that brings me to the next question, right? Notional, it's quite interesting because you guys are building a fixed rates protocol by you're not the only one in the space. Out of the top of my head, I can think of others like 88mph. A closer example would be Yield. Could you explain the key differences between Notional and your other competitors, if any, at all?

Teddy Woodward [00:09:08]: 
Ah yeah, sure. So I think like the first thing is just to zoom out a little bit. So, you know, there's a few categories of protocols that are trying to deliver fixed rates. Ourselves, and, Yield are actually kind of like, so we were kind of like the original fixed rate protocols and there have recently sort of newer protocols that kind of sprang up, which you've taken a little bit different of approach. So most of the newer fixed rate protocols stuff like you know, Pendle or, or Element these focus exclusively on lenders. So they allow people to lend their crypto at a fixed rate and they don't allow people to borrow crypto at a fixed rate. And so like that, like on Notional of course we allow you to do both. And so that is a key advantage and differentiating factor that I think we have versus the majority of the fixed rate protocols out there, you can both lend your crypto and you can borrow at fixed rates. And so I think that that's like, you know, that's, again, it's a key advantage that we have. And then to Yield specifically because they are sort of basically the only protocols that allow you to borrow at fixed rates are ourselves and Yield, and that's because we're, you know, somewhat similar in construction. But I would say that like a pretty key differentiator between ourselves and Yield is those N tokens that I was talking to you about, you know, just a couple of minutes ago. So we, we realized that, you know, a key barrier to Notional's growth in V1 was that liquidity providers like it wasn't good enough for liquidity providers and liquidity providers are absolutely critical, right? And so we, weren't doing a good enough job of giving them a good opportunity, N tokens really, really do that. And Yield does not have an equivalent. So they still rely on, you know, liquidity providers having to put liquidity into a particular maturity that maturity expires. They have to roll their liquidity. They have to do all the nasty stuff that that I talked about earlier. And so I think N tokens are going to be a key advantage for all the reasons I said earlier. And also, because they are ERC-20, so they're going to be really easy to integrate with other DeFi applications, which is, again, also really important.

Benjamin Hor [00:11:20]: 
I guess the key advantage is to be the customer journey, right for LP providers. It's not a big hassle, and even gas fees as well it can be a pain doing all that mini transactions over and over.

Teddy Woodward [00:11:30]: 
Yeah, yeah, yeah, yeah, absolutely. Absolutely. You know, something that I think is really cool that I, I hope we're going to see a lot of is that on Notional V2 because N tokens or collateral you can actually, like, let's say you're a borrower and you want to borrow USDC against your ETH. You can take your ETH, mint N-ETH so provide liquidity with your ETH on Notional and then borrow against that liquidity that you've provided. So instead of having your ETH just sit there earning nothing, your ETH can be earning the Compound interest rate, the liquidity fees on Notional and note incentives. So it's like, yeah. So it's just turning a dead asset into like a high returning one as your collateral, which is I think, I think, you know, really cool. And I think we're, you know, I hope that we're going to see a lot of that.

Benjamin Hor [00:12:17]: 
Yeah. Yeah. I mean, that's it's basically optimizing your capital right. In the best way possible, which brings me to the next point actually. We, we talk a lot about fixed interest rates right, and how it's actually a growing niche in the industry, but why are fixed interest rates so important?

Teddy Woodward [00:12:32]: 
That's a, that's a great question. And you know, what I would say is like fixed interest rates, you know, ultimately they offer people stability, certainty, and the ability to plan for the future. So you know, that sounds all like, kind of a bit abstract, but it's really important. And you know, you can see like, if you look at traditional financial markets the vast majority of debt is issued at fixed rates of interest as opposed to variable rates of interest. And just what that shows you empirically is that people like much prefer to know exactly what they're going to be paying and what they're going to be earning rather than have that uncertainty. So you can see empirically that people think it's really important. You know, we can think of like a tangible example. So like imagine you're taking out a loan, like, so imagine you're, you're taking a mortgage right. So you, you want to buy a home and you're getting a mortgage it's 30 year mortgage. If you weren't using a fixed rate, you were instead using a DeFi variable rate, right. So, so you might have like one month, you're paying $500 of interest. The next month you're paying $5,000 of interest. It's just wildly variable, you know, maybe that's okay if you're only borrowing for like a month or, you know, a week or a month at a time, but no way are you going to sign up for that, that kind of volatility for 30 years. I mean, you just can't. It just, doesn't like, it's not going to work with like people and businesses sort of lives and, and how they do, you know, how they live and how they do business. Yeah. So that's like a tangible example right. And, and it just demonstrates the fact that like, you know, when you talk about longer and longer timeframes, the value of fixed interest rates just increases. It gets more and more important. 

Benjamin Hor [00:14:16]: 
I guess this, this is really crucial now, right? Because crypto is quite small at the moment, which actually brings me to my next point. In the industry, like our Q3 2021 report by CoinGecko, we kind of looked at the fixed interest rates. Just looking at the tokens and we estimated to be roughly valued at 200 million, although there's not really reliable indicator, this suggests the fixed interest rates segment is still very small, right. What are your thoughts on this? 

Teddy Woodward [00:14:42]: 
Yeah, so, I mean, I think that I would say a couple of things, you know, first of all, I would say that you know, a lot of the, the sort of the major projects in this space have not yet issued a token. So you know, ourselves and, and some of our competitors, we don't have a token. So those that value is not represented. The, the other point I'd make is that you know, we're just like, it's easy to forget, but DeFi hasn't been around for all that long. We're very early. So I would say that fixed interest rate protocols are just more complicated than variable rate lending protocols. And it's very, it's challenging from both a technical standpoint and an economic design standpoint to get something that works well for everyone. And, and just really nail the design. You know, I believe that Notional V2 has a very strong design, that is, you know, poised to be successful, but it took us time. Right? So, so notional, like we've been around for almost two years now. You know, it took us a year to, to launch Notional V1. We got good traction on that, but we also kind of, for some of the reasons that I talked about earlier, we knew that we had to launch a second iteration to really succeed. So, you know, it's taken almost two years to get to a point where we think that we have the design fully nailed down and fully secure and ready to go. So I think it's just like, it's really more than anything, it's just, it's early. That's what I would say. 

Benjamin Hor [00:16:00]: 
So moving back a little bit, cause you mentioned earlier that the industry for the fixed rate market in trad-fi world is huge, right? It's the biggest market for the finance. Do you believe that there is a knowledge gap for fixed interest rate products in crypto because they often seen as sophisticated financial instruments. I mean you yourself just mentioned. And if so, how would you recommend bridging the gap? 

Teddy Woodward [00:16:21]: 
Yeah. Yeah. Okay. So I think that, I, I would say that there is a knowledge gap here and you're right. I, I do think that they're just more sophisticated. However, you can package these things up in a way that like, does not require the user to like really understand, and, and get all of the intricacies. So, you know, as a user it's actually not that complicated, right? If you want to lend for a year, you're getting a 7% fixed interest rate for a year. That's all there is to know right there, there isn't you, you know, that you're putting in a hundred dollars right now and you're going to get $107 a year from now, that's it. Right. It's not complicated. And, and I think that, you know, what we've tried to do with Notional V2 is like abstract away as much of that complexity as we possibly can and I think we've done a pretty good job. So, you know, like I'll bring up the N token example again. Right? So as the liquidity provider, you just put your money in and you hold this N token and that's it. Right. It's again, it's not complicated. All this sort of complicated stuff is sort of like handled on the backend for you.

Benjamin Hor [00:17:21]: 
Yeah.

Teddy Woodward [00:17:22]: 
Right. So I think that that's, that's important and that's taken us time to do that, but I think that that's like a, it's a way to sort of like make these products more accessible. 

Benjamin Hor [00:17:30]: 
Okay. That's cool. Moving back to Notional V2, right? I guess earlier you mentioned a little bit about the NOTE Token, and how there'll be a governance token as well. Want to get your thoughts on as a whole, why is this important. And more generally, what are your thoughts on governance tokens in general, in the space where we see a lot of protocols, for example, that the most recent one is dYdX issuing governance tokens, and it was doing really well what are your thoughts?

Teddy Woodward [00:17:54]: 
Yeah. So I think that they're I think they're pretty, pretty important. So I think, you know, first of all, something that every DeFi protocol has to contend with is smart contract risk. It's something that every, you know, every protocol knows, is aware of all the users hopefully are aware of, you know, it's a real risk, right? For everyone. You know, so as a new DeFi protocol, you're asking people to put their money into a system, which, you know, you've tested, you've gotten audited by all these auditors. You've, you've been testing it internally, but it's still like untested in the wild, right? So there's, there's risk with that. And governance tokens allow you to sort of compensate your early users for taking that risk, right? And, and people need to be compensated for, for taking risks. So I think that, you know, the governance token, it provides like a critical function there. You know, another thing that I think is really important for something like Notional anyway, is that having a governance token, like gives us a way to incentivize people, like not only just to provide liquidity to the platform, but also to build, because you know, Notional is totally open source. It's a decentralized protocol, and we want people to integrate with Notional, to build products and services and tools on top of Notional. And the governance token gives us a really good way to encourage that behavior by incentivizing it with something that has financial value, as well as like aligning incentives between ourselves and the people who, you know we'll be building products and services on top of Notional. And so I think that, that is, that is pretty, pretty crucial as well as just like, like allowing your, your community to sort of share in the success of the protocol, because the community like beyond just the people that are building products and services. The community is very, very important in, in like helping people, promote awareness of the protocol. And, and it's, it's important to have a way such that they can share in the protocol's success. So I think that yet governance tokens are really important for coordinating just a large group of different kinds of people to all push in the same direction.

Benjamin Hor [00:20:02]:
Ya I, I completely agree. Could you just share a little bit about what your governance token NOTE, will entail? Yeah, what's even going to be use for?

Teddy Woodward [00:20:09]: 
Sure. You know, it's a governance token, right? So it's going to be the kinds of votes that will be taken will be things like setting risk parameter, onboarding new collateral types, upgrading the actual smart contracts and that sort of its governance function. Now the governance token will also like, so every time someone lends or borrows on Notional V2 the protocol captures a small transaction fee. That transaction fee flows to the protocol's reserves. So the governance token sort of implicitly controls those reserves. So we'll be able to like determine, you know, how the treasury is managed, how the protocol's reserves are managed. So it's going to be like, you know, like it's, it's going to be an important part of that ecosystem. Yeah.

Benjamin Hor  [00:20:51]: 
All right. So I guess this, now just moving on to a more abstract question, right? So Notional optimally offers a defy lending product. What advantages or disadvantages do you see with Notional over other traditional lending products? Like maybe not just variable products, variable lending interest rates, maybe bonds or anything like that at all.

Teddy Woodward [00:21:08]: 
So you know, we've talked, we've talked enough about kind of fixed rates versus variable rates. So I think that like, let's, let's compare a Notional to something like BlockFi or, or a Celsius or something like that. You know, I think that a lot of like a lot of what makes Notional, in my opinion, a superior product is, is sort of just the general qualities of DeFi, right. Which is. You're not taking counterparty risks. You know, if you're, if you're lending money to BlockFi, you have no idea what they're doing with it. They can tell you something, but you ultimately don't know and ultimately it's not up to you. And so that is extremely risky in my opinion. You know, like those lending desks are kind of like black boxes, give them your crypto and you just hope you're going to get it back. With Notional, cause it's open source and it's all transparent, like, like DeFi you know exactly what is happening with your capital, you know exactly what's happening and it's, you know, our contracts are verifiable by anyone. And I think that, that is a crucial difference. And then, you know, the other thing I would say is just to keep harping on capital efficiency. You know, when you take out a loan on, on BlockFi and you, you give them your ETH as collateral let's say, yeah, you want to borrow some USDC so you give them some ETH, they're going to just take your ETH and do whatever they want with it and earn returns that they keep, right? They're not giving you an interest on your ETH. But on Notional, like we talked about before, you can provide liquidity with your ETH and you keep all the interests, right? So it's like, there isn't this like central thing that's just like taking value away from you. It's you keep all the value. Which is yeah, that's like part of what makes DeFi, I think like just a much better system for the user than the traditional financial system. And you know, at Notional, we're trying to take full advantage to that.

Benjamin Hor [00:22:53]: 
Yeah. Ultimately is removing the middleman.

Teddy Woodward [00:22:55]: 
Yeah exactly, yeah.

Benjamin Hor [00:22:57]: 
And then I guess this brings me to more a future kind of question. So in your opinion, what will the future of DeFi lending products look like? You know, the ideal, what would it look like? 

Teddy Woodward [00:23:07]: 
Yeah, so I think that, you know, I think layer two is going to be a big step forward for this. So, you know, it's going to unlock access for a, just a huge number of users, I think, right? Cause like, you know, you just look at the transaction fees in Ethereum, a lot of people are priced out. Right? And I think if you lower those transaction fees, and, and now DeFi protocols have been around for awhile and they've been tested, so like they're not as risky. I think once you lower transaction fees, you're going to see just like a ton of new users come in. So I think layer twos are going to be critically important. I think that you're going to see increasingly so, more and more sort of crypto native collateral types, right? You know, people are starting to experiment right now with, you know, using NFTs as collateral in certain cases, and like figuring out models that works and people are, you know, there are these new crypto projects, these new crypto projects have tokens. Uh, these tokens are eligible collateral, so I think that you're just going to see, as you see just an explosion of crypto assets and just like the aggregate value of the crypto ecosystem. You're just going to see more and more eligible collateral types that you can borrow against, right? And I think that like efficiency, as a capital efficiency is just super, super important. Yeah, it's an awesome thing about crypto is this stuff like is, is very easy to transfer. You know, there's zero friction in transferring and storing and using crypto assets. So every new crypto asset is potentially eligible as collateral, and we know that people want maximum collateral, you know, capital efficiency. So I think that you could see like, you know, people borrowing against a hugely increasing number of crypto assets. And yes, I think that like the overall market for, for DeFi lending is only gonna increase, and it's gonna increase very, very rapidly. 

Benjamin Hor [00:24:54]: 
My last question for the day is actually just what are Notional's plans for the end of the year, as well as 2022?

Teddy Woodward [00:25:01]: 
Yeah. So you know, as we're talking about here the immediate plan is to launch Notional V2 and Notional governance token. So we currently expect to launch that in early November. So again, if you're listening to this podcast, you know, hopefully are already live. So that's kind of the immediate goal here. And then you know, for the rest of the year, we want to focus on getting Notional V2 integrated throughout the sort of defined ecosystem. And then I think 2022 is going to be a super interesting year for us. You know, from a development standpoint, we are going to be, I would say, mainly focused on layer two. You know, what we want to do is increase Notional's presence within the current and existing DeFi ecosystem. And you know, we're going to introduce a grants program that should, I hope encourage and support people who want to help us integrate Notional. And then, you know, we're going to be working on layer two. So I, you know, I think that, you know, in the months to come, I, I think the notional is going to be integrated in, in DeFi and, and hopefully we should have a layer two implementation before, too long so that we can open up access to fixed rates for everyone.

Benjamin Hor [00:26:02]: 
All right. Sounds really good. I guess that's all for today. Thank you so much, Teddy for joining us at CoinGecko podcast. Great to have you. 

Teddy Woodward [00:26:08]: 
Thanks a lot Ben.

Bobby Ong [00:26:10]: 
All right. That wraps up the show. Thank you for listening to the CoinGecko podcast. If you like our show and want to know more, check out podcast.coingecko.com or please leave us a review on iTunes. If you have any feedback, do drop us an email at hello@coingecko.com. Join us for more next week. See ya! 

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