Trade on Interest Rates
Learn how and why to trade Interest Rate Swaps
How to Trade Interest Rate Swaps: A Step-by-Step Guide
Understanding the Basics
Before you start trading, understand what you're doing:
Pay Fixed, Receive Variable: You think rates will go UP
Pay Variable, Receive Fixed: You think rates will go DOWN
Notional Amount: The size of your position (you don't need to deposit the full amount)
Collateral: What you actually deposit to back your position
Step 1: Choose Your Market
Interest rate swap markets are created with specific parameters:
Reference Rate: Which rate you're betting on (Aave USDC, Morpho ETH, Compound DAI, etc.)
Term Length: How long the swap lasts (1 month, 3 months, 1 year, etc.)
Collateral Token: What you deposit to secure your position
Example Markets:
3-month Aave USDC rates (collateral: USDC)
6-month Morpho WETH rates (collateral: WETH)
1-year Compound DAI rates (collateral: DAI)
Step 2: Determine Your Position Size
Key Concepts:
Notional Amount: The swap size (e.g., $100,000)
Collateral Required: Typically 10-20% of notional (e.g., $10,000-$20,000)
Leverage: Notional ÷ Collateral = Your leverage multiplier
Example:
You want $50,000 notional exposure to Aave USDC rates
Market requires 15% collateral = $7,500 USDC deposit
Your leverage = 3.33x
Step 3: Choose Your Direction
Bullish on Rates (Expect rates to RISE)
Position: Pay Fixed, Receive Variable
You pay a fixed rate (e.g., 5%)
You receive whatever the variable rate becomes
Profit if: Variable rate goes above your fixed rate
Loss if: Variable rate stays below your fixed rate
Example:
Current Aave rate: 4%
You pay fixed 5%, receive variable
If Aave hits 8%, you earn 3% on your notional
On $50k notional with $7.5k collateral = $1,500 profit (20% return)
Bearish on Rates (Expect rates to FALL)
Position: Pay Variable, Receive Fixed
You pay whatever the variable rate is
You receive a fixed rate (e.g., 4%)
Profit if: Variable rate falls below your fixed rate
Loss if: Variable rate rises above your fixed rate
Example:
Current Aave rate: 6%
You pay variable, receive fixed 4%
If Aave drops to 2%, you earn 2% on your notional
On $50k notional with $7.5k collateral = $1,000 profit (13% return)
Step 4: Execute Your Trade
Through the Protocol Interface:
Connect Wallet: Use MetaMask, WalletConnect, etc.
Select Market: Choose your reference rate and term
Enter Position Details:
Notional amount
Direction (pay fixed/receive variable or vice versa)
Review the fixed rate being offered
Approve Collateral: Allow the protocol to use your tokens
Submit Transaction: Confirm the swap creation
Key Elements:
Reference Rate: Current variable rate for a given market
Current Fixed Rate: Fixed rate for a given market at a point in time
Collateral Requirement: How much you need to deposit
Liquidation Risk: When your position might get closed
Step 5: Monitor Your Position
What to Watch:
Current Variable Rate: How the reference rate is moving
Unrealized P&L: Your current profit/loss
Collateral Ratio: Make sure you don't get liquidated
Time Decay: How much time is left on your swap
Managing Risk:
Add Collateral: If your position moves against you
Close Early: Exit before expiration if desired
Roll Position: Close current swap and open a new one
Step 6: Settlement
At Expiration:
Calculate Average Rate: The protocol determines the average variable rate over the term
Net Settlement: You pay or receive the difference
Collateral Return: Get back your remaining collateral after settlement
Example Settlement:
You paid fixed 5%, received variable on $50k notional for 3 months
Average variable rate was 7%
You receive: (7% - 5%) × $50,000 × (3/12) = $250
Plus your original collateral minus any fees
Common Strategies
Hedging:
Lender Protection: You're lending on Aave, worried about rate drops → Pay variable, receive fixed
Borrower Protection: You're borrowing variable rates, worried about spikes → Pay fixed, receive variable
Speculation:
Bull Market Play: Expect DeFi rates to spike → Pay fixed, receive variable across multiple markets
Bear Market Play: Expect rates to crash → Pay variable, receive fixed
Volatility Play: Trade around major events (Fed meetings, protocol updates, etc.)
Arbitrage:
Cross-Protocol: If Aave and Compound rates are misaligned
Term Structure: If short-term and long-term rates seem mispriced
Basis Trading: Combine with underlying lending positions
Risk Management Tips
Start Small: Use lower leverage until you understand the mechanics
Diversify: Don't put all capital in one rate/term
Watch Liquidations: Keep collateral ratios healthy
Understand Correlation: DeFi rates often move together
Monitor Gas: Factor in transaction costs for smaller positions
Time Decay: Longer terms give more time to be right, but tie up capital longer
Advanced Features
Partial Closing: Exit part of your position early
Rolling: Close and reopen in new terms
Portfolio View: Manage multiple swaps across different markets
DISCLAIMER: Interest rate swaps are leveraged instruments. You can lose all of you initial collateral if positions move significantly against you. Always understand the risks before trading.
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