Interest Rate Swap
A derivative contract where two parties exchange interest payment streams, commonly swapping a floating rate for a fixed rate, without exchanging the underlying principal.
An interest rate swap is a derivative contract in which two parties agree to exchange streams of interest payments calculated on a shared notional amount, most commonly one party paying a fixed rate while the other pays a floating, variable rate tied to some reference rate. Only the interest payment streams are exchanged; the underlying notional principal itself never actually changes hands.
In DeFi, interest rate swaps let a borrower or lender exposed to a variable rate from an interest rate model (see Kaavon's "Interest Rate Model" glossary definition) convert that floating exposure into a predictable fixed rate, or vice versa, without needing to actually move their underlying lending or borrowing position — this is useful for anyone wanting more certainty over their future borrowing cost or lending income, in exchange for giving up the potential benefit if rates move favorably in the other direction instead.
Examples
- A DeFi borrower worried about rising variable interest rates might enter an interest rate swap to effectively lock in a fixed borrowing cost instead.
- In an interest rate swap, only the interest payment streams are exchanged between the two parties — the underlying principal amount itself never changes hands.