Introducing Rho Protocol

The 2021 crypto cycle was partly driven by a surge in Decentralised Finance (DeFi) protocols, many of which implemented products familiar to Traditional Finance markets. With a new dawn of pro-crypto regulation which could unlock an even bigger wave of DeFi innovation, this report delves into Rho Protocol –  the first crypto-native rate derivatives exchange.

The largest asset class in traditional finance is fixed-income, with a significant portion of volume driven by interest rate derivatives such as fixed to floating interest rate swaps. Currently, Rho’s leading product is interest rates futures which allow users to trade fixed-to-floating rate swaps on BTC and ETH perpetual futures funding rates and on ETH staking rates. Swaps are typically bilaterally negotiated contracts which are traded over-the-counter (OTC), however Rho Protocol’s rates futures trade on-chain with standardized terms and maturities. 

Rho is built on the Arbitrum network – a layer 2 network for Ethereum. An Ethereum staker is a typical user of Rho’s products – a staker that anticipates lower demand for gas usage on the network over the next month which will result in a drop in staking rates, may hedge against that risk by paying the indexed variable rate to receive the fixed rate.

With asset-tokenisation and DeFi both narratives that will likely continue to benefit from a more crypto-positive regulatory landscape in 2025, Rho Protocol has the opportunity to expand beyond their current product offerings to on-board a wave of Trad-Fi and crypto-native rate derivatives on-chain. This will create an even larger market for institutions to hedge against (and speculate on) changes in crypto-native rates, as well as devise sophisticated trading strategies by combining their products with others to unlock new use cases.

Today, we dive into Rho Protocol and answer: how exactly does it work?

A Primer on Rho Rates Futures

An interest rate swap is an agreement between two different parties to exchange a series of cash flows over a fixed period of time. These cash flows are based on changes in some underlying interest rate. One of the parties, called a ‘payer’, will pay the other party, a ‘receiver’, a fixed-rate that is agreed upon in advance. In return, the payer will get a floating rate payment dependent on a variable underlying index. The fixed rate represents the market’s consensus on the expected average of the floating rate over the term of the contract. 

At the time of writing, the markets available on Rho include the Binance BTCUSDT Perpetual Funding Rate Future, Binance ETHUSDT Perp, OKX BTCUSDT Perp, OKX ETHUSDT Perp, and finally, CoinDesk’s Indices CESR (a daily benchmark rate which tracks the mean staking yield of validators on Ethereum). Within those particular contracts, traders can choose from different maturities (maximum up to 3 months) such as JAN25, FEB25 and MAR25 and levels of leverage from 0-230x. 

The key components of Rho rates futures are as follows:

• Swap term reset date – this is the expiration, or maturity date, of the contract. At the swap term reset date, all payments are settled with no intermediary payments during the course of the contract. 
• Underlying floating rate – this is the variable interest rate based on the particular contract being traded. For the OKX ETHUSDT contract for example, the floating rate is the 8 hour perpetual funding rate of that contract. 
• Currency denomination – Rho swaps are priced and settled in an agreed-upon underlying currency, such as USDT, or wETH. 
• Rho’s proprietary oracle – Responsible for tracking and feeding the floating rate into the protocol. 

Suppose a trader A is interested in the “BINANCE-BTCUSDT-FUNDING-MAR2025” contract on the Rho platform, which expires on the 31st of March, 2025. The current floating rate on the contract is 11% per annum (equivalent to a 0.0095% funding rate every 8 hours). The fixed rate currently quoted on Rho’s market is 13% per annum. If the trader takes the position of a payer, it means they are long the contract and can lock in a fixed interest rate. The trader agrees to pay the fixed rate while receiving the floating rate over the course of the contract. Effectively, the trader believes BTC’s perp funding rate will be larger than 13% on average over the lifetime of the contract, such that they are profitable when they receive a floating rate (which tracks Binance’s BTCUSDT Perp Contract) that is higher than the fixed rate they pay (13% p.a.). 

In contrast, the opposite would be true for Trader B – a trader who takes the position of a receiver, expecting BTC’s funding rate to fall. 

With Rho’s rate futures, the pricing mechanism ensures that the difference between the fixed and floating rates accrued over the contract’s term is reflected in the final settlement. At contract maturity, the payout is determined by the net difference between the fixed and floating rate sides.

Rho’s Virtual Token Based Approach

Interest rate swaps have two legs – the fixed and floating leg. Rho’s floating leg (rate) tracks the rate of an external index – such as the perpetual swap funding rate on a centralised exchange. When creating a new market to facilitate trading of a fixed-for-floating swap, Rho creates two virtual tokens: an rfxToken and an rflToken, as an on-chain representation for the value of the fixed and floating leg of a given rate respectively. For example, a contract denominated in USDT would have an rfxUSDT token and an rflUSDT token. 

A stylised example

We will illustrate Rho’s implementation of collateralised rate derivatives with a stylised example.

Suppose you enter an arcade with some amount of money (collateral) and have the choice to play various different games. Each game requires you, the player, to take a long position in a token that represents either the fixed or floating leg of the swap, paid for by a corresponding short position in the other leg. Entering the game as a ‘payer’ would imply having a long position on rflTokens and a short position on rfxTokens. The entry to the game is zero cost (as a fixed-for-floating rate swap should be). The ratio between the player's position size in the long and short legs of the two tokens, i.e., how many rflTokens and rfxTokens represent the player’s position, is determined by the exchange rate between the two tokens when entering the game, which is itself a function of the prevailing fixed rate of the swap (something we explain in more detail in subsequent sections).

That exchange rate varies over the lifetime of the game according to the rules of the game and reflects the changing fixed rate of the swap. The rules of the game being how one rate changes against the other, which in turn affects the value of one token against the other. When the game ends (or the player wishes to stop playing), the player must return their long position, and close a corresponding proportion of their short position at the prevailing market rate between the rfx and rfl tokens. However, as the exchange rate of the two tokens may have changed as a result of the rules of the game, this will leave them with a non-zero position in one of the two tokens – either in their long or short leg.

However, the player cannot take the tokens away from the arcade or spend these tokens elsewhere – they are essentially accounting tools used within the arcade. In order to release their collateral and leave the arcade, the player must close their remaining net position by either crediting or debiting from their deposited collateral.

Conclusion

Rho Protocol is the first exchange for trading crypto-native rates and has introduced Rho swaps rates – tradeable financial derivatives that enable traders to lock in a fixed rate (whether that be a funding rate, or a staking rate) in order to hedge against the price volatility of crypto assets and speculate on how these rates may evolve. Market makers can also benefit from the protocol by acting as liquidity providers and earning transaction fees. A staker on Ethereum who may anticipate a decline in staking rates may enter the Rho staking future that tracks ETH staking rates in order to hedge against any such decline.

As more crypto-friendly regulation in the U.S. and other regions onboards more users (retail or institutional) into the rails of DeFi, protocols such as Rho stand to benefit significantly.