Introducing Rho Protocol

Introducing Rho Protocol 

The 2021 crypto cycle was partly driven by a surge in Decentralized 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-tokenization 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 deep 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’s rates futuress 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 centralized 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 centralized 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 stylized example

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

A less stylized example

In our example, the game that we wish to play is ‘Binance BTCUSDT perp MAR2026’, which tracks Binance’s Bitcoin perpetual funding rate between entry date and the end of March 2026.

Suppose that the (market-determined) fixed rate of the contract at entry is 10.23% annualized, and that the floating rate accrues to 7.16% annualized over the lifetime of the contract.

At entry, a trader deposits an initial margin, chooses the direction of his trade (payer or receiver), and chooses a trade size: say a notional position of 100,000 USDT (100x leverage, collateral 1,000 USDT), with the time to maturity as 1 year – he is now playing the game, and the amount of money he will be credited or debited with when he exits, depends on the floating rate against his chosen fixed, applied by the rules of the game.

To apply those rules, the game creates a virtual rflToken that tracks the floating index rate (Rho’s centralized oracle is responsible for providing this continuously over the lifetime of the swap). At entry, each rflToken is created with a value equal to 1 unit of the denominated currency – here the collateral is denominated in USDT and hence each rflToken has a value of 1 USDT. For the CESR staking rate, the collateral is denominated in wETH and therefore the value of the rflToken would be 1 wETH. 

The value of rflUSDT against USDT (i.e. the amount of USDT collateral returned for closing a long position in rflUSDT) adjusts dynamically based on the accrued floating rate. In our example of a 7.16% accrued rate, at expiry,  the value of the rflUSDT token will be equal to 1.0716 USDT – the value of the token is enforced by the settlement of the token against the trader’s deposited collateral. Whilst we are using the example of the accrued rate at expiry, the same concept is applied if the trader exited before expiry. If the trader exited when the accrued rate was only 5% for example, the value of rflUSDT at that point would be 1.05 USDT.

Equally, Rho would also create a virtual token called rfxUSDT. In this example, rfxUSDT, represents the fixed-rate obligation over the one-year period. Rho Protocol treats the fixed leg as a zero coupon bond (there are no periodic interest payments and the face value at maturity is 1 USDT). This means at the contract’s expiry, each rfxUSDT equates to a fixed payout of 1 USDT (again, enforced by settlement against the trader’s collateral), and its present value is the value of a zero-coupon bond implied by the market’s fixed rate. Based on the above parameters, the present value of 1 rfxUSDT token would be 0.90719 USDT, which accrues to 1 USDT at the term reset, reflecting the 10.23% fixed rate.

When the trader enters the market, the number of rfxUSDT tokens received for selling 100,000 rflUSDT depends on the market rate between them. If the rflUSDT tokens are worth 1 USDT at entry (no rate has been accrued on the floating rate so far as the contract has just been entered), and each rfxUSDT token is worth 0.90719 USDT (present value of the zero-coupon bond), then the price of 1 rfxUSDT in terms of rflUSDT is 0.90719. The trader therefore, at entry, receives 110,230.49 rfxUSDT in return for taking on the short position of 100,000 rflUSDT. A receiver of the fixed rate will be long 110,230.49 rfxUSDT and short 100,000 rflUSDT. 

At expiry, the long rfxUSDT position will be worth 110,230.49 USDT (as it is a zero-coupon bond at expiry, entered into at an implied annual rate of 10.23%) and the short rflUSDT position will be worth 107,160 USDT (the floating leg which began the trade at entry had an accrued rate of 0, has by expiration accrued to 7.16%). The net value of the traders position is 3,070 USDT, equivalent to the result of paying a net of 3.07% (10.23% - 7.16%) on a notional of 100,000 USDT.

At term reset, they will receive the equivalent of a fixed-rate cash flow and pay the floating-rate cash flow accrued from their position. These virtual tokens are not regular blockchain assets and there is no physical flow of the assets – they exist solely as a means of accounting for the protocol to track the accrued fixed and floating rates more easily, simplifying the settlement process. The value of each token relative to the underlying and therefore to each other at any point during the lifetime of the contract (including at expiry) is enforced by the payment given or taken from a trader's collateral at expiry.

We note that the fixed rate is determined by the market. If the fixed rate is well-priced (by which we mean that it accurately reflects the rate accumulated over the period) then the net position at expiry will be 0 USDT.

Pricing Engine, Virtual Automated Market Maker (vAMM)

Now that we understand how the two virtual tokens are created and their use case, how is the fixed swap rate determined? 

Rho utilises a virtual Automated Market Maker (vAMM) model, inspired by Uniswap’s constant product AMM, or the x  y = k model, for price discovery. Here, x is the virtual reserves of rfxTokens in the vAMM and y is the number of rflTokens. The product of the number of tokens of each asset in the liquidity pool is always preserved by each trade against the pool – this constant relationship determines the number of y tokens that must be added to the pool to pay for the removal of a given number of x tokens, whenever trades are placed. We cover this model in more detail here. 

The goal here is to get a present value of the token representing the fixed leg (rfxUSDT in our example) in terms of the underlying currency (USDT), by using the market-determined exchange rate between it and the floating rate token (rflUSDT), which is itself a known function of the floating rate accrued (that is supplied by a centralized oracle).

The constant product formula allows us to get the implied price of an rfxToken (the fixed leg) in terms of rflTokens in the vAMM simply as the number of rflTokens (y) divided by the number of rfxTokens (x).

price = y/ x  

Using this, Rho expresses the price of the fixed leg, or in other words, the price of the zero coupon bond, as a function of the floating rflTokens. The rflToken’s value and thus the floating leg price itself is more easily calculated as it just tracks the accrued interest collected by the floating rate (we note that the centralization of the oracle centralizes the pricing formula via this dependence). The fixed swap rate can then be calculated from the relationship between price and yield-to-maturity: 

Swap fixed rate = (1Pfx)1/t-1

Further details of the price derivations can be found here.

As the time to maturity gets closer, i.e., t tends towards 0, the (present value) price of the fixed leg token, rfxToken, will tend towards 1. Equally, for the floating leg token, rflToken, the value becomes equal to 1+x, where x represents the accrued rate. 

As part of Rho’s vAMM price discovery mechanism, they are also utilising Uniswap’s v3 concentrated liquidity model. Price takers on one end are reliant on the vAMM’s liquidity of rfx and rflTokens to execute their trades and liquidity providers (LP’s) are the counterparties who earn fees for providing liquidity. The concentrated liquidity model ensures that LP’s can provide their liquidity within particular yield ranges, as opposed to having it spread across an infinite range of prices (or yields), thereby making their capital more efficient (earn higher fees as their liquidity is used more often) and reducing price slippage. 

The vAMM is currently how Rho is facilitating trades on their platform. However, this can also be done via a central limit order book (CLOB) that may be implemented in the future.

Rho Risk Engine

Rho’s Risk Engine is the mechanism by which risk is managed on the platform by liquidating trader’s positions. Liquidation occurs when a trader's margin falls below a threshold (explained in more detail below), and there are two reasons why this may occur. 

The first is market risk: this stems from the fact that a trader’s margin changes with their profit and loss, which itself depends on changes in the index rates, or changes in the implied swap price of virtual tokens. The second is liquidity risk, or the cost of unwinding or liquidating a position, including factors such as transaction fees or slippage – that risk is larger during high market activity periods. 

To minimise both of these risks, traders (both payers and receivers, as both trade without posting full collateral) must deposit some collateral and ensure that it remains above the initial margin threshold (when opening a new position) and the liquidation threshold, which vary depending on the product. In the table below, we outline the formula for each threshold depending on the product:

Doing so guarantees future settlements and covers the potential losses from any positions. The collateral deposited by a trader changes as a function of the sum of the deposits and withdrawals by the trader, but more importantly as a function of any accumulated mark-to-market profit & loss from their positions:

Margin = Deposits - Withdrawals  - Fees + PnL

If a trader’s margin falls below the liquidation threshold as a function of their PnL (or withdrawals or fees), their position is forcibly closed (or liquidated) by independent liquidators. That mark-to-market PnL is a function of the market price of the zero-coupon bond that encodes the fixed leg of the swap, as well as the value of the floating leg token which is input via the centralized oracle supplied by the Rho protocol team.

Rho utilises independent liquidators whose role is to monitor margin accounts and flag traders who fall below the liquidation threshold. These liquidators are incentivized to take over a trader’s position and add extra collateral to bring the trader’s account back to the initial margin level. In return, the liquidator earns a fee, which is a percentage of the remaining margin in the account. 

Alternatively, in a case where no liquidators step in, Rho Protocol itself can unwind a trader’s position by placing a counter-order on their initial position. The cost of this is paid by the trader. In an extreme case where there isn’t enough liquidity to execute liquidations, Rho Protocol has a Stability Fund – this is funded perpetually via fees collected from traders when they enter positions and is maintained by a smart contract.

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 a decentralized platform however, one notable point is that Rho’s oracle (which tracks external index rates) is currently centralized, as these rates are supplied by the developers of the protocol itself. Beyond this, Rho utilises a clever concept of virtual fixed and floating tokens and currently its vAMM mechanism, built upon Uniswap’s constant product formula creates a more seamless mechanism to track profit and loss of different positions on the platform. 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.