Day count conventions and DeFi: Difference between pages

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The day count convention determines how interest accrues over time in a variety of transactions, including bonds, swaps, bills and loans. Interest is usually expressed to accrue at a rate per annum (the reference period). It is often due and payable at shorter intervals, usually a number of months (the interest period).
''Cryptoassets - cryptocurrencies.''
The day count (or 'daycount') convention regulates how the parties are to calculate the amount of interest payable at the end of each interest or other period.


It is commonly expressed as a fraction. The [[numerator]] will be the convention for the number of days in the period - usually actual or a notional 30. The [[denominator]] is the convention for the number of days in the reference period - often 360 or 365.
DeFi is an abbreviation for ''decentralised finance''.
Conventions vary depending on the market type, location and the currency in question.  


For example, euro-denominated bonds are usually calculated on an actual/actual basis, while fixed rate non-euro denominated bonds are often calculated on a 30/360 basis.


The London interbank market, on the other hand, operates on the basis of actual/360, except where the currency is sterling, for which the London interbank convention is actual/365.
DeFi enables the lending and borrowing of cryptoassets without using a central exchange.
Commonly used day count conventions are considered below, but first it is important to bear in mind the various business day conventions that may apply. These regulate the start and end date of each period.


==Business day conventions==
DeFi services are algorithmic-based services that rely on smart contracts and are delivered over distributed ledger technology platforms without intermediaries.


====No date adjustment====
Cycle dates are not adjusted for weekends or holidays and are forced to land within a cycle month.


====Following business day/next good business day====
DeFi is an alternative system to CeFi.  CeFi facilitates lending and borrowing crytpoassets through an exchange.
Dates are adjusted for weekends and holidays to the next good business day.


====Preceding/previous good business day====
Dates are adjusted for weekends and holidays to the previous good business day.


====Modified following/modified business day====
:<span style="color:#4B0082">'''''DeFi's regulatory challenges'''''</span>
Dates are adjusted to the next good business day unless that day falls in the next calendar month in which case the date is adjusted to the previous good business day.


====End of month – no adjustment====
:"The highly decentralised and global structure of the DeFi sector along with the difficulty to trace end users provide a unique set of challenges for regulators.  
Dates are adjusted to land on last day of the month.


====End of month – previous good business day====
:Even on an initial view it is clear that the sector is opaque, complex and undertakes financial activities that carry risk – activities that are regulated with the traditional financial sector.
Dates are adjusted to the last day of the month but if that day is a weekend or holiday, then it is adjusted backward to the previous good business day.


====Two business days prior to third Wednesday of month====
Dates generated are two business days prior to the third Wednesday of the month (used in conjunction with Eurodollar futures).


====Deposit rollover method====
:... the degree of decentralisation currently varies across platforms.  
Each date is set so it occurs on the same day of the month as the previous date. Each date is set to the next good business day but no
dates may be adjusted past the last good business day of the month.


==Day count conventions and conversions==
:However, in an extreme form, a DeFi platform could be completely decentralised with no identifiable legal entity, ownership nor even a point of human contact.


Interest is calculated as the principal times the interest rate times the day-count fraction, where the day-count fraction is defined by the day-count convention associated with the interest rate.
:DeFi is still in its early infancy but its rapid growth means that regulators, domestically and internationally, need to think seriously now about the risks of a broad range of financial services being effected through DeFi platforms and how to ensure risks are managed in the DeFi world to the same standards as they are managed in traditional finance."


====Money market basis (actual/360)====
:''Is 'crypto' a financial stability risk? - Bank of England - Jon Cunliffe, Deputy Governor, Financial Stability - October 2021.''
This basis is commonly used for all Eurocurrency LIBOR rates, except sterling. The day count fraction is defined as the actual number of days in the period over 360.


====Actual/365 fixed====
This basis is commonly used for all sterling interest rates, including LIBOR.


The day count fraction is defined as the actual number of days in the period over 365.
:<span style="color:#4B0082">'''''DeFi's channels of risk transmission'''''</span>


It is also used for money markets in Australia, Canada and New Zealand.  
:"Although the size of the DeFi market itself is not large enough to be considered a risk to the stability of the markets, the DeFi space is still worth delving into as it is growing rapidly, attracting an increasing number of retail and institutional investors alike.  


This basis is sometimes confused with actual/365, which is defined next.
:Increased interest and adoption of cryptoassets by institutional investors and other traditional financial service providers in particular is leading to increased interconnections between CeFi and the parallel DeFi system and creates channels of risk transmission to the traditional markets and potentially the real economy."


====Actual/365 or actual/actual====
:''OECD Symposium on Digitalisation and Finance in Asia - discussion paper - 2021.''
This basis is commonly used for all sterling bonds, Euro denominated bonds, US Treasury bonds and for some USD interest rate swaps.  


In this case, the day-count fraction is the number of days in the period in a normal year over 365 or the number of days in the period in a leap year over 366.


====Eurobond basis (30E/360)====
== See also ==
30E/360 is used for calculating accrued interest on some legacy currency pre Euro Eurobonds and on bonds in Sweden and Switzerland.
* [[Algorithm]]
* [[Bank of England]]
* [[CeFi]]
* [[Crypto]]
* [[Cryptoassets]]
* [[Cryptocurrency]]
* [[Distributed ledger]]
* [[Exchange]]
* [[Financial intermediary]]
* [[Financial stability]]
* [[Organisation for Economic Co-operation and Development]]  (OECD)
* [[Platform]]
* [[Prudential]]
* [[Real economy]]
* [[Regulation]]
* [[Retail]]
* [[Risk transmission]]
* [[Smart contract]]


This method assumes that all months have 30 days, even February, and that a year is 360 days. Effectively if the start date d1 is 31 then it changes to 30, and if the second date d2 is 31 it too changes to 30.


The day count fraction is defined as the number of days in the period (&Delta;<sub>360</sub>) over where (&Delta;<sub>360</sub>) is calculated as if every month had 30 days, as described in Figure 1.
==External link==
 
*[https://www.bankofengland.co.uk/speech/2021/october/jon-cunliffe-swifts-sibos-2021 Is 'crypto' a financial stability risk? - Bank of England - Jon Cunliffe, Deputy Governor, Financial Stability - October 2021]
[[File:Day count conventions figure 1.png||Bond basis (30/360) and Eurobond basis (30E/360)]]
 
====Bond basis====
This basis is used for calculating accrued interest on domestic US bonds (e.g. Yankee bonds, federal agencies, corporate and municipal bonds).
 
Each month is assumed to have 30 days, with an exception that if the last day is the 31st and the first day is not 30th or 31st then that month has 31 days.
 
So the rule is if d1 is 31 it changes to 30, and if d2 is 31 change it to 30 but only if d1 is either 30 or 31.
 
====Floating rate notes====
FRNs always use actual/360 or 365 in the case of sterling.
 
====Fixed coupon====
This basis is commonly used for Eurobonds, and the day count fraction is just one divided by the number of interest payments per year. Thus the coupon payments are always the same and any small difference in the number of days between successive coupon payments is ignored.
 
====Conversion between different day count conventions====
 
[[File:Day count conventions figure 2.png||Conversion between different day count conventions]]
 
==Compounding conventions==
 
====Simple or periodic interest====
Simple or periodic interest does not offer the opportunity to earn interest on interest, ie, there is no compounding of
interest. Simple interest is typically used for instruments with a maturity of less than one year.
 
<math>Discount factor (DF) = \frac{1}{( 1+ R \times \frac{days}{365})}</math>
 
where:
 
:'''R''' = simple interest rate on an actual/365 or actual/360 fixed basis; and
:'''days''' = number of days in period (365 or 360).
 
====Compound interest====
Offers the opportunity for interest payments to be reinvested in order to earn interest on interest. Compound interest is typically used for instruments greater than one year.
 
<math>Discount factor (DF) = (1+\frac{1}{1+r})^{n}</math>
 
where:
 
:'''r''' = compound interest rate;
:'''n''' = number of compounding periods; and
 
====Continuous compounding====
Compounding can be taken to an extreme in which the interest is continuously compounded, i.e. where f in the previous formula tends towards infinity. Continuously compounded rates are rarely quoted in practice, although they are used extensively in derivatives pricing systems.
 
<math>Discount factor (DF) = e^{-Rt}</math>
 
where:
 
:'''R''' = continuously compounded interest rate;
:'''t''' = number of years to maturity; and
:'''e''' = 2.71828 (to five decimal places).
 
====Converting between different compounding frequencies====
 
[[File:Day count conventions figure 3.png||Converting between different compound frequencies]]
 
==Settlement day conventions==
 
The settlement day is the day on which traded bonds or securities actually change ownership and are paid for. This is often a few business days after the transaction date, T. Interest rate calculations normally start on the settlement day.
 
Settlement in Euro denominated bonds and in most markets is on T+3, although for US and UK government bonds and bills it is T+1, and for sterling bonds it is T+5.
 
 
==See also==
* [[Day count]]
* [[ACT]]
* [[CertFMM]]
* [[Compound interest]]
* [[Effective annual rate]]
* [[LIBOR]]
* [[Nominal annual rate]]
* [[Periodic discount rate]]
* [[Periodic yield]]
* [[Simple interest]]


[[Category:The_business_context]]
[[Category:Investment]]
[[Category:Long_term_funding]]
[[Category:Long_term_funding]]
[[Category:Cash_management]]
[[Category:Identify_and_assess_risks]]
[[Category:Manage_risks]]
[[Category:Risk_frameworks]]
[[Category:Risk_reporting]]
[[Category:Financial_products_and_markets]]
[[Category:Technology]]

Revision as of 00:15, 16 November 2021

Cryptoassets - cryptocurrencies.

DeFi is an abbreviation for decentralised finance.


DeFi enables the lending and borrowing of cryptoassets without using a central exchange.

DeFi services are algorithmic-based services that rely on smart contracts and are delivered over distributed ledger technology platforms without intermediaries.


DeFi is an alternative system to CeFi. CeFi facilitates lending and borrowing crytpoassets through an exchange.


DeFi's regulatory challenges
"The highly decentralised and global structure of the DeFi sector along with the difficulty to trace end users provide a unique set of challenges for regulators.
Even on an initial view it is clear that the sector is opaque, complex and undertakes financial activities that carry risk – activities that are regulated with the traditional financial sector.


... the degree of decentralisation currently varies across platforms.
However, in an extreme form, a DeFi platform could be completely decentralised with no identifiable legal entity, ownership nor even a point of human contact.
DeFi is still in its early infancy but its rapid growth means that regulators, domestically and internationally, need to think seriously now about the risks of a broad range of financial services being effected through DeFi platforms and how to ensure risks are managed in the DeFi world to the same standards as they are managed in traditional finance."
Is 'crypto' a financial stability risk? - Bank of England - Jon Cunliffe, Deputy Governor, Financial Stability - October 2021.


DeFi's channels of risk transmission
"Although the size of the DeFi market itself is not large enough to be considered a risk to the stability of the markets, the DeFi space is still worth delving into as it is growing rapidly, attracting an increasing number of retail and institutional investors alike.
Increased interest and adoption of cryptoassets by institutional investors and other traditional financial service providers in particular is leading to increased interconnections between CeFi and the parallel DeFi system and creates channels of risk transmission to the traditional markets and potentially the real economy."
OECD Symposium on Digitalisation and Finance in Asia - discussion paper - 2021.


See also


External link