Expectation Theory

Expectation Theory in financial markets posits that the current long-term interest rate is determined by the market's anticipation of future short-term interest rates. In the context of cryptocurrency and derivatives, this theory suggests that the yield curve reflects the collective forecast of traders regarding future asset returns and inflation.

If investors expect higher rates in the future, they will demand higher yields on long-term assets today. This framework helps participants in options and derivatives markets price forward contracts and determine the fair value of interest rate swaps.

It assumes that market participants are rational and have access to the same information, though behavioral game theory often highlights deviations caused by market sentiment. Understanding this theory is foundational for analyzing how macroeconomic shifts impact the cost of borrowing in decentralized finance protocols.