An Updated Primer on Bonding

Olympus changed the game with its bonding mechanism to acquire liquidity. Olympus-style bonds have been around for almost 18 months and have been used by over 50 protocols on 7 chains. Bonding allows savvy protocols to generate on-demand liquidity using their governance tokens.

However, bonds are still under-utilized in the broader crypto market. We intend to change that.

Bonding was initially designed by OlympusDAO to incentivize and lock liquidity by exchanging your Liquidity Provider (LP) tokens for newly minted $OHM at a discount. Your discounted $OHM is then vested linearly over a short period of time (initially 5 days). This approach allowed Olympus to acquire and own 100% of its liquidity, which has generated $41M in LP Fees since inception.

To learn more about LP Tokens and Yield Farming, see this reference from Gemini

Brief History of Liquidity Mining

To understand why liquidity bonds are so powerful, we need to understand how protocols typically approach liquidity incentives. In order to bootstrap liquidity, new protocols will incentivize users to pool their native token and a reserve asset (ex: DAI or wETH) on decentralized exchanges. Afterwards, users deposit their LP tokens in a “yield farm” that “rewards” depositors with the protocol’s newly-issued governance tokens. If you think issuing new tokens leads to inflation and token holder dilution, then you’re absolutely right! Liquidity incentives are notoriously difficult to get right.

Incentives too low? Liquidity will not reach target depth.
Incentives too high? Supply inflation will devastate token price.

To add insult to injury, incentivized liquidity is temporary and therefore has low stickiness. According to a study by Nansen, “a large majority of farmers appear to exit within the first 5 days of entering a farm, and half of all farmers never stay beyond 15 days.” For protocols, paying yield farms has been compared to renting liquidity. You will be surprised how destructive this can be in the long run. We will go further in-depth on this topic in a future article on Protocol-Owned Liquidity.

Reserve Bonds

After bonding flipped the script on liquidity, Olympus quickly realized that bonding can be used to acquire reserve assets directly. Reserve bonds lower the barrier to entry, simplifying user experience by reducing the number of transactions (ex: deposit LP). The mechanics are exactly the same: a bonder pays the protocol in exchange for governance tokens at a discount, which vest over a predetermined span of time.

But ser, bonds are debt instruments!
One of the common objections we hear to describing this process as “bonding”is that TradFi bonds are debt instruments. But Olympus-style bonds are not debt instruments. They are fully backed at point-of-purchase by the underlying governance tokens.

Issuing debt is the process of bringing future productivity into the present, one of the most powerful mechanisms in modern economies. In TradFi, bond purchasers lend funds to companies in return for future yield. Debt financing is the bedrock of Traditional Finance.

Meanwhile in DeFi, uncollateralized lending is one of the toughest problems to solve, requiring familiar-sounding terms like credit scores and co-signing. Due to this, over-collateralized lending is the norm in DeFi. Web3 protocols with limited off-chain footprints are at a significant disadvantage when in need of on-chain assets like liquidity. To complicate matters further, their treasuries are notoriously concentrated in their own governance tokens.

With our bonds, protocols can unlock value and diversify their treasuries.

Our Bonds

On launch, Bond Protocol will offer two configurations of vesting terms for our bonds: Fixed-Term and Fixed-Expiry. One major difference between the Bond Protocol and Olympus Pro contracts is that the underlying governance tokens vest fully at maturity, instead of being claimed linearly. This greatly simplifies the bonding contracts and allows for tokenized bonds.

Vesting Terms
In exchange for purchasing governance at a reduced price, bonders accept a vesting term defined by the protocol. Enforcing these vesting terms on-chain aligns incentives with long-term holders and protocols who can distribute their governance tokens over time.

Fixed-Term Bonds will be most familiar to users of Olympus Pro. They mature a fixed number of days (ex: 30 days) from point-of-purchase. Bonds purchased on different dates are not fungible, so these bonds will use the ERC1155 NFT standard.

Fixed-Expiry Bonds were created to allow fungible positions for longer-dated bond programs. They mature at a specific date and time (ex: Dec-31–17:00). This type of bond will use the ERC20 tokenization standard which offers broad composability in DeFi. Fungible bond positions open an exciting range of possibilities (ex: lending) that we plan to pursue to create long-term value for protocols and bond holders.

Future Bond Types
Bond Protocol’s contract architecture is incredibly powerful, allowing new bond types to be added in the future. Keep an eye out for new developments and collaborations with industry leaders by staying up-to-date with our socials.

Upcoming Article

How do protocols currently price vested governance tokens? How does one approach pricing the same governance token with different vesting terms? What the heck is a BCV? These questions and more will be answered in the next article on Auctions.

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