BarnBridge is an idea & whitepaper originally conceived in Q2 2019. At the time, MakerDAO was starting to garner mainstream awareness and capture the imagination of what is now known as the DeFi, or decentralized finance, community. Over a year later, with 60% of Global debt yielding less than 1% & over $15 trillion of global debt yielding negative rates, capital continues moving into higher risk yield streams.
Meanwhile, there is a decentralized financial system, referred to as Defi in this paper, burgeoning in the digital economy with digital assets and cryptocurrencies. While debt levels, which is referred to as TVL, or total value locked in decentralized financial protocols, has increased from hundreds of millions last year, to billions of dollars in 2020, yield on these instruments continues to dwarf the menial rates offered by comparable products in the legacy TradFi system. Conversely, due to assumed higher risk levels coupled with higher efficiencies provided by smart contract technologies, annual percentage yield (APY) is far higher on decentralized protocols than what can be found in the traditional financial system. Working capital is following the historical trend of following higher yield which is why we are seeing TVL moving to Defi at an accelerating rate. This is a trend that will continue.
The need for familiar TradFi instruments to exist throughout the DeFi ecosystem has never been stronger. BarnBridge is an idea whose time has come.
DeFi Primer: Risk Ramps and TradFi Bridges
The yield products in the decentralized markets which are yielding higher APY than yield products in traditional markets are currently crypto backed loans. Instead of selling crypto for fiat, borrowers are staking digital assets and receiving digital assets in return. While these loans have mostly been short term loans to traders, the system has proven to be efficient & ripe for expansion. These efficiencies will inevitably attract higher value, longer duration loans to decentralized ledgers. The efficiencies referenced are enabled by smart contracts’ ability to hold digital collateral until both sides of the transaction fulfill their obligations algorithmically. The reduction of custody, settlement, and escrow — labor-intensive, costly actions within the legacy system — to algorithmic actions is reducing the rent charged by the labor to perform these actions. These efficiencies, coupled with the perception of higher risk, are why the yields are higher on decentralized systems. As risk in DeFi converges on risk levels perceived in TradFi, by the nature of the loans moving from crypto backed loans to traders to collateralized mortgage loans to homeowners, for instance, the efficiency of smart contracts will continue to offer higher yield on decentralized systems than traditional centralized systems.
What’s more, the efficiency of smart contracts and DAO technologies allows for far more complex derivative instruments to be built & provides a level of transparency and security unfathomable to current financial networks.
All of these efficiencies are currently stemmed and built off of crypto backed loans.
As previously discussed, these efficiencies should extrapolate to mortgage debt and corporate debt moving to decentralized platforms on a longer timeline. This should also encourage more complex derivatives based on debt and yield to move to decentralized platforms. We will be able to structure far more complex derivatives and track them with far greater efficiency and transparency than possible before the innovations of blockchain, cryptocurrency, smart contracts, and decentralized autonomous organization technology were realized. $244 trillion in debt and yield based derivatives will continue to move to more efficient technologies over time. The migration of yield and yield-based derivatives from less efficient centralized financial systems to more efficient decentralized financial systems will be one of the largest movements of wealth in human history. BarnBridge exists to help facilitate this transition and make the decentralized financial system much more efficient, risk-flexible, and attractive to a wider range of participants.
There is a massive market for people wanting to get into crypto who (1) don’t want to bite off the entire risk curve of owning, lending, or receiving an entire digital asset & (2) will never take the time to use a decentralized autonomous organizations (DAOs) to create a smart contract which algorithmically scripts both sides of the loan or agreement. Over 99.9% of global debt is still structured via traditional markets and is starving for yield. Conversely, more advanced financial companies have different risk tolerances. This allows for different structures at each point of the yield curve with the riskiest (likely hedge funds) wanting to put the least money down with the highest return for their bet/hedge. On the contrary, more conservative investors are often willing to give up a large portion of upside opportunity in order to access safer instruments. “Riskless” products, as tradFi describes them, are not currently offered in the decentralized financial ecosystem. The opportunity to structure these types of instruments will allow for more risk averse investors in the traditional markets to move into the decentralized markets.
In the shorter term phase (DeFi) & medium term phase (Proof of Stake) risk ramps will continue to create markets and industries for traditional investment firms who want to “get off zero” or “get above 1%.” As this happens, more and more types of loans will move to decentralized ledgers. In the long run, and partially through this process, lenders and borrowers will understand why decentralized and trustless intermediaries are superior and less costly than the current 3rd party intermediaries. As this happens, larger portions of the $244 trillion in global debt will move to the chain, creating the opportunity for more yield, more risk ramps, and higher CD-like (collateralized debt) products for fiat and crypto depositors of the new age commercial banks & financial markets.
1. Fluctuation Derivatives Protocol
BarnBridge is the first fluctuation derivative protocol. Before the advent of smart contract technology it was close to impossible to track & attribute yield to a divided allotment of capital, trustlessly & transparently, to provide hedges against any and all fluctuations. Conceptually, you can build derivative products from any type of market driven fluctuation to hedge various risks. Examples include, but are not limited to, interest rate sensitivity, fluctuations in underlying market price, fluctuations in predictive market odds, fluctuations in default rates across mortgages, fluctuations in commodity prices, and a seemingly infinite number of market based fluctuations to hedge a particular position.
We plan to create the first cross platform derivatives protocol for any and all fluctuations. To start, we will focus on yield sensitivity & market price. Downstream, we plan to introduce a far wider variety of hedges against fluctuations in the decentralized ecosystem. BarnBridge aims to be platform and asset agnostic.
You can reduce the risk of digital assets & digital asset yield sensitivity by breaking them into essentially infinite, separate, dollar-denominated chunks, or tranches, and building derivatives off these tranches. BarnBridge aims to smooth out the risk curve and offer layered risk management to both DeFi & tradFi investors by building more efficient debt & yield based derivatives.
2. Initial Product Offerings
Smart $BONDS — Structured Market Adjusted Risk Tranches
2.1 Smart Yield Bonds
Interest rate volatility risk mitigation using debt based derivatives.
Currently, the decentralized financial system is primarily offering variable rate annuities. However, the ability to structure yield into fixed rates will come in the form of locked collateral with a maturity on repayments, or bonds, as well as fixed rate yields with no maturity, or annuities. We don’t believe this to be a novel idea & we believe naturally that these types of products will come to DeFi over time. However, the types of derivatives & complexity reduction in financial planning you’ll be able to structure and implement with the existence of fixed yield in smart contracts will be mind blowing to traditional financial markets.
Decentralized financial instruments are showcasing the power that a trustless financial industry can wield. Powerhouse projects in the DeFi space like MakerDAO, Synthetix, AAVE, Compound, Curve, and others are producing yields for users that have none of the constraints and rent seeking of tradFi instruments by replacing bookkeepers, escrow and various overhead with algorithms, trustless oracles, and decentralized ledgers. Different market driven yields can be found on numerous decentralized platforms, but there is nothing out there that services & pulls together all of the different decentralized protocols & allows for a normalized risk curve and derivatives for risk mitigation.
Furthermore, efficiencies across lending protocols are non-existent in the current DeFi markets. The ability to pull yield from numerous protocols and tranche them into higher and lower yield buckets is something that exists in traditional financial markets but is more efficient in decentralized financial markets, assuming an acceptable level of liquidity.
Our first structuring will not only allow deFi users to get access to fixed yield but also pools yield from numerous protocols across the ecosystem creating a more efficient market, again, smoothing out the yield curve across the entire industry.
While we expect singular lending protocols to introduce concepts around fixed income on their platform, a major differentiation of a cross protocol based approach to fixed income is the diversified assets & diversified platform risk. By algorithmically pooling interest generating digital assets on a number of lending platforms, we will create greater efficiencies by spreading risk & normalizing the industry risk curve. Since BarnBridge does not lend money directly off a native platform, & instead pools lending across the industry, it allows us to be platform agnostic & digital asset agnostic which in turn will allow for more complex structuring and bond rating systems downstream.
Pooled collateral would be deposited into lending protocols or yield generating contracts, and the yield will be bundled up into different tranches and tokenized. So you could buy exposure to the most senior tranche and get a lower yield but have a much lower risk profile. SMART bonds are a way to buy and sell risk on yield with all of the pricing driven purely by the market.
Reference financial structuring can be found here.
2.2 Smart Alpha Bonds
Market Price Exposure Risk Mitigation using tranched volatility derivatives.
The SMART Alpha bonds will not be structured via traditional yield tranches but instead with various levels of market price exposure, which we will call risk ramps. The idea is that every bucket or tranche of price exposure does not need to be flat across the entire risk curve, meaning the first $100 of price exposure does not need to deserve the same upside and downside volatility. This is similar to having fractional ownership but with different risk/reward for the fractions.
For example, if the current price of 1 ETH is expected to be $1000, and moves to $900, the first tranche (the riskiest tranches) takes a higher percentage of the loss. Conversely, if the current price of 1 ETH is expected to be $1000, and moves to $1100, the first tranche (the riskiest tranches) takes a higher percentage of the gain.
How these gains and losses are measured & allocated across tranches can be done algorithmically with smart contracts. Each tranche can be traded as a unique digital asset. For example jETH (a junior tranche of ETH price exposure), mETH (a mezzanine tranche of ETH price exposure, and sbETH (a senior tranche of ETH price exposure). The tranches will exist as risk ramps in which users of various risk appetites can gain price exposure to digital assets.
The SMART Alpha product will make way to build tranches of single asset and multi-asset pools that generate yield and where lower risk ramps get lower returns when the underlying assets rise & lower losses when they drop. However, we can build this without needing yield attached at all. The opportunity for downstream opportunities to use various risk ramps for differing collateral obligations is a logical progression these risk ramps will create.
3. Token — $BOND
BOND is an ERC-20 token. It will be used to stake in the system, and as a governance token when the governance module is launched. As it conforms to the ERC-20 standard, the $BOND token is tradeable on any exchange and storable on any wallet — allowing anyone in the world to access it.