SMART Yield Bonds

Interest rate volatility risk mitigation using debt based derivatives.

Abstract

Currently, the decentralized financial ecosystem 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 but  we do 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 can be maintained.

The person doing the bundling / securitization is banking on the fact that this structure will pull more funds towards the supply side of lending markets, which in turn will lower borrowing rates (a mechanic to incentivize borrowing), which will lead to more loans being taken out. More loans = higher supply interests, which means the “CLO” will make even more returns, and there will be even more incentive for investors to create new pools.

SMART Yield overview

BarnBridge is proposing a system where there are 2 types of participants:
Junior token holders – jTokens (More Risky)
Senior bond holders – sBONDs (Less Risky)

Junior token holders provide liquidity and buy risk from Senior bond investors. The risk in the case of SMART Yield is the risk of variable rate annuities going down.

Investors that buy the Senior Bonds (sBONDs) will have a guaranteed yield for the life of the sBOND, which will be one of the 2 main properties of the sBOND (along with TVL).

The liquidity provided by the Juniors and the value locked in the sBONDs are invested in various DeFi lending platforms and the resulting rewards cover the guaranteed reward for senior sBONDs. Some of these rewards come in the form of governance tokens which our system will sell on Uniswap for the native token of our pool. As an example, let’s consider Compound as a lending platform and DAI as a pool token.

The Juniors will benefit from the extra rewards generated by liquidity (DAI) locked in sBONDs by Seniors in situations where the variable APY of Compound (including the COMP rewards) is higher than the guaranteed yields of current sBONDs. On the other hand, in the event of falling rewards from Compound, the returns of Juniors are diminished and if need be, their locked funds will be used to pay for the guaranteed returns of sBONDs.

In order to provide the best UX for Juniors and encourage them to participate in SMART Yield pools, the system will allow them to join the pool at any time. Moreover, they will have a possibility of instant withdrawal of at least part of their funds, without affecting the integrity of the system and keeping the guarantees.

To do that, we calculate the profits and losses of the pool very efficiently. We do that by averaging all existing sBONDs into one “weighted average” sBOND.

Fee Structure

On the Senior side, fees are collected after maturity date, when sBonds are redeemed.

On the Junior side, fees are collected on jToken purchases (jTokenDAI in the example above).

The percentage of fee that goes to BBDAO treasury is set by the BBDAO.

Secondary Markets

The Junior Tokens are ERC-20 compatible since they are fungible. Secondary markets can easily be created for these (e.g. Uniswap). This will allow jToken holders that need liquidity to exit quickly, probably with a discount.

The Senior Bond tokens (sBOND) are non-fungible (NFTs), but transferrable. One could sell these tokens before their maturity date at a discount to someone who is willing to wait until the end to claim the principle plus the guaranteed reward.

BarnBridge will build a marketplace for selling and buying of senior tokens. The pool is permissionless so others can build marketplaces as well.

Risk and Loss Scenarios.

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.