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Tokenized Risk Protocol

A fluctuations derivatives protocol for hedging yield sensitivity and market price.

Abstract

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. This is not a coincidence or a trend. Historically speaking, going all the way back to biblical times, working capital chases yield, assuming relatively equal risk.

The acceleration of debt levels, across the globe, was happening before the financial crisis caused by Covid-19. In Q1 2020, we saw global debt increase to $258 trillion. This number is 331% above global GDP, according to the IIF, which represents global banks and financial institutions. With the Federal Reserve operating under the pretense that they have an infinite supply of cash and the euphemism “money printer go brrrr” joining the mainstream lexicon, it’s quite clear these numbers will likely increase and debt issuance to GDP will continue to accelerate.

The traditional financial system, referred to as TradFi in this paper, is experiencing a historic uptick in aggregate debt levels while yield and interest rates plummet. 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 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 organization (DAO) 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 no 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. Tokenized Risk Protocol

BarnBridge is the first tokenized risk 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.

Risk and Loss Scenarios.

Scenario 1:

Scenario 2:

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 sETH (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.

2.3 UI/UX Interface (Light)

2.4 UI/UX Interface (Dark)

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.

3.1 Distribution

The distribution breakdown is designed to facilitate the most decentralized protocol and make sure power doesn’t reside in the hands of a few.

3.1.1 Fair Vesting

The vesting schedule is designed so that there is not a giant cliff waiting over users heads at a specific point. The tokens allocated to the Founders, Seed Investors, and Advisors are locked in a smart contract that releases the tokens on a weekly basis over a two year period. The vesting period starts with the launch of the Yield Farming mechanism. This breaks down as such:

  • Total amount of $BOND tokens: 10,000,000
  • Percent of $BOND tokens allocated to Founders, Seed Investors, & Advisors: 22%
  • Total amount of $BOND tokens vested: 2,200,000
  • Length of vesting: 100 weeks
  • Release schedule: 1 week
  • Amount of $BOND tokens released each week: 22,000
  • Percent of $BOND tokens released each week: 0.22%

3.2 Governance

The $BOND token will be the system’s governance token, empowering $BOND holders to vote on updates to the platform. Combining governance mechanisms and incentivizing holders, it will serve as a means to align the different stakeholders in the system. $BOND will also serve as a security and policy management medium. Decentralized, automated governance, that incentivizes participants and aims for security, sustainability, and participant welfare is key to a DeFi protocol’s success.

3.2.1 DAO First Approach

BarnBridge is taking a “DAO First Approach” to spinning up the protocol, choosing to use decentralized tools from the start to achieve our final goal of complete decentralization and having a flexible smart contract system able to add / upgrade / remove functionality all based on DAO proposals. There will be an incubator DAO called Launch DAO & the final protocol DAO called BarnBridge DAO.

Launch DAO

Starting with Launch DAO, the Founders, Seeders, and Advisors are using an Aragon DAO Company Template which uses transferable tokens to represent ownership stake. Decisions are made based on stake-weighted voting. The native token of the Launch DAO will be $BBVOTE. The Founders will receive 45%, Seeders will receive 45%, and Advisors will get 10%. The support will be set to 62%, which means more than 62% of the voting shares need to be present at a vote. The minimum will be set to 62%, meaning for a proposal to be passed it must be approved by at least 62%.

The funds from the seeders and the initial supply of the $BOND token will be kept in the Launch DAO treasury. Launch DAO will also have Aragon Agent activated and we will possibly develop integrations for Uniswap pool allocation and Balancer pool allocation control directly into the DAO.

BarnBridge DAO

BarnBridge DAO will be the DAO that is controlled by the $BOND community. The BarnBridge DAO will have full control over the protocol and the features that are built into it. We are doing this through the use of the the Diamond Standard (EIP-2535), which allows us to upgrade the protocol without having all the members remove their tokens and switch to a version 2 of the protocol that time arises. The BarnBridge DAO will have full control over the Diamond which provides amazing flexibility in the WEB3 space. We expand on this in the Smart Contracts section (4.2.1).

4. Scope of Work

4.1 Development Introduction

The following section describes the MVP / Beta release of the product, which will help inform the product development direction, allow us to start collecting data and ensure the product is aligned with what the market needs.

We are determined to provide a great user experience for users, making sure previous pools are visible and our community can make a well informed decision about when and how to join in. However, we expect the community to build some of the analytics which will accompany the core product. We welcome this development as it will provide more insight into the product.

4.2 Components & Timelines

Launch DAO

We will use the community contracts based on Aragon DAO Company Template to create the base of the core DAO. Because the contracts have already been in production for so long, we trust the functionality and features they provide.

We expect to do minimum changes to the initial source code. However, we will create tests for our most common use cases, make sure the user flow makes sense and the users have an easy UX to join in the DAO.

  • Estimated time to build, test and launch: Completed

BarnBridge DAO

This subsequent DAO might need to have multiple specific functionality that the Aragon DAO Company Template does not already have. This is why we will likely choose an upgradable smart contract system (such as EIP-2535), which will allow us to add, remove and upgrade functionality as the community sees fit.

The BarnBridge DAO will become the core component of the BarnBridge Platform because it will be able to make decisions in a decentralized manner that will be able to enforce the best actions for the wellness of the community.

  • Estimated time to build, test and launch on testnet: 6 weeks

An additional external audit will push the launch on the mainnet by approximately 4 weeks. More details in 4.2.2 on Audits & Simulations.

SMART Yield Bonds

The whole DAO setup is done to solidify the path towards SMART Yield Bonds. This is the first DeFi product of the BarnBridge Platform. The Voting DAO will be able to deploy pools that anyone can join if they want to take advantage of this core mechanic.

Because the DAO’s control the whole system, which means the community decides how the system will be used, the parameters for this DeFi product will be in part determined by the community. Some of the other parameters will be decided by the decentralized oracle system (such as Chainlink), which needs to set proper, real and attainable parameters for the pools to be valid.

This consists of pool contracts that the users interact with, the deployment factories that deploy & set up the pool contracts, and the complimentary back-end and front-end that creates a high fidelity UX for the community.

  • Estimated time to build, test and launch on the testnet (including the oracle system): 12 weeks

An additional external audit will push the launch on the mainnet by approximately 6 weeks. More details in 4.2.2 on Audits & Simulations.

SMART Alpha Bonds

Following the model of the SMART Yield Bonds, the DAO controls the setup and the parameters for SMART Alpha Bonds. Additionally the smart contract oracles will be critical in determining the price of the staked assets, as well as the price when the pool period starts and also when the period ends, to have a fair distribution of earnings or losses.

This DeFi product is composed of the actual pool contracts the users interact with, specific deployment factories, which deploy and set up the pool contracts, and the complimentary back-end and front-end.

  • Estimated time to build, test and launch: 20 weeks

An additional external audit will push the launch on the mainnet by approximately 6 weeks. More details in 4.2.2 on Audits & Simulations.

4.2.1 Smart Contracts

Because we want to have a completely decentralized system, our whole infrastructure is based around a community driven DAO. The DAO will be the owner of the core contracts of the system and will be able to define what the contracts are able to do.

The architecture is using the Diamond Standard (EIP-2535) which allows for smart contracts to add, upgrade or remove functionality. The Ethereum smart contracts are limited to 24KB of maximum contract size, however implementing this standard allows us to bypass this limitation.

It also allows the BarnBridge DAO to choose what functionality to be changed and how. If we promise that a specific functionality will be later disabled from the contract system, we can remove the bytecode which was specifically describing that functionality. That means that there’s no risk of that part of the contract to be re-enabled in the future. Because we can remove specific parts of the contract, we remove the bloat from our contract system, making them easily auditable by the community, while having greater flexibility.

This will not only be an amazing addition to the tech stack but also would help push forward the Ethereum ecospace. This EIP brings many advantages, not only to our protocol, but the Ethereum ecosystem at the aggregate level.

To keep the core philosophy of having a completely decentralized system, we will use a decentralized oracle system such as Chainlink. This will allow us to do off-chain computation that can be later used on-chain. This will be useful for, but not limited to, setting pool parameters such as the lending APY. Of course this off-chain system can be replaced and upgraded by the DAO.

4.2.2 Audit & Simulations

To make sure our platform behaves as we expect it to, we will do multiple internal audits throughout the development cycle. Our team has the capability to write secure code that behaves according to the specs.

Additionally, to the internal audits, we will do external audits with top companies in this space. External reviews are an absolute requirement as the development team is too close to the written code to look at it with fresh, new eyes & be critical of the design choices. An external audit reveals inconsistencies between specifications and implementation, makes sure the documentation is updated, stresses the security model of the smart contract, and creates a better experience for the actors interacting with the contracts.

On top of audits, we will also do agent simulations to model different scenarios and user behaviors, in order to visualize how the system evolves over time. We can model different user strategies that interact with our system and fast forward time to see how the system’s properties change.

We will also do formal verification of core contract functionality. Formal verification is an expensive and complex process but it provides additional security. Core parts of the system will be modeled and formally verified by our team internally but also by external auditors. It is important to make sure that we do this because the distribution, internal accounting, mathematical properties and specific variants keep our users safe.

4.3 Post-MVP

The post MVP, or the next release of the product will have the mainnet release as its highlight. Protocol agnostic SMART Yield Bonds, and development and testing of the SMART Alpha product will mark the post MVP - and therefore complete the launch of the full featured BarnBridge protocol and products. The SMART Yield product and liquidity mining will launch before the SMART Alpha product.

5 Future Work

5.1.1 Gas Fees

As multiple operations with different gas costs are necessary, these fees can add up pretty quickly. There are layer 2 solutions that would increase scalability and allow for complex operations and large numbers of transfers while simultaneously reducing associated costs. A potential solution that has already hit mainnet (looking at you Loopring) are zk rollups - which at a high level involve the bundling up transfers into a single transaction. Most of the computations are done off chain, and enforced through validity proofs. Moving the heavy lifting off-chain allows for much higher throughput, keeps costs lower, and - just as importantly - doesn’t sacrifice security. For an app that targets large numbers of active users, a solution aimed at scalability is the way to go.

5.1.2 SMART Swaps - one loan broken into 4 instruments

5.1.3 SMART Prediction Hedge - Derivatives hedging fluctuations in prediction market odds.

5.1.4 Market Driven Ratings Oracle - Trestle Point Index

Leveraging the wisdom of the crowd we can create an index that works as a ratings system providing an oracle mechanism that can be used by any platform in DeFi. A Moody’s for the decentralized future if you will.

The risk assessment framework used to rate the tranches could be used to determine market sentiment. Driven by the markets that form behind the tokenized tranches, the ratings that determine the tranche formation would become a ‘fear gauge’. In short, if the riskier tranches are more popular then it could offer an early sign that the underlying components are less risky. Similarly, if the usage of the lower yield, safer tranches see an increase in volume, this could be an early warning sign that a vulnerability was found and an attack is potentially imminent.

6. Team

6.1 Core Team

  • Troy Murray - Troy runs RUDE_labs, a crypto centric artist company. Troy has been exploring the many benefits that Blockchain can bring to media and artists since 2012 when he got bit by the Bitcoin bug and has been falling down the rabbit hole ever since. Troy has worked in an around the Crypto space, devoting most of his time to Ethereum based projects. Previously was working on SingularDTV/Breaker and snglsDAO trying to decentralize media and entertainment. Before that he was building a Title III equity crowd funding platform using Ethereum tokens in 2016.
  • Tyler Ward - Tyler runs Proof Systems, one of the largest marketing & UI/UX companies specializing in digital assets. Tyler has worked with ConsenSys, Earn.com (who was acquired by Coinbase), FOAM, Dether, & Grid+, Centrality, Sylo (a decentralized messaging dApp with 300k users in NZ), NEAR Protocol, DARMA Capital, SingularDTV & the snglsDAO. He started working in crypto in late 2016 & has bought and sold numerous ecommerce companies.

Digital MOB - DigitalMob, a software development company experienced in building complex blockchain products, is taking the technical role in the product with an extensive team of web3 developers, web and mobile developers, system architects, security experts and analysts.

  • Milad Mostavi - Milad co-founded and runs DigitalMOB. He is a seasoned software architect and in the past 5 years has worked with ConsenSys on a dozen of different projects. His contribution was decisive in successfully launching SingularDTV and Gnosis and orchestrated the development of SingularDTV’s entertainment decentralised ecosystem.
  • Bogdan Gheorghe - Bogdan considers himself a DeFi nerd - with a background in mathematics and data science, he spent the past 2 years at Alethio doing data analysis on blockchain data, using and researching almost all DeFi protocols in order to put a DeFi flavor to the Alethio product suite. Having also worked on development and sales for the Codefi DeFi data API, he was in contact with all of the major protocol teams. Now he is part of Digital MOB taking the product owner responsibility to build DeFi products.
  • Dragos Rizescu - Dragos is responsible for product development at Digital MOB. His background is full stack developer with a passion for building highly scalable user interfaces. In the past 5 years Dragos has been at the forefront of web3 technologies. He co-founded Treum.io, a blockchain supply chain solution that brings transparency, traceability and tradability to highly valuable physical assets. As a developer, he was part of the core team to launch projects such as Gnosis and SingularDTV and has advised and supported multiple projects in the ecosystem, most notably Alethio. He worked with ConsenSys to support the enterprise arm of the company, being part of the development team to deliver the first non-financial Ethereum use case, a track and trace solution of rock samples for BHP and a solution for decentralized energy markets with BP.

6.2 Advisors/Technology Partners

  • Aaron McDonald - Co-Founder and CEO Aaron is a 20 year tech industry veteran with experience leading teams across all aspects of a technology company managing portfolios over $1b in value. Aaron founded Centrality a leading $100m global venture studio supports a venture portfolio leveraging decentralised technology to create new market innovation and customer experiences. Aaron is a board member or advisor to more than a dozen venture companies around the world. In 2018 Aaron was awarded EY Entrepreneur of the Year for the technology and emerging industries category.
  • Atpar - the company behind ACTUS protocol -- whose goal is to provide the Ethereum community and the TradFi world with the tools necessary for fulfilling the vision of an open, interoperable and frictionless financial ecosystem. At its core, the ACTUS Protocol leverages the Algorithmic Contract Types Unified Standard (ACTUS) which is a formal representation of all kinds of financial contract types in terms of their financial obligations.

6.3 Development Team

  • 1 Project Lead
  • 1 Software Architect, QA & DevOps
  • 2 Solidity developers
  • 2 Front end developers
  • 1 Back end developer