The SPAC of DeFi?
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TLDR below. This is not financial advice.
Season 1 is for the foundations of economics design, token economics and token engineering. The fun stuff comes now in Season 2!
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BarnBridge is a new DeFi product in the market. Unlike the existing DeFi products, BarnBridge goes to a new level of mixing the various existing protocols.
This is unlike the usual economics content we cover. Usually, it’s very economics design focused. This time, it’s more of financial design and engineering focus. This is still relevant to economics, in terms of financial economics.
Instead of the usual market design, mechanism design and token design pillars, we will focus more on the tokens in BarnBridge, governance structure, comparison with other protocols, understanding the 2 fixed-income bond-like products and suggestions for improvements.
What is BarnBridge
Essentially it’s like a SPAC. What they do is they raise funds from the public and then allocate funds into these different startups or ventures. They collect returns from them. BarnBridge kind of works like a SPAC because they’re raising capital from the public and then they’re allocating into these different bonds or assets that they’re structuring.
1. 4 Tokens in BarnBridge
$BOND(ERC20): Governance token
$BBVote: Temporary governance token
$BOND ( ERC721, NFT): Experimental token
(Future) Tokenize the bond product: Representing the financial product itself
2. Governance Structure
The whole point of governance for BarnBridge is that they want to decentralize it from the beginning. This will be done via a DAO.
With the $BOND token, you can vote on the DAO. Currently, there is no information about what the votes can do.
It would be interesting to explore more about the governance structure. I am worried about the type of governance power given to the general public. Financial engineering is not easy and structured financial products are complicated. Giving the general public to decide how the products will be structured can be quite worrisome.
3. $BOND vs $YFI, $AAVE, $SNX
A lot of people find that finance is a bit difficult so let’s start by comparing BarnBridge with three different products in the DeFi space. Now they’re not the same but it will give you an understanding of what BarnBridge does by comparing the existing DeFi products.
BarnBridge VS Yearn
What BarnBridge does is called risk optimization and what Yearn finance does is called ROI optimisation. Let’s say I have 100 DAI. I can do three things with it:
Put it in my wallet and keep it there
Liquidate it to change to something else (e.g. Bitcoin)
Invest it in some DeFi protocol
In Yearn, you can give the 100 DAI to the system. The system will find the protocol with the best returns and place your 100 DAI there. You optimise for returns.
In BarnBridge, it is about optimising for risk. If I like risk to get more returns, I can choose that product. If I do not like risk and happy with small returns, I can choose that product.
Let’s say I’m a very risk-loving person and I just want to make as much returns as possible. I’m looking at let’s say a very high-risk product something like 90%. If the market does very well, then I get 90% upside. If the market does badly, I would lose 90% . BarnBridge has such kind of products where if I have 100 DAI then I can put it into this product that has very high risk but also very high returns. so that’s one type of product. The other type of product is if I have 100 DAI and I don’t really like risk so I look at a low-risk product so maybe just 10% and put my money in there and if the market goes up I get 10% of whatever the market does but if the market goes down I only lose 10%.
Yearn finance is where you optimise returns. BarnBridge is where you optimise risk.
BarnBridge VS Aave
Aave is a lending protocol so it is more like a one product yield whereas BarnBridge is multiple product yields. I have 100 DAI and I can put it into the Aave protocol to earn interest rates via their system.
BarnBridge does it a bit different. One of their bond products is that they will look for yields in many different protocols. 100 DAI will be added to the various products to be getting returns. Now the second difference is that Aave specializes in lending whereas BarnBridge can do a lot of other things because at the end of the day they’re just taking whatever is available in the space and packaging them together into a new product.
Aave is where you get exposure to 1 protocol (Aave). BarnBridge is where you get exposure to more protocols available in DeFi.
BarnBridge VS Synthetix
Synthetix is to create synthetic assets and protocols so instead of having USD you have synthetic USD and instead of having tesla shares you have synthetic tesla shares. It follows the market of how tesla market works. Instead of trading the actual tesla, you’re trading the synthetic version of tesla. You have different counterparties who are matching your orders so it means instead of buying and selling the actual tesla’s share in the tesla market ,you’re creating a synthetic version. It’s like fantasy football. Or kinda like Dungeon and Dragons.
Now what BarnBridge does is that instead of synthetic assets, they’re investing the actual money and capital into real assets and protocols. When the money or the capital is in the bond, the money in the bond will be allocated to actual assets and protocols. E.g. DeFi assets.
Synthetix is the creation and trading of synthetic version of products (create sUSD). BarnBridge uses the capital in actual products (put capital in protocol).
4. Fixed Income Bond-Like Products
Smart Yield Bond
It is an interest rate volatility risk optimiser. They want to optimise it so they want to reduce the interest rate volatility risk. It’s kind of like a fixed income bond so you have a fixed coupon for this bond. If you have this product and when I buy this, it means that every month I will get a small portion of it into my bank account.
That’s fixed for every month so it’s a fixed coupon or a fixed income. I don’t really have to care about what the risk is outside because that’s what the company does. They structure these products to help you reduce your risk and in return, I will get a fixed amount of money or fixed income.
Get money from people or raise funds from the public. They’ve raised a few hundred million dollars,
Create a pool of products so BarnBridge puts money into these actual assets and protocols. It could be to take the money from people and put it into Aave, Compound, or Maker to be investing and getting yields. There are two pools available you have high risk and you have low risk so people who want high rates put money in high risk and people who want low rates put their money in low risk
We calculate the risk and returns of these assets so defining the interest rates. It could be high risk and you’re putting money into very risky protocols and are not very sure of the returns then you calculate the risk and the potential returns that are available. Low risk is a bit less risky and the returns are not so high but you have a higher confidence level that the money wouldn’t just disappear.
Smart Alpha Product
This is the price exposure risk so it is to get exposure to the price change with the level of risk that you’re comfortable with.
This has a similar concept to you purchasing options to hedge against your risk.
Let’s say I have ETH that’s worth $400 and I’m worried about the value of this is going way too high or way too low.
Step 1: They collect assets from the community. (E.g. ETH)
Step 2: Liquidate assets for DAI, a stable currency with low volatility.
Step 3: In six months’ time, we’ll use that DAI to buy back the ETH.
Step 4: It could be more or less depending on what the market is. When I give my ETH to BarnBridge protocol, I can choose between two types of risks. It could be high risk so something like 70% or low-risk something like 30%
Step 5: The risk profile (70% or 30%) you choose determines your income or loss.
Let’s say six months ago ETH was worth $400 and today it is worth $500. It means that prices increased by $100.
If I am in a high-risk profile, of this extra $100, I will get $70. People in the lowest risk profile will get $30.
If within the six months time prices drop by a $100 then people in the high-risk profile will lose $70 and people in the low-risk profile will lose $30. This is the entire idea and concept of smart alpha bond.
Personally, I think the idea is great. As the space attracts new people into the space, the focus shifts from yield optimisation to risk minimisation. BarnBridge can structure such products with risk in mind. Thus, here are 3 recommendations for them to look into.
One of the problems in traditional finance is when all these bond stuff are being created, we’re not calculating the risk exposure very well. Even if we can calculate them, we’re not recalibrating them constantly according to the kind of risk exposure that we want in real terms and not nominal terms.
This is something that DeFi could add a lot of value in. The kind of inefficient traditional financial products that are available so we can look at it as a smart contract. If this bond represents a 30% risk exposure, we can look at using smart contracts and math to automate this recalibration of the risk given the new inputs available.
Disclose Structure Strategy
One of the inefficiencies in traditional finance is that regulations ask you to disclose a lot of different things but the problem is that these structures and strategies are complicated and not only are they complicated in creating them but also in trailing them to find out where your yields are coming from or where your risks are coming from so with smart contract and decentralization there could be an improvement because now they will disclose. It could be written in a smart contract where you can see the constant change in where the yields are coming from and what kind of risks are being diversified into the different protocols so having a very clear understanding of the structure would be very important because it becomes a lot easier to be tracing and looking at where all these yields and risks are coming from so that people can make informed decisions.
It’s kind of like a mix of discounted cash flow plus some form of voting equity-like structure. It’s very complicated and a lot of people are using governance token and governance token as a way to give a reason for the existence of native tokens which makes sense. But what I would suggest is to have a clearer use case for it.
With these financial products, there isn’t a very clear use case for governance token because what are you governing? Having a specific mandate for governance can reduce uncertainty of random individuals with less than adequate knowledge to decide the creation and structure of financial bond products.
The whole idea of buying these financial products is that I as an individual don’t want to look at all the different risk profiles of protocols and structure a product together and then invest in them because I can do it by myself. The idea behind buying into these products is that someone else who is really smart could do that. And I just put my money in it.
Listen on Podcast
BarnBridge is like a SPAC — raising funds from the public, allocate it to various protocols and find counter-parties within their ecosystem. The idea is great and the product is not out yet.
It is unlike other DeFi products in the space, with areas of suggestions worth looking into.
Get smart: Innovative ideas and concepts that could do with more clarity in the mechanisms.
Get smarter: Right now it’s still an idea and the product is not out yet so it’s kind of like a SPAC with no resume.
Listen to the full interview with BarnBridge.