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DeFi Dives: Barnbridge

DeFi Dives: Barnbridge

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<100 subscribers

SMART Alpha

I think the best place to start is SMART Yield, as everything else really builds of that.

SMART Yield

In essence, what Barnbridge proposes is nothing new in finance, they are known as CLO’s (Collateralised Loan Obligations) but for those not familiar-

This is when you pool debt instruments together to form one combined security. The theory is that you reduce default risk on the overall debt and can achieve higher returns than possible otherwise.

The interesting part is they applied it to crypto. Traditionally you need bankers, lawyers, contracts and a lot of structuring involved to create these types of instruments. With crypto a lot of this friction is removed and you are able to do this via smart contracts, reducing the fees and (in some ways) the complexity.

We have also seen this with Ribbon, the structured products protocol I wrote about previously here.

SMART Yield takes this concept and then lets users pick a risk profile.

You have **Senior tranches **and Junior tranches.

The senior tranches get a fixed rate return, this will be lower than what is available in the markets, but the market rates are variable and so have a degree of risk.

The junior tranches receive a variable rate of return but this will potentially be higher than what is available in the market because it is boosted by the senior tranche.

The senior tranche basically sacrifices some upside for the guarantee that they will get their fixed %.

The junior tranche gets a higher % but takes on more risk.

What is this risk? That the % needed to cover the senior tranche isn’t reached or is only just covered and the junior tranche has to either cover the losses with their principal, or gets little/no return on their principal.

You can see here on Barnbridges website for example:

If you want to supply DAI as a senior pool you can get 1.44% on your principal.

As a junior pool entrant, you would receive 2.23%.

One other way to think about it:

You have $1000 to invest and so do 10 of your friends. All of you have different risk appetites, unsurprisingly.You decide to all pool your capital but 4 of you agree beforehand that you want a minimum of 5% on your money after 3 months. Anything that gets made on top of that 5% can go to the remaining 6 friends who don’t want a guaranteed return and are happy to take on that risk.

If in 3 months' time (I chose this time period at random) the investment makes a 20% return, as a group you have $12,000 dollars.

However, you and your 3 friends (the senior tranche) personally have $1050 each. Why? Because 5% of $1000 = $50.

Your 6 friends who took on the higher risk (the junior tranche) have $1300 each, because they get to claim the 15% made on top of the 5% minimum. This is actually a 30% return for them.

Great for them!

But what happens if they only made enough to cover the senior tranches 5% or worse, what if they lost money!?

The junior tranche has to subsidize this loss. In the first instance, where they only made enough to cover the senior tranche, the junior tranche gets nothing.

In the instance where they lost money, they have to pay the difference out of each of their initial $1000.

You can see quite quickly how this creates an appealing dynamic for those involved. People with a lower risk tolerance are happy to take a fixed yield, while those who are more aggressive get leveraged upside, but also greater downside risk- and everyone loves leverage in crypto right?… :)

This is the essence of SMART yield!

SMART Alpha

SMART Alpha works on a similar principle, but this time instead of stabilising yield it is connected to the underlying price of the asset.

In this way, the two tranches are broken down and the senior tranche just has less exposure to the upside AND downside swings of the asset. Conversely, the junior tranche has a multiplied exposure to the price swings.

Another way to word this, if the price of ETH is $3000 and it drops to $2500, the junior tranche has a higher exposure to the loss than the senior tranche. The same is true in reverse, if the price of ETH moves to $3500, the junior tranche gets a higher percentage of the upside.

If you look on Barnbridge’s website currently, we can take the WETH-USD 1 week pool.

The senior tranche is protected against 10.43% downside movement of ETH. i.e they will only start taking losses if ETHs price decreases by more than 10.43%

However, for this protection they only get 7.18% of the upside. i.e for every $100 ETH increases the senior tranche gets $7.18.

The junior tranche takes the opposite side of this. The junior tranche has 7x leverage to the upside, but also 7x leverage to the downside.

The % difference is variable with each asset pool depending on the calculations performed in the smart contract.

Barnbridge has some great wording around this:

(The) Senior rate is defined as the maximum amount of downside price movement the underlying asset can experience in a week before senior depositors suffer dollar-denominated losses. Junior dominance is defined as the share of a given ERC-20 token’s pool that is comprised of junior depositors.

This gives people two options: you can have less downside risk while holding an asset BUT you get less of the upside.

OR

You get leveraged exposure to the upside BUT you also have leveraged exposure to the downside.

This can be useful in portfolio construction where perhaps you want to hedge your exposure, or you are very bullish an asset and want more upside.

One other thing to note, Barnbridge launched fully as a DAO. They issued their $BOND token as the governance mechanism.

Interest in the protocol certainly wained with the end of Defi summer but I note that there was a recent proposal to change some of the DAO processes.

You can read more here:

Barnbridge has some fascinating mechanics and has brought some interesting tradfi structures to the DeFi landscape. They were extremely early in allowing degens to even consider getting fixed-rate/variable-rate risk-adjusted returns on deposits.

Since their inception, other protocols have come along like Yield & Notional, but they were pioneers in this space.

Granted Barnbridge suffered with the CREAM exploit and users lost money. However, and I do not say this lightly, we all understand that smart-contract risk is a huge risk in the space with any platform you are using.

Nevertheless, I think it is an interesting protocol to look at and understand the principles of how it functions.

This is not intended as an exhaustive history of Barnbridge and its uses-cases, but an introduction to the concepts behind it and how it was a first-mover in bringing some helpful concepts and experiments to the DeFi space.

Thanks

Kieran

PS.

I have to say, Barnbridge has also done an excellent job of curating their documents to make the protocol easier to understand.

For those wishing to learn more, I highly recommend you start there:

https://docs.barnbridge.com/

SMART Alpha

I think the best place to start is SMART Yield, as everything else really builds of that.

SMART Yield

In essence, what Barnbridge proposes is nothing new in finance, they are known as CLO’s (Collateralised Loan Obligations) but for those not familiar-

This is when you pool debt instruments together to form one combined security. The theory is that you reduce default risk on the overall debt and can achieve higher returns than possible otherwise.

The interesting part is they applied it to crypto. Traditionally you need bankers, lawyers, contracts and a lot of structuring involved to create these types of instruments. With crypto a lot of this friction is removed and you are able to do this via smart contracts, reducing the fees and (in some ways) the complexity.

We have also seen this with Ribbon, the structured products protocol I wrote about previously here.

SMART Yield takes this concept and then lets users pick a risk profile.

You have **Senior tranches **and Junior tranches.

The senior tranches get a fixed rate return, this will be lower than what is available in the markets, but the market rates are variable and so have a degree of risk.

The junior tranches receive a variable rate of return but this will potentially be higher than what is available in the market because it is boosted by the senior tranche.

The senior tranche basically sacrifices some upside for the guarantee that they will get their fixed %.

The junior tranche gets a higher % but takes on more risk.

What is this risk? That the % needed to cover the senior tranche isn’t reached or is only just covered and the junior tranche has to either cover the losses with their principal, or gets little/no return on their principal.

You can see here on Barnbridges website for example:

If you want to supply DAI as a senior pool you can get 1.44% on your principal.

As a junior pool entrant, you would receive 2.23%.

One other way to think about it:

You have $1000 to invest and so do 10 of your friends. All of you have different risk appetites, unsurprisingly.You decide to all pool your capital but 4 of you agree beforehand that you want a minimum of 5% on your money after 3 months. Anything that gets made on top of that 5% can go to the remaining 6 friends who don’t want a guaranteed return and are happy to take on that risk.

If in 3 months' time (I chose this time period at random) the investment makes a 20% return, as a group you have $12,000 dollars.

However, you and your 3 friends (the senior tranche) personally have $1050 each. Why? Because 5% of $1000 = $50.

Your 6 friends who took on the higher risk (the junior tranche) have $1300 each, because they get to claim the 15% made on top of the 5% minimum. This is actually a 30% return for them.

Great for them!

But what happens if they only made enough to cover the senior tranches 5% or worse, what if they lost money!?

The junior tranche has to subsidize this loss. In the first instance, where they only made enough to cover the senior tranche, the junior tranche gets nothing.

In the instance where they lost money, they have to pay the difference out of each of their initial $1000.

You can see quite quickly how this creates an appealing dynamic for those involved. People with a lower risk tolerance are happy to take a fixed yield, while those who are more aggressive get leveraged upside, but also greater downside risk- and everyone loves leverage in crypto right?… :)

This is the essence of SMART yield!

SMART Alpha

SMART Alpha works on a similar principle, but this time instead of stabilising yield it is connected to the underlying price of the asset.

In this way, the two tranches are broken down and the senior tranche just has less exposure to the upside AND downside swings of the asset. Conversely, the junior tranche has a multiplied exposure to the price swings.

Another way to word this, if the price of ETH is $3000 and it drops to $2500, the junior tranche has a higher exposure to the loss than the senior tranche. The same is true in reverse, if the price of ETH moves to $3500, the junior tranche gets a higher percentage of the upside.

If you look on Barnbridge’s website currently, we can take the WETH-USD 1 week pool.

The senior tranche is protected against 10.43% downside movement of ETH. i.e they will only start taking losses if ETHs price decreases by more than 10.43%

However, for this protection they only get 7.18% of the upside. i.e for every $100 ETH increases the senior tranche gets $7.18.

The junior tranche takes the opposite side of this. The junior tranche has 7x leverage to the upside, but also 7x leverage to the downside.

The % difference is variable with each asset pool depending on the calculations performed in the smart contract.

Barnbridge has some great wording around this:

(The) Senior rate is defined as the maximum amount of downside price movement the underlying asset can experience in a week before senior depositors suffer dollar-denominated losses. Junior dominance is defined as the share of a given ERC-20 token’s pool that is comprised of junior depositors.

This gives people two options: you can have less downside risk while holding an asset BUT you get less of the upside.

OR

You get leveraged exposure to the upside BUT you also have leveraged exposure to the downside.

This can be useful in portfolio construction where perhaps you want to hedge your exposure, or you are very bullish an asset and want more upside.

One other thing to note, Barnbridge launched fully as a DAO. They issued their $BOND token as the governance mechanism.

Interest in the protocol certainly wained with the end of Defi summer but I note that there was a recent proposal to change some of the DAO processes.

You can read more here:

Barnbridge has some fascinating mechanics and has brought some interesting tradfi structures to the DeFi landscape. They were extremely early in allowing degens to even consider getting fixed-rate/variable-rate risk-adjusted returns on deposits.

Since their inception, other protocols have come along like Yield & Notional, but they were pioneers in this space.

Granted Barnbridge suffered with the CREAM exploit and users lost money. However, and I do not say this lightly, we all understand that smart-contract risk is a huge risk in the space with any platform you are using.

Nevertheless, I think it is an interesting protocol to look at and understand the principles of how it functions.

This is not intended as an exhaustive history of Barnbridge and its uses-cases, but an introduction to the concepts behind it and how it was a first-mover in bringing some helpful concepts and experiments to the DeFi space.

Thanks

Kieran

PS.

I have to say, Barnbridge has also done an excellent job of curating their documents to make the protocol easier to understand.

For those wishing to learn more, I highly recommend you start there:

https://docs.barnbridge.com/