The fixed-income corner of DeFi just got a major boost with Sense Finance going live on restricted mainnet. For the uninitiated, Sense.Finance is decentralized and permissionless infrastructure. Here teams can build and develop new yield primitives for DeFi, such as fixed income tokens, yield tokens, and other custom re-divisions of exposure for existing tokens. Built on Ethereum, its main feature is yield-stripping with nearly unlimited customization. The fundamental parts of this feature are the network’s eponymous Principal Tokens and Yield Tokens, which break down a digital asset into its principal and yield-bearing components. The simplicity of this framework is deceptive, because the Sense team has been able to pair it with an incredible amount of flexibility for issuers to craft custom fixed-income products, new types of primitives, and for users to trade in them all on a permissionless level of digital infrastructure. 

What is Sense?

Sense helps a wide range of actors who want to realize gains on yield-generating assets, including fixed-income earners, issuers, market makers, and arbitrageurs. The ways in which users can capitalize on the Sense Protocol’s functionality are based on its two core outputs: Principal Tokens (PTs) and Yield Tokens (YTs).

Principal Tokens (PTs): PTs are like zero-coupon bonds, delivering a single cash flow at maturity. They are simple and easy to value.

Yield Tokens (YTs): YTs are like floating rate bonds, delivering unknown cash flows at future date(s). They are more complex and harder to value, but they present fertile ground for financial innovation.

In this way, issuers can lock up yield-bearing assets in a similar way to vault protocols like Maker or Compound, but receive liquid, transparent, and functional components of the underlying asset in return. The yield component will remain variable, but the principal source of that yield will always be visible and known, providing a predictable source of yield for issuers and traders. This results in the other functions of the Sense platform that users can capitalize on, such as tranches for fixed rates in non-underlying terms and debt positions issued to firms or internet-native organizations like DAOs. 

Fixed-Yield Variety and Digital Asset Equity

The beauty of Sense is in its ability to let users curate their own products in so many ways. Products can be created with any number of different attributes, such as being paid out in stablecoins or in like-kind, compounded reinvestment or immediate withdrawal, or collateralized debt positions to fund additional leverage or raise additional working capital. 

Internet native organizations, such as DAOs, have both large treasuries of digital assets and future liabilities which are denominated in fiat currency. Often, in order to pay these liabilities, they are forced to liquidate the assets held in their treasury. Rather than using these assets or tokens to pay these liabilities, they could earn fixed yields in fiat currency on these assets by using the Sense platform. In this way, they are able to pay their liabilities with future stablecoin cashflows without losing valuable exposure to native tokens or other digital assets held in their treasury. Internet native organizations in particular are having a difficult time managing their tax burdens given the amount of fluctuation in asset value and their need to pay contributors meaningful compensation. 

Built-In Yield Markets

The fundamental structure of Sense automatically fosters markets in future expected yields. This is due to the delineation of principal and yield-bearing properties of underlying assets, which present very different investment profiles. This feature is integral to the Sense Space liquidity pools, where liquidity providers earn yield on their LP shares from Principal Tokens, yield-bearing assets, and trading fees. Unlike many other liquidity pool platforms, the risk of impermanent loss is substantially lower than in other, more common trading pairs. 

For those interested in additional customization, Sense offers another layer of collateralization through their integrated Fuse Pool. The Sense Fuse Pool allows users to collateralize Principal or Liquidity Pool tokens, which can then be used to borrow Principal Tokens and yield-bearing assets. 

Potential Use Cases

The functionality of this protocol being properly addressed now only begs the question of how best to utilize it. Although creative groups will get together to capitalize on these concepts in their own way, here are a few potential directions and industries Sense could easily disrupt:

• Annuities – Annuities are insurance products that provide a reliable, steady stream of payments to support one’s financial needs for the rest of their life or for a predetermined number of years. Annuity yield can be fixed or variable, and could be tethered to a Sense issuance in a number of ways, and potentially be wrapped into pre-existing annuity insurance contracts. 

• Surety Bonds – A Surety Bond is a legally binding agreement that provides a guarantee that a company or individual will deliver on their obligations. Surety Bonds help ensure a company or person will complete the duties it has promised to carry out, and is used in contract bidding, professional licensure applications, court bonds, fiduciary or probate bonds, and other private transactions. All of these applications could be made on-chain using the Sense platform.

• IOLTA Accounts – IOLTA is an acronym for Interest on Lawyer Trust Accounts, which hold client funds in trust and can be audited at any time by state regulators to ensure compliance and safety of these funds. Interest earned on IOLTA accounts is usually directed to support legal aid programs. 

• Payday Loans – With more paycheck direct deposit functions on services like Coinbase and CashApp, people have greater access to being paid in crypto. This could lead to alternatives to payday loan services, which often charge exorbitant interest rates of almost 400 percent. A product using the collateralization function of the Fuse Pool could easily offer a more competitive rate. 

• On-Chain Trust Accounts – Banks like Anchorage and internet-native organizations like DAOs are increasingly looking to the trust as a vehicle for managing assets. In the interest of minimizing risk, officers of these on-chain trusts may use Sense for fixed-income to better serve their fiduciary duties to clients. 

• Corporate/DAO Bonds – Firms and DAOs can use Sense to increase available working capital with the current v1 iteration of the platform. Debt can currently be issued either secured or unsecured, and offers many options for DAOs and corporate entities that may wish to preserve their treasury’s digital asset equity.

For even more use cases, see the following information posted by the Sense team, or take part in the conversation at the Sense Discord channel:

• FAQs | Sense

• Sense Use Cases

• Earn Fixed APY on your stETH

• Earn stablecoin income on ETH

• The yields are LOW, so profit off their rise

• You’ve never provided liquidity like this before

What is ION and Why Does It Exist?

From the start, $ION seemed to be a sort of “living fossil” leftover from the code of the Osmosis testnet, “an enigma embedded in the genesis file” which was included in the mainnet launch of Osmosis. Until this year, it didn’t seem like there was any indication of what the tokens or the project would be used for, if anything. 

However, now the project has acquired real market value, and members of the Osmosis ecosystem see value in bringing it to life as a DAO project with real utility. In spite of the passed proposal creating the ION DAO and its native integration with Osmosis, it effectively remains a project in search of a use case.

The History of ION in the Osmosis Ecosystem

In the beginning, exactly 21,294 ION tokens were airdropped to users seemingly at random until the ION airdrop was reverse-engineered. The airdrop was based on the snapshot of Cosmos wallets taken on February 18, 2021 (which was originally intended for the OSMO airdrop). ION was given to wallets that either: 

1. Voted in Cosmos governance (1 ION for each governance vote prior to the snapshot); or

2. Delegated to Sikka (1 ION for each wallet delegating to the Sikka validator at snapshot).

Unfortunately, it was determined that a good chunk of the airdrop went to addresses that had not participated in the Osmosis ecosystem at all, and a clawback specific to all unclaimed ION was added to Proposition 32 to bring it back to the community fund along with the clawback of unclaimed OSMO. As time went on, ION’s market cap grew to $125 million (now more than double), and the community of ION holders began debating the future of the protocol without a purpose.

The Ionize community started gathering steam after Proposal 54 passed, which implemented the clawback of unclaimed OSMO and ION into the community fund. In the case of OSMO, this clawback was simply an effective way to fund projects that use Osmosis to bootstrap their protocols. However, without further instruction from the community, ION would have sat in the Osmosis treasury as an asset without a unified community or even a clearly-defined use case. That all changed when Proposal 107 passed, which signaled the Osmosis community’s intent to integrate the CosmWasm smart contract operating system, which would allow DAOs to be built on Osmosis. 

Given this upcoming functionality, Proposal 120 was suggested by the nascent ION community as a way for ION tokens to be combined into a DAO built on Osmosis, and to allocate ION from the community fund back into the treasury of the DAO itself. Rather than an outright distribution, this proposal merely signaled the community’s intent to commit to the proposed action before time, energy, or other resources were committed to building the DAO itself.‍

Potential Roadmap for Implementation

With Proposal 120 passed, the Osmosis community has signalled its desire to create ION DAO and has precommitted to releasing its 16,572 ION to the DAO once it has been created. Implementing this proposal will likely involve the following next steps:

1. Osmosis will need to fully integrate the CosmWasm smart contract operating system;

2. ION Community Members will need to use CosmWasm to build ION DAO’s smart contract, including a governance structure and treasury;

3. Another governance proposal will need to be posted and passed to actually transfer the Osmosis community fund’s ION to the DAO;

4. ION DAO should (ideally) airdrop tokens from its treasury to Osmosis community members who voted to release ION to the DAO from the community fund to compensate them for their donation and to prevent centralization; and

5. ION DAO will need to figure out in an ongoing way how to govern itself, its assets, and its use case (whatever it ends up being).

If all goes well, it could represent a bold new project on the already exciting Osmosis ecosystem. However, ongoing concerns about centralization and use case fragility should not be ignored.

The Future of ION and its Community

According to the ION Token’s page on Commonwealth, there is a wide range of potential use cases for the ION DAO that are still up for discussion. The most recent and well-developed of these is the Ionize Proposal, which seeks to establish the DAO as a market for synthetics (an artificial asset that tracks the price of an existing asset, but is not collateralized by the asset itself) that would function in a similar way to Terra’s algorithmically-controlled, synthetic US Dollar ($UST). Interestingly, Terra already has a native general synthetics market called Mirror ($MIR), but it does not utilize the same mint-and-burn method that Terra uses to maintain a stable peg to underlying assets. 

In a similar way to Terra, the Ionize Proposal suggests using ION tokens to maintain a stable peg for any synthetics created and approved by the network. Due to the supply flexibility required of this token-based system, this proposal would also eliminate the current fixed-supply aspect of ION. Generally, this proposal and the creation of ION DAO have met with mixed reviews, including worries of a collateral death-spiral if the value of synthetics becomes volatile. However, the ION community has discussed the idea and found it to be worth pursuing as long as (1) ION holders betting on scarcity aren't rugged, (2) the value of “Ionization” exceeds the value of the network’s mysterious backstory, and (3) “Ionization” brings more value to both Osmosis and ION. 

Ultimately, the community has spoken, and Figment supports the boldness of this experiment. Projects like these hint at the massive potential of CosmWasm smart contract functionality in the IBC ecosystem, and with the passing of this proposal, the Osmosis community supported hitting the ground running with a new DAO and (potentially) a brand new synthetics protocol based on the core tenets of decentralization that has made Terra such a great success. If ION has commanded this much value even prior to an established use case, value will surely increase once they have a fully funded, decentralized community behind their efforts. 

OVERVIEW OF TERRA

Terra was created as a response to one of the most centralized corners of the crypto economy–stablecoins. Through its mint-and-burn mechanism, Terra automatically adjusts the supply of its native token, LUNA, to maintain a stable peg to USD for its stablecoin, UST. 

This algorithmic, automated stability mechanism means that the stablecoins supported by Terra are truly decentralized and not controlled by any third-party. This is a stark contrast to USDC and USDT, which are backed by and may be redeemed for (allegedly) corresponding amounts of USD held in a centrally-controlled bank account. 

In addition to UST, Terra supports a host of other stablecoins, including TerraSDR (or “SDT”), based on the International Monetary Fund’s Special Drawing Rights, which relate to a shared pool of fiat currencies managed by the IMF. SDT is described in the Terra White Paper as “the flagship currency of this family, given that it exhibits the lowest volatility against any one fiat currency (Kereiakes, 2018).”

OVERVIEW OF BRETTON WOODS

The Bretton Woods system refers to an agreement reached between 44 allied nations towards the end of WWII, which consolidated all major fiat currencies into a “basket of currencies” managed by the IMF and originally backed by the gold standard. 

This system was based on the idea that by pooling monetary resources and limiting exchange rates between countries, the economic stability of a unified world economy could be preserved and developed after the war was over without undermining the independence of member countries. 

Once the United States abolished the gold standard in 1971, other countries followed suit until 1973, when SDRs ceased to be based on gold and the original Bretton Woods system ended. The result was a special drawing rights system and floating rates supplied by the IMF, which we still use today.

The term “Special Drawing Rights” (or “SDR”) refers to foreign exchange reserve assets maintained by the IMF. When the original Bretton Woods system was in place, these were originally created to remedy a shortfall of preferred assets, such as gold and USD.

After the collapse of the fixed-rate system, the SDR was modified to represent a unit of account with the IMF’s fiat-based system, rather than 0.888671 grams of fine gold.

Now, the value of a SDR is based on a basket of key international currencies reviewed by IMF every five years.[3] The weights assigned to each currency in the XDR basket are adjusted to take into account their current prominence in terms of international trade and national foreign exchange reserves.[3] In the review conducted in November 2015, the IMF decided to add the Renminbi (Chinese yuan) to the basket, effective 1 October 2016.[9] Since that date, the XDR basket has consisted of the following five currencies: U.S. dollar 41.73%, euro 30.93%, renminbi (Chinese yuan) 10.92%, Japanese yen 8.33%, British pound sterling 8.09%.[10]

BEYOND STABLECOINS: THE DECENTRALIZED VERSION OF AN INTERNATIONAL ASSET

The IMF is a centralized monetary institution that allows members to benefit from decentralized traits. One of these benefits is the ability to request collateral based on a pool that is derived from the monetary stability of multiple economic areas. 

Another benefit is the transparency of assets by which SDRs are based, which has led to 14 countries basing their currencies on the SDR. However, the main pitfall of this system is that only the IMF can allocate this collateral, and they can only be allocated to countries themselves, not private parties. 

In essence, the IMF in its discretion uses these assets to bootstrap the economic improvement of developing countries (or those recovering from crises) using the pooled monetary stability of countries that contribute to their currency reserves. There have also been concerns that these practices are predatory and lead to increased corruption among countries receiving allocations. 

Terra’s IMF stablecoin, TerraSDR (or “SDT”), is a synthetic version of SDRs, and maintains its peg to them in the same way UST maintains its peg to USD through minting or burning LUNA as the price increases or decreases. 

SDT also realizes the full benefits of decentralization, and may arguably be considered an even more secure stablecoin than most current offerings, which are based on the monetary fate of a single country’s currency. This is presumably why, Terra states, “the Terra protocol uses TerraSDR or SDT as its base currency for calculations and to set standards.”

WHAT IS SDT USED FOR?: Original Intent

Not only is SDT used as the base currency for protocol calculations, but according to Terra’s treasury documentation, SDT was intended as the primary currency for a now-unused tax mechanism meant to incentivize miners toward stable, long-term network growth. 

In this iteration, miners were rewarded with seigniorage rewards, with seigniorage being defined as the value of a coin minus the cost to produce it. While the Treasury module is still active, it has been effectively rendered toothless by the governance proposals that now burn all seigniorage rewards and have changed the stability fee tax rate to zero. This results in LUNA being deflationary in nature, and provides the backbone for the current price peg system of Terra.

WHAT IS SDT USED FOR?: Present Use

SDT is the base pool for Terra’s host of stablecoins, but a market has not developed for it as a stablecoin in its own right due to the success of these other fiat-based stablecoins. However, its continued presence as a functional Treasury module asset should give comfort to those betting on the long-term stability of Terra. 

There is a lot of uncertainty in the world, particularly given rising inflation and increasing border conflicts, and the Terra community has done well to preserve a functional “Plan B” in its protocol should an externality affect its peg. 

Terra itself considers SDT “the base Terra stablecoin.” This means that even if the arbitrage/market maker function that Terra currently uses fails or if the market is otherwise decoupled due to mining activities, the network can easily implement the Treasury module and associated functions if needed since the Terra protocol utilizes SDT at its most basic level. At a minimum, SDT can and should be seen as one of the most well-thought-out decentralized stablecoins ever created. 

STAKING ON TERRA/RELATION TO UST

As the base stablecoin on Terra, SDT is the currency in which transaction fees, miner rewards, and stimulus grants are denominated. It is also the fundamental base of all other stablecoins supported by Terra, including UST. 

Currently any of these stablecoins, including UST and SDT, can be swapped for LUNA (Terra’s governance/stability mechanism token) for staking on the network. This can easily be done by delegating LUNA to a validator, such as Figment. Rewards are earned in stablecoins at the present rate of between 7-8% APY.  

As a staking services provider, Figment has been involved with Terra from its early stages, and currently ranks among the top 10 validators for the entire network. We believe not only in providing top-of-the-line staking services, but also that conversations like these are essential to the ongoing health and development of networks like Terra. 

Given the boldness that Terra has used to establish itself as a dominant stablecoin based on decentralized principles, we will continue to take part in the development of this network with high expectations for the future.