Hey you!
Just a heads-up, this article doesn't touch on the tokenomics of $BOND. It attempts to analyze what BarnBridge is and how it could change DeFi.

I'm a vivid user of DeFi and an active trader of cryptocurrencies. As such, I love the risks and accompanied volatility. As anxiety-inducing as some of the swings may be, we all believe that we will come out on top in the end as a collective.

But that's just it: we believe.

Every person has a different risk-appetite, and not everybody is willing or able to risk an amount of their wealth on assets that may or may not lose or gain 50% of their values (sometimes within the same day, hah).

This is even more true for financial institutions like banks or hedge funds. Thus, every financial system requires a variety of different assets for different use-cases. Currently, APYs and risks are spread far and wide in DeFi.

DeFi's ultra-high APYs

DeFi yield farming currently covers anywhere from 15% to upwards of 100,000% APY. Needless to say that these interest rates are entirely unsustainable. But how do we get here in the first place?

Crypto-backed loans

Crypto-backed loans generate most of today's yield. The interest rates on them are significantly higher than in TradFi for two reasons.

  • Perception of higher risk
  • Reduction of inefficiencies

The higher the risk, the higher the yield. Who would lend money to somebody with a bad credit score at the same rates as somebody with a good one? Nobody, that's who. High risk, high reward!

With the usage of smart-contract powered trust-less custodianship, automatic settlements, price oracles and so forth, DeFi also removes many inefficiencies present in the legacy system that is TradFi.

Both lead to significantly improved yields, even though you are essentially lending out the same asset (USD/USDT, XAU/XAUT, etc).

Hyper-inflatable token supplies

The second reason for having even higher APYs are hyper-inflatable token supplies. Farms such as SUSHI & co issue new tokens at such a high velocity that the market, after a very brief moment of ultra-lucrative farming, becomes oversaturated (“money printer goes brrrrr”).

TradFi money is coming!!!!11 🤑

Ok, settle down moonbois. The banking and investment industry is one of the hardest to disrupt. But if anything can move them forward, it's money. There are over $244 trillion in debt and yield-based derivatives. These are starving for yields as high as we currently enjoy, with a way to access these.

TradFi is waiting for DeFi to reach maturity. Right now, unless they are a risk-seeking hedge fund, there is very little chance that they're interested in cryptocurrencies (as much as they'd like to).

We need sophisticated investment devices that limit risk exposure for every appetite. After reading BarnBridge's whitepaper, I can honestly say that I believe that it will ring in DeFi 2.0 — and that is good.

Risk-flexible instruments

This is where BarnBridge comes into play. It's one of the most interesting whitepapers I've read in a while. Not only for the protocol that they're developing, but I also learned more about how more complex financial assets work.

For example, the concept of “tranches” (e.g. buckets of higher and lower-yielding assets) combined into one derivative doesn’t exist in DeFi yet. After barely understanding what means, I am excited.

But there are more reasons to keep BarnBridge on your radar.

Algorithmic decision-making

A significant improvement to TradFi instruments will be algorithmic decision-making in smart contracts. Not only are they decentralized and trust-less, but they are also significantly cheaper as they're automated.

Never-seen derivatives

Another benefit of DeFi is that far more complex and transparent instruments can be built. Since everything is done in code, whatever can be programmed, can be deployed and invested in. This could provide never-seen agility to the financial markets.

Integrated risk mitigation

As mentioned earlier, risk a big deal. An asset (or rather asset-class in our case) will have a hard time attracting a wide spectrum of investors if it doesn't offer them what they are looking for.

BarnBridge attempts to smooth out the risk curve by offering a platform that allows the development of flexible-risk assets . Things like fixed-percentage bonds and derivate assets that contain a multitude of tranches (or parts), will all be possible and drastically improve (yet complicate) this space.

Here's what they say:

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. (Source)

There's a virtually infinite amount of possibilities of what type of assets to build. If you love financial experiments in DeFi 1.0, wait what 2.0 got in store for us.

Diagram of an asset where one tranche has a fixed interest rate of 5% while the other has variable yield, potentially resulting higher reward or loss.

Smoothing out yields

BarnBridge's whitepaper directly names some "powerhouse projects", namely MakerDAO, Synthetix, AAVE, Compound and Curve. While these projects are great, the yield among them is highly unstable and changes significantly based on supply and demand at any given time.

However, the missing link is that no platform is pooling all of these together to smooth out yield. This leads to large sums of money constantly flowing wherever they generate the highest returns. This isn't great for the protocols, the users, and certainly not for our precious omni-congested Ethereum.

By algorithmically pooling interest-generating assets on all the above & others, they can smooth out the process and eliminate yield hopping, thereby removing risks, guaranteeing an acceptable level of liquidity everywhere and normalizing risk exposure once again.

A big plus is that pooled collateral would be deposited wherever needed (e.g., AAVE or Compound) and from there tokenized. This would allow BarnBridge to be platform and asset agnostic, as it is only dealing with its own tokenized assets.

Diagram of how pooled funds can average out interest rates across protocols.

SMART Alpha Bonds

Something they describe these as "Market Price Exposure Risk Mitigation using tranched volatility derivatives" 🤯 — it's a mouthful, I know. However, when you try to understand what it does, it opens a world of opportunities.

Here's how they explain it:

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. (Source)

Still not clear? OK, let's walk through an example together.

I'm sure you've heard about dollar-cost averaging (DCA).  This is similar, except that you buy one derivative contract that contains a logic to pretend that you bought at different prices to change your risk exposure.

Instead of buying, for example, 1 ETH at $350, you could buy 1 contract ($XETH). The asset would represent $ETH at different price entry-points. While the contract would move in the same direction as the underlying asset, it moves at a slower pace, therefore reducing volatility.

Here's how they explain it:

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. (Source)

I still don't fully understand how this would work from a technical aspect. The financial system is extremely complex and much still has to be learned and adopted. Not only by DeFi, but also by its users.

Hopium for the hungry

The previously mentioned $244 trillion in debt and yield-based derivatives? That's 99.9% of the global debt which is currently still structured in TradFi. In the current global economy, they're generating little to no yield at all.

BarnBridge argues that the types of derivatives as well as their ease of use will drive adoption profit-yielding smart contracts, which would be "mind blowing to traditional financial markets".

As technology progresses, these trillions will continue to move into DeFi at an increasing velocity. If successful, it will mark one of the largest movements of wealth in human history.

Final Thoughts

In a nutshell, BarnBridge aims to smooth out the inefficiencies in DeFi to make it appealing to a broader spectrum of investors. If low-risk instruments were available right today, many more people would use them.

We have to understand and accept that not everybody is looking for the same thing. Some prefer a fixed, low-risk percentage return on their investment, while others are willing to take higher risks for greater reward.

DeFi, as it exists right now with its limited financial instruments, is demonstrating the power that a truly trust-less financial system can wield.

Look out for the follow-up article in which I will dive into their $BOND token, and what all this has to do with NFTs.

I hope you enjoyed this mere attempt of understanding what are quite complex concepts in the financial world. If you find any mistake or you'd like to add anything, please let me know on Telegram.

— Robin

Preview of the BarnBridge user interface.