My Thoughts on BarnBridge V2 — The Mechanism is Already Working…?
A retrospective.
[You can skip this part if you don’t want to read my soap box retrospective.]
DeFi got a little crazy last year.
It’s honestly a little crazier now but in a different way (some of the valuations of defi are priced as if these aren’t zero debt organizations throwing off cash with low burn on the blue chip side). Some of the narratives are bonkers (but I’m not here to discuss that). Not sure how your cash position survives nuclear war which is how you are pricing this.
But I digress.
Like everyone, I got swept up in NFTs last year. And gaming. The narrative made sense. They’re the first thing we’ve ever seen in crypto that had native demand outside of number go up. People were buying art because they liked it. People will play games because they like them.
I still liked them as financial primitives and was excited to see how Uniswap has used them.
I think for the CFA types in defi, monkey JPEGs was a solid meme to justify getting torched by a bunch of art collectors. If I’m being brutally honest, I lost a ton of respect for many defi threadooors for their inherent misunderstanding of supply and demand.
The way us financial autists in defi looked at monkey JPEGs & the degens of JPEG Morgan is how the actual J.P. Morgan looks at US. I think this specifically has to do with the lack of real world assets on chain and our need for inherent on chain DEMAND to drive YIELD.
The “what are we financing” meme ultimately extrapolates to a ponzi with a lack of demand side. Meaning we need demand for native on chain assets or real world assets no matter how much you like the smell of your own farts. However, WITH a robust demand side.. it starts to work. Still, I guess everything is a ponzi depending on how nihilistic you are, but the point is, it will start looking a lot more sustainable at the point where we have a robust demand side.
So let’s talk about the supply side. ETH is on track to forego 430,000 $ETH of new supply coming onto the market. It actually blows my mind $ETH was able to withstand this sell pressure from miners. That’s around $600m in new supply at current prices.. every month. SOMEBODY was buying or holding to keep the price stable. We now have $600m less in monthly supply & should assume consistent demand as nothing on the demand side has changed. I think if you extrapolate that to an annual number and assume the next bull market will have MORE transactions which INCREASES the burn.. this all starts to look very attractive with or without Monkey JPEGs.
So let’s talk about Fixed Income in DeFi. To anyone with depth in understanding of financial mechanisms, I think it was clear that Terra/Luna wasn’t going to work. If I’m being brutally honest I feel like I helped develop components of it given that everything I’ve done has been open source and creative commons to date. I personally helped to champion a system where a fixed rate of return is subsidized by an LP who is willing to sit in the variable/junior/LP/etc. (we all called it something different). A lot of people waited on BarnBridge to launch, put lipstick on it, and came up with more obscure ways to hide this blatant error in the design.
The problem is, even WITH inherent demand, the system I helped to design was never going to hold up. There are simply some environments where a variable yield is more attractive and some environments where a fixed yield is more attractive. “Environments” here can be swapped for: use cases, markets, global conditions, beras, bullas, brink of disaster and moon missions. We would always be subsidizing one side or the other until the tides went out and NOBODY was wearing pants.
However, even with everyone pantless, the meme that fixed yield in defi doesn’t have product market fit is dead. It had such strong product market fit it blew up the entire system so miss me with that bullshit meme.
Or maybe I’m just the worst ponzu creator in history and the jokes on me but I believed in all of this.
I still do.
So we tore it all down & built BarnBridge V2.
First Epoch, Rollover, and Second Epoch (okay and just a LITTLE more soap box)
[So I’ll get off my soap box and try to be a little short winded so this post isn’t 60 pages.]
I’m writing this to explain why I am EXTREMELY happy about the mechanism & its performance over the past epoch.
I’m not going to talk in detail about the mechanism we designed for BarnBridge v2.
You can read a primer:
I hate to tell you to go read that & come back but this is for the people who are familiar with the mechanism & want to know why I’m so excited.
Anyone who followed along the last year knows I personally went through hell getting us here, but we’re past that.
I texted our CTO last night and said:
“We should be really proud of ourselves. I don’t need to explain the implications if we invented a superior mechanism to price risk & rates on fixed. Variable crypto has had this covered for a while but nobody has tackled this proper on fixed which was what we set out to do. While it is anecdotal at these depths of liquidity.. if this system can price risk & market driven rates I’m not exaggerating that is “COULD” change the world. Not “automatically will” since a lot has to happen & we have a lot of work to do.. but if this does hold up our job gets much easier as we don’t have to do the work for the mechanism… it does it for us. We tried to fight it and the market won”
The end point is that the mechanism is working BETTER than I expected this early on.
First Epoch, Rollover, and Second Epoch (for real this time)
Let’s go through numbers of the first two epochs.
It’s probably important to think about this through the context of borrowing against a Compound or AAVE position & depositing into BarnBridge v2. If you know you’ll receive a higher APY than the trending 120 day borrow rates, you’re in the green.
Use that lens while reading this.
So we saw:
A 100% increase in TVL. And the mechanism arb’d the interest rate back down to a similar rate. I actually slept in and forgot to roll over my personal deposit which would have actually pushed the price to parity of the 5.8% (I did the math).
This means we can know that on a limited sample size, the market is pricing the Fixed APR in our system, on main net, at 5.8% to 6.3%. I’d expect that number to diminish as people become more comfortable with the mechanism which is probably preferable for the profitability of the system (albeit I hear you degens, I like higher yields too). The issue is sustaining a rate at 5.8–6.3% when the originator is giving us .89%.
However, the beauty of BarnBridge V2 is it doesn’t matter what I think (which was the point in writing this retrospective). I’ll paint a picture of how we get it profitable regardless of what the market does.
The point of this thread is the mechanism is working. I think I’ve made that clear.
The other point is I think you can tell where I am saying this starts to get fun.
We tried to influence it by artificially topping up the “earned yield” to what we would have received from higher originators (like Curve, Beefy, and Velodrome). We also added more of our own Protocol Owned Liquidity in the deposit period.
It still arb’d down to the same interest rate. It’s a little early given the sample size (hence my earlier text) but I was shocked to sleep in from utter exhaustion only to wake up to realize I didn’t need to get up in the first place.
The mechanism did the work for us.
I think you can tell where I am saying this starts to get fun.
Early Sign of A Success Story
SYv2 feels like a game that we (as the LP) are learning to play.
The market is pricing fixed income in our systems at 5.8–6.3% no matter what we did over the past 2 epochs so we need to find an originator for stablecoin deposits at ABOVE that rate for the DAO to meaningfully profit. The other option is to enhance our own protocol deposits by a wide margin against the fixed side (our models show we can profit at a 3.5% originator rate). However given that $1 in POL has resulted in $2.5 in Fixed (User) Deposits it seems more sustainable to chase higher yields.
Since this will likely happen on L2s & the depth of liquidity is on L1s.. this will be a battle we have to fight. I think you can tell where I am saying this starts to get fun.
Okay, cool. Where Do We Go From Here?
My recommendation is we raise the funding rate on main net in an attempt to attract higher capital deposits to L2s. We ultimately have to push the interest rate down on main net, earn more money against Fixed/user deposits, and find a 3.5%-6% originator for stables we are comfortable with.
Again, I think you can tell where I am saying this starts to get fun.
In terms of L2s, the numbers in epoch 1 and epoch 2 are actually healthy because there are numerous places we can find this in the market that aren’t too far downstream in risk.
I think for ease of use & keep it simple stupid is to have the standardized pools of 7, 30, 73 and we play with those. Everyone asks “why 73?” and the answer is because it’s better if we line up longer dated deposits on work week days. You play the market M-F and the subscription period ends at market close in EST on Fridays. Once we understand how 7 day & 73 day is different in market demands for rates vs. say 30 day is also huge. 30 day pools will always end on off kilter days but maybe the market doesn’t care.
Idk though, we’ll find out.
We already have Velodrome and Curve integrations going into audit so that gives us some flexibility in originators. I think I’ve said in the Discord we probably need 6–8 originators across the system for it to work flawlessly. Depending on the number of L2s we port to affects that number.
The Velodrome integration (already under audit) seems to be an integration that will pay a ton of dividends. The first obvious layup is the >10% stablecoin pools. We’d very much crush at those levels at the originator.
Futher, we’ve already discussed we have spoken with our friend Jacob from Lido and are working on our first partnership where our DAO isn’t the LP taking a position. Nothing is official yet because we still have work to do. We naturally had to find a solid originator since AAVE isn’t paying out any yield & has no LTV on stETH deposits. In terms of an integration like this.. we still will charge a funding rate across the system, so we have to ensure the numbers align for all parties (us, the new LP, and depositoooooors).
So this was a win even if I don’t expect that APY to remain:
Again, I think you can tell where I am saying this starts to get fun.
We are learning to play the game, we’ll only get better with time.
I said yesterday that I feel like Anakin when his pod racer finally turned on and people will stop thinking we are the underdog here soon. But I’ve used that meme before prematurely.
Let me accurately paint where we are in Shawshank Redemption format.
This is the end goal here:
Quick Closing Thoughts
In closing, I’ve discussed that at $20m in TVL our system essentially pays for itself with development & infrastructure in place. We’re playing with lower levels of liquidity while we test the mechanism but I think those goals are entirely achievable once we scale the mechanism.
I think we’ll achieve much higher levels as we scale. At that point, BarnBridge becomes a cockroach that becomes extremely hard to kill.
I love that about cockroaches.
