BOND tokens

BOND tokens are a variation on REP tokens which have slightly different powers. The primary purpose of issuing BOND tokens is to raise capital. Additionally BONDs can be constructed to incentivize and reward different behaviors, such as bounties for work, founder’s valuation, investment, and power revaluation. Applications include bounties, investor bonds, founder bonds, underwriting bonds, and governance bonds. The design of the contract parameters derives from the theory of reputation tokenomics.

Overview

Suppose a DAO wishes to raise capital, say for the purpose of incentivizing improvement in one of the DAO’s smart contracts, by offering a bounty for development. Centralized companies in a traditional economy have several options. First, they can maintain a treasury of capital holdings for the purpose. This is suboptimal due to holding costs. A second option is to secure a loan, which is suboptimal because they would be paying an outside fee. Third, they can issue stocks, which carries the threat of diluting power, eroding faith in the company, and inevitably the market for stocks is not perfectly efficient. In some cases a fourth general option is ideal, to issue bonds. Bonds avoid some of the pitfalls of the previous three options. Like a loan, a bond can be constructed with a payout schedule which optimizes for the company’s current purpose, for instance paying out at a particular future time when the company expects a contract to close. Further, bonds do not have the same collateral security requirements. Finally, the most likely bond purchasers will be most familiar with the company, and will be more likely to have a predilection for improving the company so their bonds are secure, instead of harming it (by shorting the stock, e.g.). Thus bonds have the added advantage of building solidarity.

Many DAOs have implemented the obvious solution to raising capital, building a treasury. Many blockchain networks have amassed a treasury by setting aside ICO money, or by taxing their transactions with a fractional fee in order to build such a reserve to pay for future development or paying off early investors. The existence of a treasury gives the signal that the DAO is valuable, which is often used to attract more investment before the DAO begins to earn outside fees. However the holding costs of such a fund are entirely wasted, which betrays their unsophisticated design.

The already suboptimal solutions of loans and issuing equity are exacerbated in a decentralized environment. Traditional loans are fundamentally more difficult for a decentralized blockchain-based organization to secure than for a centralized company because of coordination problems with a group that is owned by a dynamically shifting multitude of international pseudonymous participants.

With the new technology of smart contracting, however, we have more tools available. A DAO can now make a type of internal loan. A DAO may arbitrarily choose to mint a new type of reputation token, called a BOND, that will algorithmically pay off their bounties later, through smart contracts.

There are several types of contracts that can be made in the attempt to match the BOND reward to the proposed bounty $b$. Assuming no treasury, the BONDs are paid out by the DAO’s REP salary as fees come in. The DAO is not in control of when outsider customers may choose to engage the DAO’s Work Smart Contract and pay the DAO fees. Therefore, without resorting to a treasury and its attendant holding costs, there is necessarily some variability in some aspect of any BOND, whether it be the rate of payout, the lifetime of the BOND, or the amount ultimately paid. However, BONDs can be designed which mitigate for any of these factors.

Mechanism design

We calculate the formulas for the lifetime $L_{B}$ and the quantity $q$ of BOND tokens needed to accurately match the cash value $\$b$ of BONDs with various different payout schedules. The general theory that dictates these formulas is REP tokenomics.

Given the choice of one or more of these variables as random, we can solve for the formula that will determine the rule for the chosen BOND type. The rate of payout and the BOND lifetime $L_{B}$ are dependent on each other and constrained by the payout $\$b$. With those targets, the types of bonds break down as fixed-period or variable-period contracts.

Fixed Period, Risky Payout

Main page: Fixed-period BONDS

Given a fixed pay period $L_{B}$ the developer is given the number $q$ of BOND tokens that match $\$b$ based on the present value. This amounts to solving the equation $qPVf_{B}^{1}=b$ for $q$. Once $q$ and $L_{B}$ are fixed, the payout will be a random variable, with expected value $\$b$.

This solution leaves the ultimate value of a BOND token to chance, dependent on the random variables of the fee rate $f'$, the interest rate $r$, and the number $R$ of other BOND tokens that will be minted during the time $t<L_{B}$. The actual payout will depend on how accurate your estimates of these random variables are. However, the contract itself is deterministic (i.e., fixed). It performs algorithmically as promised, though the ultimate payout is a gamble.

Almost every traditional financial tool has similar risks. For example, even the instrument which seems like the most predictable contract possible, a long-term fixed-rate bond, actually carries the risk that the interest rates will grow higher than expected before the bond expires, which changes the bond’s ultimate valuation.  

However, there is an approach that eliminates even this risk:

Riskless Contracts

Main page: Riskless BONDs

An approach that can eliminate some or all of the randomness is to make the lifetime $L_{B}$ a stopping time. In this case, a smart contract is made to pay a certain quantity $q$ of artificially minted BOND tokens. In this case $q$ is directly related to the rate at which the BOND is paid off. Then the lifetime $L_{B}$ of a token is set to depend on the actual fees $f'$ the DAO brings in.

The technical terminology is that $L_{B}$ is a random variable, called a stopping time, which is determined by the stochastic process given by the incoming fees $f'$ and interest rate $r$ random variables.

There are two approaches to riskless contract design are to make fixed payouts or the more complicated fixed present value payout.

Fixed payout

The lifetime $L_{B}$ of the BOND can simply be set to end once $\$b$ is matched in fees, then the rate $q$ will be of prime importance when deciding how valuable the BOND reward is. The rate depends on $q$ and $f'$. Since $f'$ is a random variable, the stopping time $L_{B}$ is a random variable. If $L_{B}$ is large, then even though the contract is eventually guaranteed to pay out $\$b$, the present value of this solution still depends on chance.

A better solution, one that does not depend on chance, is the following:

Fixed present value payout

To account for the time it takes to pay out $\$b$ fees for a BOND contract, we can include the present value calculation in the lifetime $L_{B}$. This financial instrument uses the programmable contract to absorb all randomness (if you trust the oracle dictating the varying value of $r$). This solution gives a guaranteed payout of exactly $\$b$ in present value calculated from the time the BOND was minted. In this case, the BOND pays out more than $\$b$ in fee salaries over the course of its lifetime (assuming $r>0$) stopping only when the present value is reached. This is analogous in some ways to a floating rate bond, and in other ways to a student loan which has a predetermined payback schedule that depends on the student’s future salary.

In all these cases, besides the lifetime $L_{B}$ the major consideration is the quantity $q$ of BOND tokens minted for the reward. For a fixed reward $\$b$, the quantity $q$ will always be inversely related to the lifetime $L_{B}$ that obtains for the BOND tokens. The reason is that the quantity $q$ is directly related to the rate of the fees $f'$ that the rewarded BOND tokens shares, so larger $q$ means smaller $L_{B}$ is needed to match the value of any fixed bounty.

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1.2     Riskless contracts

Bonds issued by a government may be considered risk-free in the sense that they are guaranteed by force of law to pay out as they are advertised. DAOs can issue BONDs with similar contracts guaranteeing any fixed payout, which can be assured by self-executing smart contracts, as long as the DAO remains solvent. But such contracts, with pre-determined end dates and values still carry risk, in the sense that the interest rate may increase during the tenor of contract, so the fixed return on the bond may ultimately have a lower present value than expected.

In this section we eliminate even this type of risk, using the same basic REP tokenomics equations. We simply make the lifetime of a BOND token into a variable which is dependent on the actual fees the DAO earns, instead of the expected fees as before. The basic idea is that the variable lifetime   of a riskless BOND will grow if the fees shrink or the interest rate increases, and the lifetime will shrink if the fees grow or the interest rate decreases. Technically, a riskless contract makes the lifetime of the BOND  a stopping time of the stochastic process given by the fees. The smart contract governing the BOND tokens uses the record of fees to determine the expiration date dynamically, which guarantees the present value of the  BOND tokens at the time of issuance will be precisely .

Remember the income stream for a BOND token is

for time  The present value of a single BOND token is

We assume  tokens are minted to make a reward of value . We use  to denote the total number of BOND tokens that are earning reputational salaries in the DAO at any given time , which includes  and any other BOND tokens that have been minted during the relevant time period. Combining these facts gives the following result.

Proposition 7 To pay a bounty of  BOND tokens minted to have exact initial present value  make the stopping time  as the random variable that satisfies the formula

This formula works under general assumptions, as any of the terms may be variable. The result is not as deep as all the technical terminology might make it seem. The basic idea is simple. First, keep track of the random processes given by the fees , the new BOND tokens added , and the interest rate . That simply means we record the history of their values. Then the stopping time  is reached at the first time  that the above equation is satisfied. The stopping time is merely the moment we end the fees paid to the  BOND tokens. When programming the smart contract which controls this financial device, the integral simply becomes a sum, and the stopping condition is given by an IF THEN statement. The only variable that poses any difficulty in decentralized environments is the interest rate , which requires an oracle, since the other two variables,  and , are automatically recorded.

Proposition 7 gives a means for calculating the expected value and variance of the stopping time  under various assumptions on the parameters , , , and .

1.3     Bound on BONDs

In order for a BOND contract to be fully paid, the DAO must remain solvent, meaning the fees it earns must be great enough for the present value to be eventually realized. In the case of riskless BONDs the fees must satisfy the constraint

Equation 8

This gives a limit for how many bounties can be proposed, lest the BONDs cannot be paid if  is too small.  

For example let us assume that the lifetime of tokens is  and all the parameters are constant, such as the rate fees .  Assuming the group has reached REP equilibrium, we have  . Further simplify by assuming the only outstanding BONDs  are the  that are currently under consideration. Then the integral in Equation 8 may be solved to get

A DAO cannot repay a bounty that doesn’t satisfy this equation. The limit is

which is seen by letting , because, in that case, the DAO will use all its fees to pay back the  BONDs for eternity.

Proposition 8. A DAO cannot mint bonds of value in excess of .

Conversely, solving the above constraint for  shows the rate of fees must be large enough to satisfy

or else the DAO cannot ever repay the bounty, no matter how large the stopping time. Therefore, don’t seek a bounty  from a DAO unless you can expect their fee rate to eventually far exceed .

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In addition to raising capital, the BOND mechanism gives the DAO the power to “put their finger on the scale”. I.e., the DAO can mint and issue BONDs through governmental decision to redistribute power in order to serve their goals. As such a BOND can be seen as re-weighting the Forum’s WDAG through an act of DAO governance.

Alternatively, another use of the BOND mechanism is for DAO governance to resolve to issue a series of BONDs through an automated process, to serve a long-term goal. Especially, for example, when the DAO requests some specific work to be done on their behalf, such as software development. In this latter case, BONDs will follow the standard procedure for securing work: workers submit their ASCs. Some worker's ASC is randomly selected. That worker submits a WSC for validation. A BOND is issued in payment. This process gives the DAO, itself, the role of the public, as the DAO requests work from an appropriate bench. The only difference is that the BOND pays off later. ??

2       Applications

In this section we detail some basic applications of the tokenomics principles derived above.

First, we consider applications of BOND tokens. BONDs are simply financial instruments that pay out programmatically in the future, and so can be created for a variety of purposes. Major applications include incentivizing future work through bounties, attracting investors, or transparently broadcasting the future power of founders. BOND tokens can also be used to make algorithmically controlled stable coins. They are also the basis of decentralized markets in REP tokens, created to help workers exit a DAO gracefully, or to create a pillar for decentralized underwriting. ??

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To Do:

·      Make formula for Early Investor BONDs vs. Founder BONDs vs workers who take advantage of the DAO’s systems the Investors and Founders created.

o  Investors Tokens given above

o  Founders deserve some percentage of the profit and power created. This is transparently broadcast. The Founder BONDs

§ pay off at a certain later date

§ can be directly dependent on the amount of profits the DAO achieves

§ can be inversely dependent on the amount of further founder work that is done—meaning there could be a fixed percentage of Founder % of all future profits for a fixed period of time (possibly infinity, or it can attenuate)

o  Example, how do we give ourselves power in the DGF?

o    Workers receive

o  Governance tokens.

Controlling equity that has independent amounts of power in 1. the reputational salary, and 2. Governance decisions.

We may think of these tokens as “hegemony stocks” in the case that they are programmed to maintain power for their owners independently of how power is redistributed through other means. That is, hegemony stocks can be designed which maintain for their owners a fixed minimum percentage of governance power, with any programmed We may think of these as pure governance tokens

o  All these parameters can be subject to evolution. I.e., they are optimized across multiple DAOs, who all argue and experiment about what the best parameters are for fair reward of founder work. They want to give what is appropriate; not too much, not too little. But the answer will be dynamic and will obviously depend on the situation. E.g., a DAO that copies another DAO’s foundational structure, shouldn’t pay its founders as much, since they didn’t do as much foundational work. (That DAO should probably pay the other DAO’s founders some amount [smaller than the original DAO paid, though, all things being equal].)

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2.1  

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[3] Damiano Montani, Daniele Gervasio, & Andrea Pulcini, “Startup Company Valuation: The State of Art and Future Trends”, International Business Research; Vol. 13, No. 9; 2020. Available online at

https://pdfs.semanticscholar.org/88d9/839fb8e7a2aa34b7ee28feb82005285a9ab4.pdf  Retrieved 12/12/22.

They break the risk factors down by 1. Risk of the management, 2. Stage of the business, 3. Political risk, 4. Supply chain or manufacturing risk, 5. Sales and marketing risk, 6. Capital raising risk, 7. Competition risk, 8. Risk of technology, 9. Risk of litigation, 10. International risk, 11. Risk of reputation, 12. Exit value risk.

Applications

• Dev bounties
• Investor bonds
• Founder bonds
• Underwriting bonds
• Governance bonds
• Treasuries
• Stable coins

Founder REP

If we start a centralized company, a major stage in its development is to valuate the founders’ worth before the company goes public or secures venture capital. This will also happen in any DAO. Founders must work before the DAO begins to generate profits. How do we make this explicit?

Assuming we accurately estimate the value of the DAO as  at the future time , and that we also estimate the percentage of that value that is due to a founder is , then how much REP do they deserve today?

Founders’ roles are similar to investors. Therefore the same considerations that helped us make the valuations of iBONDs help to measure the number and properties of the founder’s REP. The major difference is that in addition to the claims on the REP salary, founder’s REP should have normal REP properties—voting and policing and participation power in ASCs. Using Proposition 9 we get

Proposition 11. Given an fREP contract for  founder tokens minted at time  for a -founder in a DAO with future value estimated as  with uncertainty , then the variable rate of return is  The correct value is guaranteed by the expiration date given by the stopping time  which satisfies the condition

Similar to fciBONDs, a floating valuation of the DAO would allow much greater accuracy, and can be accounted for by allowing   to change in time and rederiving the above fREP contract. If we also make  a dynamic variable, this would allow the DAO to continually re-evaluate the founders’ importance in the group. Then we get

Proposition 12. Given an fREP contract for  founder tokens minted at time  for a -founder in a DAO with value estimated as  with uncertainty , then the variable rate of return is  The correct value for the  founder tokens is guaranteed by the expiration date  given by the first hitting time which satisfies the condition

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It is important to note, that this is not the only way to reward founders for their contributions. A more stable approach is given by ignoring such tokens and referencing the founders’ work with Forum references which is discussed in this other section [link] ??