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.

The basic function of a BOND is that it pays out the same as a REP token as it shares in the REP salary, but it doesn't have the power of a REP token for governance or for securing work in the DAO. Further, a BOND token typically has a different lifetime from a REP token.

The design of a BOND token depends on the variables of payout rate, the expiration time, and the value of the BOND. These variables constrain each other. A DAO can choose two of these contract parameters at will, then solve for the third to determine a fair contract using reputation tokenomics theory.

DGF hopes to eventually support fixed- and variable-period BONDs for a variety of applications including bounties, investor bonds, founder bonds, underwriting bonds, and governance bonds. (Cf., Legal issues.)

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. In the case of stable coins, a treasury of some type is necessary (though the treasury for MakerDAO is distributed). However the holding costs of such a fund are entirely wasted, which betrays the unsophisticated design and juvenile state of most DAOs which rely on treasuries. More dangerously, the existence of a treasury is a focus of competition which erodes solidarity in a DAO and erodes the incentive to collaborate for the purpose of increasing the value of REP tokens.

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 the coordination problems in a group owned by a dynamically shifting multitude of international pseudonymous participants. And issuing equity in a DAO is a greater threat than in a centralized organization, because offering ownership to the highest bidder undermines its decentralization.

With the new technology of smart contracting, however, we have more tools available than just treasuries or ICOs. A DAO can now make a type of internal loan. A DAO may arbitrarily choose to mint a new type of financial token, called a BOND, which can be sold at market to amass capital for sellers immediately, then algorithmically pay off buyers later, through smart contracts. (The market for BONDs can be external or internal to the DAO.)

There are several types of contracts that can be made in the attempt to match the BOND reward to the proposed bounty . Assuming no treasury, the BONDs are paid out by the DAO’s REP salary as fees come in. The DAO does not control when outside customers choose to engage the DAO’s Work Smart Contract, so it cannot entirely anticipate the fees it earns. Therefore, 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 programmed to mitigate for any of these factors.

In the next section we detail several complicated algorithms for programming BONDs and make the effort to rigorously derive the formulas for their accurate valuation. The reason we go to the trouble is that the more accurate the valuation is, the more efficient the capital raising mechanism becomes. Whatever uncertainty exists in the valuation is paid for by the risk the buyers take. If there is more risk on the return from a BOND that promises to pay back  over the period of  years, then the buyer will only accept a lower price than when there is less risk. So any clarity we can bring to the pricing of a BOND token will increase the efficiency and profitability of the DAO.

Mechanism design

The BOND token design we detail here is a variation on a REP token, which pays out similarly through the REP salary.

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 by stopping the first time the constraint $qf_{B}^{1}(L_{B})=b$ is satisfied. In this case, the rate $q$ will be of prime importance when deciding how valuable the BOND reward is. The rate of payout 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 $\$b$ as long as the DAO continues to earn fees, 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 $L_{B}$. In this case we treat the left hand side of the equation $q_{0}PVf_{B}^{1}=b$ as a variable that depends on the variable lifetime of the $q_{0}$ BOND tokens minted at time $t_{0}=0$. 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 desired discounted 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 share, so larger $q$ means smaller $L_{B}$ is needed to match the value of any fixed bounty $\$b$.

BOND market design

The market for selling newly minted BONDs may be external or internal to the DAO issuing them. Relying on an external market is often preferred because market depth and liquidity improves its efficiency, so larger external markets are generally superior. However, relying on an external market incurs transaction costs that can be mitigated with an internal market.

External markets

If a DAO is using an external market to sell its BONDs, then it must decide how to exchange between the DAO's currency and the market's currency. This is called a cross-chain swap.

Then the DAO must set the price it will accept for its BONDs and the quantity it wishes to sell. Since the DAO is decentralized, coordinating these decisions is a difficult governance issue. To a large degree the issues amount to the same difficulty as setting the prices for an internal market.

Internal markets

**This section needs development.

Legal issues

BOND tokens are a type of security that a DAO issues promising to pay back some investment with a percentage of future profits the DAO earns through work fees. For a DAO to issue BOND tokens, it must comply with local laws for each of its members. Given that members may be pseudonymous and international, a DAO will have difficulty identifying which jurisdictions are relevant to determine which laws must be satisfied regarding disclosures and filings before making a market for BOND tokens.

In the United States the regulations are set and policed by the SEC. In the EU, the relevant governing body is the ESMA. Securities in Japan are governed by the SESC, in Korea by the FSC, in India by SEBI.

DGF is attempting to create protocols for algorithmically satisfying the requirements of as many regulating bodies as possible. There is a major difficulty in this undertaking, inasmuch as regulating bodies sometimes have contradictory requirements, such as disclosure vs. privacy protection. Decentralized platforms have a fundamentally different governance structure than centralized corporations, and so the same types of disclosures are often nonsensical or impossible, since there are no fixed leaders in a genuine primary DAO.

Our argument is that designing transparent mechanisms which quantify the risk more accurately than traditional corporate securities should convince legislatures of many countries that it is possible to create protocols which serve their citizens faithfully, giving them access to these new financial technologies.

Currently, however, we cannot recommend issuing BONDs under DGF unless your DAO is entirely composed of members in jurisdictions with clear rules for compliance. As such, the formulas given in this DGF wiki are entirely academic arguments for future BOND token mechanisms.

Applications

Major applications of BOND tokens 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 for example to help workers exit a DAO gracefully, or to create a pillar for decentralized underwriting.

• Dev bounties
• Investor bonds
• Founder bonds
• Insurance DAOs
  • REP-to-BOND market
• Governance bonds
• Treasuries
• Stable coins
• Graceful Exit BOND market
• Financial derivatives
  • calls
  • puts

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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.

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] ??

See Also

• Fixed-period BOND
• Variable-period BOND
• Dev bounties
• Treasuries
• BOND Markets
  • Investor BONDs
  • Founder BONDs
  • Graceful Exit
  • Underwriting
  • Stable coins
  • Derivatives
  • generalized chit fund banking
• PoR block production consensus
• Governance BONDs