Article source: Messari

Article translation: Block unicorn

Article translation: Block unicorn

Investing in cryptocurrencies can be rewarding, stressful or, more likely, a combination of both. With new capital entering this nascent asset class, many will find the volatility not for the faint of heart. After all, what good is a portfolio if it's up 100% one day and down 50% the next?

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BarnBridge background

BarnBridge is a cross-chain risk management protocol established in 2019. The protocol provides investors with composable solutions to hedge against interest rate volatility and price volatility. In September 2020, Barnbridge completed an initial $1 million seed round with 7.5% of the token supply, valuing the project at $13.3 million. Seed rounds include venture capital funds and industry founders. Notable investors include Fourth Revolution Capital from Synthetix, ParaFi Capital, Kain Warwick, and Stani Kulechov from Aave.

Funds raised during this seed round are stored in a temporary incubator DAO called Launch DAO, managed by project founders, seed investors and advisors. This gives the team a chance to start working on their roadmap before the protocol is officially released. The full transition to the full protocol DAO - the BarnBridge DAO - occurs in Q1 2021 and grants community members governance over the protocol.

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SMART Alpha overview

Launched in September 2021, SMART Alpha allows investors to calibrate their exposure to financial assets by taking on senior or junior positions in pooled pools. Those on the senior side are better protected when the value of the underlying asset falls, but forego the upside when it rises; the opposite applies to junior users who take advantage of price fluctuations. That is to say, the junior party bears the price risk that the senior party gives up.

How much risk is transferred between counterparties? Well, junior and senior results are determined based on junior dominance or the percentage of the asset pool that consists of junior fractional deposits. If the dominance of primary markets is low, older people receive less downside protection and primary products are more vulnerable to price changes. Conversely, when junior dominance is high, more investors are bullish, so seniors are more protected and juniors trade with less leverage. BarnBridge adds two limits to quantify the extent of downside protection:

1. Senior downside protection limited to 80% of junior dominance

2. Premium downside protection capped at 35%

Note that investors are rewarded for taking a contrarian thesis, as deviations in junior versus senior dominance will directly affect the corresponding returns. So, the downside protection or upside that seniors give up really depends on the broader market environment. This is an important part of understanding how SMART Alpha works.

Once funds are allocated to the pool, both junior and senior tranche holders receive a tokenized ERC-20 asset indicating their stake in the pool. For example, a junior party's ownership might offer bb_junETH tokens, while a senior party might receive bb_senETH tokens. Just like other tokenized assets, these ERC-20 tokens are composable and can be used in other lending or trading applications.

Each SMART Alpha asset pool operates on an epoch-based timeline and can be recalibrated every interval, meaning any user can deposit underlying assets into a senior or junior asset pool until the next epoch. This can be done days in advance or with just a few minutes to spare. While the epoch parameters can be adjusted for each asset through community voting, the default epoch period is advanced every Monday at 14:00 UTC.

Protocol income is earned through fees collected at the end of each epoch. The fee is currently 0.5% of the profit for a given week (i.e. the asset price falls and the senior side is covered by the junior investor, the fee will be deducted from the amount covered by the junior investor for the senior investor; conversely, if the price rises) and only Applies to the winning side. If the asset price rises during this period, BarnBridge will receive a fee from the proceeds the senior pool receives from the junior side; if the price depreciates, BarnBridge will receive a fee from the downside relief provided by the junior side.

So SMART Alpha offers a little bit of both worlds. It's easy to imagine someone wanting to trade leverage, but who wants to be on the other side? Ideal users for the premium tranche that BarnBridge envisions include project treasuries, mortgage borrowers and investors with a penchant for lower risk. All three of these user groups want to reduce volatility and achieve some degree of price predictability. Project treasuries, in particular, can leverage their large positions as a reliable source of liquidity, helping to reduce junior dominance and increase leverage for risk-taking investors. Those who foresee partial market tops can also use advanced positions to cover potential losses while maintaining some upside should further gains materialize.

Any non-rebase ERC-20 asset pair with a Chainlink price feed can be crafted into a SMART Alpha pool — and the network isn't limited to Ethereum. BarnBridge also runs on Binance Smart Chain, Polygon, Avalanche, and Arbitrum. But Ethereum has by far the largest TVL and is the best indicator of activity.

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Visualize the SMART Alpha scene

To better understand how the product works in practice, a series of visualizations are provided below. Suppose an investor wants to open a position in the WETH-USD pool. Selecting a pool in the BarnBridge UI above pulls up the relevant details:

One of the key points of the data is the green/purple bar at the bottom, which highlights the difference between the senior and junior percentages. Primary dominance hovered above 50% in Epoch 5, corresponding to the bullish sentiment seen in mid-October. Smart investors can use the split between the two pools as a benchmark for broader investor sentiment.

Now let's simulate the scenario:

>50% Junior Advantage

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Scenario #1: Aggressive price performance with more than 50% junior dominance

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Scenario #2: Slightly negative price performance, primary market dominance exceeds 50%

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<50% primary advantage

What to do when sentiment is bearish and junior dominance is below 50%? The results were similar, but the magnitude of the returns changed.

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Scenario #4: Positive Price Performance, Primary Market Dominance<50%

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Scenario #6: Strong performance at low prices, primary advantage<50%

As you can see from the example, SMART Alpha offers investors a way to gain leveraged exposure to assets. This draws similarities to another popular product, perpetuals (perps), but SMART Alpha has four key differences:

1. SMART Alpha is a long-only product: Investors cannot take a short position in the asset, so even those holding preferred stock must have some level of confidence in the underlying asset.

2. Junior investors cannot be liquidated: After exceeding the full downside coverage, the percentage of downside borne by seniors increases. Those in the junior pool start to see progressive results, with each additional percentage loss affecting them less and less. BarnBridge's dashboard might display 5x upside leverage and 5.5x downside leverage on the interface, but the real risk/reward tradeoff is far more compelling.

3. SMART Alpha is composable: As mentioned earlier, junior and senior receive tokens representing their capital in the product, which can be used on other DeFi platforms. Investors can allocate or stake these composable tokens to increase their return on investment, making the product potentially more capital efficient if they find attractive opportunities.

4. Leverage may be limited: Leverage on the platform is based on primary dominance, which is unlikely to grow disproportionately to 20x or more leverage achievable with perps (in this context, an asset's primary dominance must be approximately 10%) for 10x upside leverage). Some might call it a feature; others might call it a bug.

Conclusions and main points

Conclusions and main points

BarnBridge expects business activity to increase in the coming months. The project team plans to collaborate with other DeFi protocols to integrate SMART Alpha's tokenized assets into the broader currency LEGO ecosystem. The timeline for these partnerships is unclear at this time.

To be sure, this latest offering has wide availability. Some investors will be ready to go all-in on the market; others may be more cautious. Both parties could end up finding themselves on opposite sides of each other in the BarnBridge pool, looking for the smarter alpha.