Arbor Finance - Gateway to Debt in DeFi
- Arbor offers projects and other on-chain entities a sustainable way to raise the capital needed for protocol development.
- Bonds issued on Arbor are sold to investors through batch auctions
- Arbor reduces the default risk of the bond issuer and protects the rights and interests of investors through the Defaults mechanism and over-collateralization
- Arbor has not yet launched a token, but the project plans to do so to compensate early partners and users
What Is Arbor Finance?
Projects in the Crypto industry are generally financed by institutions through the primary market, or by all kinds of investors through the secondary market. Both ways are basically raised through the sale of native tokens. The secondary market financing is mostly in the form of ICO/IDO/IEO, etc. Secondary market-oriented financing is usually done only once per project. For projects that have already raised funds, especially in the secondary market, these projects are generally unable to raise funds by selling tokens since the tokens are already circulating in the secondary market. Currently, there is no commonly used alternative financing method in the Crypto market, which makes it difficult for the majority of projects to obtain funding other than the sale of their own tokens after secondary market funding.
While, in the traditional financial market, it is a very common financing practice for companies to issue bonds. However, this is rarely seen in the Crypto world. The project we are introducing today, Arbor Finance, focuses on this area. It helps Crypto projects to raise funds through issuing bonds by providing a platform for bond issuance and sales.
The features and services provided by the Arbor Finance platform are simple:
- Select a suitable bond issuer, i.e. a DAO. For instance, Ribbon Finance, a project that has successfully issued bonds to raise funds on the platform before.
- Conduct proper due diligence on bond issuers and disclose as much information about the issuers as possible.
- Provide a bond issuance platform where the bond issuer only needs to fill in relevant parameters, such as bond issuance volume, collateral token, maturity date, etc., to issue bonds.
- Provide an auction platform for bond sales, allowing investors to purchase bonds.
What Are Zero-Coupon Bonds and Convertible Bonds?
Arbor Finance allows projects and other on-chain entities to borrow stablecoins through the sale of long-term debt. In order to understand Arbor's products, we need to clarify two basic concepts, namely Zero-coupon Bonds and Convertible Bonds.
A zero-coupon bond refers to a “no interest” bond in which investors earn the difference between the face value of the bond and the actual purchase price. For example, a bond with a face value of $100 and a maturity in one year might be purchased for only $80 today. This bond will allow the investor to sell it for $100 in one year and earn a profit of $20.
In Arbor Finance, the specific amount of the discount, that is, the actual purchase price of the bond is determined through an auction. While in the traditional market, the bond price is generally determined by the bond issuer considering the market interest rate.
Convertible bonds are relatively complex, which enables the holder to convert the bond to specific assets. If the price of the convertible asset rises, the bondholder can convert the bond to a specific asset for additional income. If the price remains unchanged or even declines, the bondholder can choose to hold the bond to maturity for the inherent income.
When purchasing convertible bonds, investors are effectively buying call options on the collateral assets, and purchasing a zero-coupon bond, which gives investors the opportunity to obtain additional returns.
In Arbor Finance, lenders can convert their bonds into a set amount of collateral tokens at any time prior to the maturity date, and after the maturity, the bonds cannot be converted. Only the principal and interest of the bond can be obtained.
How to Issue a Bond on Arbor Finance?
The issuer of the bond is generally the Crypto project (or a DAO). Projects that want to issue bonds need to first fill out the borrower form on Arbor Finance, which includes the financing amount, target annualized interest rate and loan period, etc. Afterward, Arbor Finance will conduct due diligence on the project that wishes to borrow funds to ensure that the applicant is the borrower, and determine whether her borrower meets the requirements for bond issuance.
After passing due diligence, the projects can start issuing bonds on Arbor Finance and can choose to issue either zero-coupon bonds or convertible bonds. First of all, the project needs to fill in the number of bonds to mint, the tokens to be borrowed (currently Arbor only allows $USDC to be borrowed), and the specific bond maturity date.
After that, the project needs to set up tokens as collateral, which are generally native tokens. If it is a zero-coupon bond, the creation of the bond will be completed after setting these up. And if it is a convertible bond, the project needs to additionally set the convertibility of the bond, and then complete the creation.
Overall, the process of creating bonds after due diligence is very simple since the bond issuer only needs to fill in a few relevant parameters to complete the whole process. In addition, the borrower also needs to pay an establishment fee, which is paid to Arbor Treasury for the development of the platform.
After the bond is successfully issued, it is ready for subsequent user investment, and the process of user investment is also the process of bond pricing. This process is currently carried out through auctions.
How to Invest in Bonds in Arbor Finance?
The bonds issued by the projects will be sold in a batch auction on Arbor.
On the Arbor platform, investors can first see what offerings are available for investment. Projects currently completing bond auctions on the platform include ShapeShift DAO Convertible Bond and Ribbon Convertible Bond.
After selecting an offering, investors can see such information as the offering amount, minimum funding threshold, and minimum order amount. Investors can submit orders according to their own wishes, and the process of submitting orders is also quite simple: they only need to fill in the amount and price to complete the creation. Submitted bids cannot be withdrawn after the auction closes.
During the auction, the bids submitted by all investors will be ranked from highest to lowest price. The lowest price that meets the minimum funding threshold is the price for everyone. Investors below this price will not receive the bond and will be refunded. Of course, the auction will not settle if the funding threshold is not met.
For example, assume that Uniswap issues 1,000,000 zero-coupon bonds with a maturity of 12 months on Arbor, and the face value of each bond is 1 $USDC, which means that each holder can receive a principal of 1 $USDC after maturity. Each bond is backed by 0.5 $UNI as collateral.
During the auction stage, suppose you decide to invest a total of 1,000 $USDC at 0.96 $USDC per bond. The final price of the bond after the auction is 0.95 $USDC. Although your bid is higher, the investment price of all investors will be the same at 0.95 $USDC at the final settlement. But if your bid is 0.94 $USDC, then you will not receive the bond and you will get your money back.
Since the actual transaction price is 0.95 $USDC, you will receive a total of 1,052.6 bonds (1,000 / 0.95=1,052.6), and you will receive 1,052.6 $USDC at maturity. If Uniswap fails to repay the bond at maturity, you will receive 0.5 $UNI tokens per bond.
For Uniswap, a total of 950,000 $USDC was raised in this bond issuance (1,000,000*0.95=950,000). When the bond matures, 1 million $USDC needs to be repaid. If Uniswap defaults, all collateral will be lost and obtained by investors.
How Does Arbor Finance Ensure the Safety of Investors' Funds?
The main risk in investing in bonds is credit risk. In order to prevent the project from defaulting, Arbor Finance has set up an over-collateralization mechanism that makes it more costly for projects to default than to repay the bonds when due.
Repayment Buffer Period
In addition, Arbor has also set up a Defaults mechanism to allow projects to postpone the repayment of bonds for a period of time, considering that some projects may have difficulty in capital turnover. If the borrower fails to make principal and interest payments by the maturity date, they are given a seven-day grace period to make the required payments and are responsible for alerting bondholders of the status of their repayment. If the project still fails to complete the payment within the grace period, its collateral can be claimed by bondholders. The reputation of the defaulting project will be damaged as their default will also be recorded on the chain, affecting the future development of the project.
Borrowers may add an on-chain promise to repay the bond, and this information will also be displayed on the bond page. This improves investor confidence and attracts investors to purchase bonds.
Who Are the Team Members of Arbor Finance?
The co-founders of Arbor Finance are Russell Ratcliffe, Cameron Schorg, and Kyle Trusler, all of whom have years of experience in the Crypto and DeFi fields. Among them, Cameron Schorg participated in extensive lending and borrowing work when he was working at Notional, serving clients including DAOs, credit funds, and prop trading firms, thus providing experience for the development of Arbor Finance's bond products.
At the same time, he also believes that the transparent, on-chain, and DeFi-based debt market built by Arbor is the right solution for project financing. In addition, the core team members also include Matt Gates and Philipp Petzka, who have made achievements in frontend and business development respectively, which are beneficial to the development of Arbor.
What Is the Token of Arbor Finance?
Arbor Finance has not yet launched a token, but the project plans to do so, which will be used to compensate early partners and users of the platform.
The Future of Arbor Finance
In addition to auctions, Arbor Finance is actively developing another way for the investment of bonds, the over-the-counter (OTC) market. In the OTC market, borrowers will be allowed to set a fixed price for their bond sales, and investors can purchase them according to their investment decisions.
In addition, in the traditional financial market, bondholders can trade their bonds to obtain income, and even mortgage their bonds for refinancing. Similarly, Arbor also has plans to build a bond exchange that would allow bondholders to trade or stake bonds for additional yield.
Thus, the Crypto bond market has a lot of room for exploration, and the emergence of Arbor Finance is expected to accelerate this process.