Decentralized autonomous organizations (DAOs) are gradually gaining traction in the Web3 space and beyond as many are beginning to explore possible ways of contributing to one. While DAOs have significant operational benefits such as organizational transparency, decentralization, and ability to utilize a wide variety of assets to operate, there are some challenges DAOs must still overcome.
Financing Difficulties for DAOs
Being in their infancy, DAOs face difficulties with raising funds and financing. It is a known fact that most DAO treasuries have high concentrations of their native token一some relying heavily on selling their governance tokens to fund operations. This puts direct sell pressure on the token price, potentially affecting long-term holders.
Some DAOs一such as ShapeShift DAO一do not have a legal business registration due to their decentralized nature. Therefore, they are unable to secure credit via traditional forms of financing. Since the majority of DAO’s assets are cryptocurrencies (and often more “risky” assets such as the native token of a protocol), traditional banks do not accept such assets as collateral when applying for loans.
This is where HourGlass and Arbor Finance come in—offering permissionless debt-based financing via convertible bonds. This form of financing allows DAOs to secure the funds they need to continue developing and growing their organizations without sacrificing their governance tokens.
Current DAO Financing Options
There are some DAO financing options that exist currently, which are as follows:
1. Token-based (equity) financing: token sales add direct sell pressure and reduce a DAO’s overall share of its governance token.
2. Variable Rate Borrowing: Margin lending–popularized by platforms such as the discontinued Rari Fuse–results in liquidations when collateral value falls below the LTV (loan-to-value) limit, making it subject to volatile price movements. Additionally, high APY’s – sometimes jumping into the triple-digits–can make paying back these loans burdensome.
3. Discounted bonds (i.e. Bond Protocol): DAOs can sell discounted tokens on platforms such as Bond Protocol. Holders can buy discounted, unvested tokens and sell their current holdings at a profit. This process results in demand for the offering, but can add short- to medium-term sell pressure to the token price (experimenting with parameters such as vesting time may help reduce this pressure).
ShapeShift’s Overcollateralized Convertible Bonds
Convertible bonds provide a unique solution for DAOs looking to obtain credit within decentralized finance, adding another tool to the list of aforementioned options. This is done via borrowing stablecoins against the native token, at a fixed-rate, without the risk of liquidation.
ShapeShift DAO has issued a convertible bond using HourGlass and Arbor Finance protocols, borrowing up to $500,000 USDC with each protocol. These offerings are overcollateralized 250% by FOX, the DAO’s governance token. ShapeShift’s plan is to pay off their current expensive variable-rate loan on Rari Fuse (currently around 135%) taken earlier this year and effectively convert it into an 18-month fixed-rate obligation with an estimated rate of 20%. Refinancing effectively saves the DAO over $50,000 in interest payments over the next three months一adding invaluable runway to the organization’s stablecoin reserves.
Let’s further explore HourGlass and Arbor Finance and make a note of some of the key differentiators:
HourGlass allows DAOs to borrow stablecoins against their governance token as a part of a fixed-rate, fixed-term, zero-liquidation loan. At high-level, this allows DAOs to raise funds to support their protocol growth, while avoiding the risk of losing their governance tokens. HourGlass is a part of the Buttonwood ecosystem, and has the following features:
- No upfront commitment - DAOs can list bonds with no-commitment or movement of funds. There’s no need to go through governance before committing, making it free to gauge lending demand. All actions are reversible until the bond is deployed.
- Fixed-Rate - Fixed-rate borrowing is more beneficial for DAOs that need to plan out longer term expenses rather than concentrate on rate movements.
- Liquidation-free - Unlike margin lending platforms like Aave, DAOs don’t have to worry about the volatility of the collateral value over the course of the loan. Their position cannot be liquidated.
- Retain Upside - DAOs sell the “Senior” tranche tokens to lenders, while retaining the “Junior” tranche. For this reason, DAOs retain any upside price movements as the Junior tranche functions like an equity instrument.
- Prepayment Opportunity - DAOs can repay early and are only charged on the interest accrued.
- Custom Parameters - DAOs can tailor the bond to their needs. They get to choose the borrowed asset (stablecoin), the bond duration (i.e. 12 months), an optional default penalty (to attract lenders), and their collateralization ratio.
Arbor Convertible Bonds
Arbor enables DAOs to raise debt based financing by issuing convertible bonds that are fixed rate/term and non-liquidatable. For lenders, Arbor offers transparent, over collateralized, and high yield opportunities where they receive a fixed rate of return along with upside to treasury token appreciation.
- Fixed-Rate borrowing - DAOs can lock in their borrowing cost, secure needed capital, and more accurately plan the future with.
- Token upside - Convertible bonds include a call option on the collateral tokens for the lender, potentially leading to higher returns depending on the performance of the collateral token. This added benefit creates a win-win relationship between DAOs and Lenders whereby Lenders get token upside and DAOs get better rates.
- Customizable bond parameters and choice of collateral.
- Auction based interest rate pricing - Lenders compete for the allocation into the bond ensuring the DAO gets the most market efficient rate
- Low smart contract risk - Arbor smart contracts have been audited twice and are on Ethereum mainnet, eliminating any bridging risk investors are exposed to.
- HourGlass Bonds are composed of tranched debt, meaning the collateral is stratified into a senior portion and a junior portion. The senior portion is what is allocated to a lender, and is paid out first. This, along with a default penalty of 75%, provides an additional layer of protection for lenders if the DAO defaults on a loan. This is possible because of the ButtonTranche protocol.
- Arbor Bonds do not have tranched-debt. The lender is compensated with the total deposited collateral if the DAO defaults on the repayment.
- HourGlass bonds are convertible at maturity. Arbor Finance bonds allow the lenders to convert the bond into the underlying collateral at a pre-defined strike price. This added benefit creates a win-win relationship between DAOs and Lenders whereby Lenders get token upside and DAOs get better rates.
- Arbor Finance has a gated listing process for DAOs to become borrowers on the platform. DAOs need to undergo a due diligence process involving internal and third party assessments to ensure the credibility of their treasuries and overall risk profile for lenders.
- By integrating the Chainlink Price-Feed Oracle for tranched debt, HourGlass Bonds offer higher customizability with an optional penalty ratio. The penalty ratio is the % of Junior Tranche paid to lenders when the DAO defaults. A HourGlass bond with a 100% penalty is equivalent to an Arber Bond. This can be helpful for DAOs that default, but still want to retain their collateral.
- Since Arbor Finance does not require an oracle, it lowers the barrier of entry for early-stage DAOs that cannot support a price-feed oracle.
- For the bond auction process, Arbor Finance uses Gnosis Auctions, while HourGlass uses an escrow. This means Arbor Finance requires a soft-commit and a governance vote to move tokens before a bond can be listed.
- Comparatively, HourGlass offers zero-commit bond-listing and no governance vote to list a bond (i.e. it's permissionless).
As DAOs continue to evolve, financing solutions are needed to support product development and growth. The ShapeShift community is impressed and thankful for protocols like Hourglass and Arbor that identify these problems and develop solutions to improve and support decentralized ecosystems. Both HourGlass and Arbor value trustless, open-source, permissionless technology, aligning closely with the ethos of the ShapeShift DAO.
HourGlass is the permissionless convertible bond market for DAOs. HourGlass is a part of the Buttonwood ecosystem, seeking to become a one-stop shop for any DAO looking to raise funds to support protocol development. HourGlass contracts were audited by Byterocket.
You can join HourGlass’s Discord here, and follow HourGlass on Twitter.
Buttonwood is a collection of DeFi primitives for building powerful decentralized financial instruments such as liquidation-free debt, convertible bonds, fiat-free stablecoins, and more. Buttonwood’s core contracts are easy to use—developers only need to build routers and a UI.
To learn about how you can build with Buttonwood, join Buttonwood’s Discord, and follow Buttonwood on Twitter.
About Arbor Finance
Arbor enables creditworthy DAOs to obtain fixed-rate financing using their project tokens as collateral. The over-collateralization of the bonds, along with the opportunity for DAOs to issue convertible bonds, makes Arbor an investor-friendly platform. By minimizing the risk of default and ensuring fixed yields, investors can identify and support decentralized financing opportunities.