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A research partner at Paradigm has proposed a framework for over-collateralized zero-coupon bonds on the Ethereum blockchain.
Dan Robinson of one of the largest cryptocurrency investment funds, today published a paper that describes the new framework, named Yield Protocol, for issuing zero-coupon bonds on Ethereum that are both cash and physically settled.
The bonds are issued as the so-called yTokens, and users can create these tokens by depositing collateral such as ETH. yToken holders can then sell to short a target asset that the bonds will be settled in. According to the paper, these yTokens can be pegged to any target asset such as Dai or Ether (yDai, yETH). Therefore, drawing yTokens essentially gives the repo holder short exposure to the target asset.
Similar to traditional zero-coupon bonds, yTokens can be sold on the market in exchange for the target asset itself. A buyer can hold yTokens to maturity, thereby locking in a fixed rate, at which point they can redeem their bonds for the equivalent value of collateral. In this sense, buying yTokens is economically similar to lending the target asset. yTokens will trade at a discount to face value throughout their terms to reflect the time value of money, with the discount serving as a form of yield.
An on-chain system, the Yield Protocol can also be used as an interest rate oracle, facilitating monetary policy decisions for groups like MakerDAO and secondary lending platforms like dYdX and Compound. Although yTokens have specific maturities, systems like Set Protocol can be used to effectively roll over exposure upon expiry.
“Yield primarily differs in that its interest rates are implicit and set by market prices, rather than being set by governance or a formula. Additionally, whereas most lending protocols use floating interest rates, Yield enables term loans with fixed interest rates, while still maintaining some degree of fungibility,” states the paper.
Robinson’s Yield Protocol follows his previously published Rainbow Network paper, which describes a protocol for a payment channel-based synthetic asset issuance platform.