Announcing SMART Alpha

This post was originally published on Barnbridge

At the heart of last year’s BarnBridge white paper were two protocols: SMART Yield and SMART Alpha. We’re excited to share that the launch of SMART Alpha is imminent, with a target release between Labor Day and mid-September. Until then, we’ll be doing extensive education around what it is and how you’ll be able to use it in your DeFi day-to-day.

These are the main takeaways from this post:

  • SMART Alpha creates single-asset pools for any non-rebasing ERC-20 with a Chainlink price feed
  • It is epoch-based, meaning that you deposit the underlying asset for a set period of time and cannot enter and exit until the subsequent epoch
  • You enter either as a junior or a senior and receive a [perpetual] ERC-20 proof of liquidity that can then be used further (e.g., junETH, senETH)
  • Seniors get absolute downside price protection in exchange for giving up some degree of relative upside price exposure
  • Juniors get leverage that is both liquidation-friendly and potentially tax-advantaged (🚨consult with your own counsel first🚨)

Today, we’re sharing an overview of how the system operates. Future posts will explore potential use cases, expectations around secondary liquidity, and scenario analysis from our own backtesting.

Beginner’s Guide to SMART Alpha

Alpha in financial markets is defined as the excess return of an asset relative to the return of a benchmark index. With respect to digital assets, the most commonly referenced benchmark index is simply the price of Bitcoin, and to a lesser extent, that of Ether. Similarly, those two flagships will regularly get compared to the performance of traditional indices, like NDX. The performance of any digital asset cannot be understood without the context provided by these benchmarks, as their movements largely dictate the outcomes for all.‌

SMART Alpha allows users to calibrate their exposure to the performance of an underlying asset. It does so by regularly redistributing an aggregated pool of the underlying asset between two groups of users: a senior side, and a junior side. When price goes up, seniors give up some of their assets to the juniors, and vice versa. Put another way, junior users are buying asset price risk off of senior users, guaranteeing them price protection up to a certain threshold in exchange for greater upside potential.‌

Juniors give some of their assets to seniors when price declines for the epoch, and vice versa

The outcome is a two-sided marketplace for asset price risk, generalizable to any compatible ERC-20 token today.


The SMART Alpha User Experience

SMART Alpha implements an epoch-based approach in which users can only enter and exit pools at a predetermined interval. In between epochs, users will be able to signal their intent to enter, exit, or switch sides within the pool for their given ERC-20 token. Epoch duration and at what time the epoch advances is a modifiable parameter for each individual pool, with the BarnBridge DAO inheriting guardianship. At launch, the default epoch advancement will occur once a week at Monday, 9:30 AM EST / EDT.

Depositors on both sides of a given pool receive an ERC-20 token as proof of liquidity. For example, if you were to deposit Ether into the senior side of its SMART Alpha pool, you would receive a bb_senETH token in return. Like any ERC-20, these tokens would then be further usable within other trading, lending, or derivative applications. These ERC-20 tokens are perpetual, meaning that new epochs only mint more of, or burn some of, the existing supply. This in turn enables juniors and seniors to both serve as money legos, as well as to provide hands-off exposure without the need for regularly closing or rolling over positions.

Both entering and exiting SMART Alpha pools requires the user to deposit either the underlying or derivative asset, respectively, prior to the advancement of the next epoch. Within the context of the default model, this could be done six days and 23 hours in advance, or a minute in advance.

How Junior and Senior Outcomes are Determined

SMART Alpha calculates how much downside protection and upside exposure seniors get in a given epoch as a function of junior dominance. Junior dominance is defined as the share of the SMART Alpha pool that is composed of junior-side deposits. Like epoch length, the equation that determines what a given junior dominance means for the senior side is a modifiable parameter for each SMART Alpha pool.

While we are still making some finishing touches on the default senior rate model, the two primary considerations that would be modifiable are:

  • The ceiling on senior downside protection
  • The rate at which seniors retain or give up upside price exposure

As every asset will have a different volatility profile and a different set of competing applications offering hedging or leverage for it, we anticipate that the BarnBridge DAO will play a key role in optimizing these models for each pool over time.

Below are two examples of how the junior and senior assets would perform in dollar terms during an epoch at 50% junior dominance under the current default model.

The senior side gives up 69% of its upside exposure as SMART Alpha redistributes some of its underlying asset to the junior side.
The senior side receives enough of the underlying asset to remain whole, as -10% was within its absolute protection range.

At different levels of junior dominance, outcomes skew towards rewarding the side taking on the contrarian view. Are users camping out in the senior side because of poor market sentiment? Then they will receive far less downside protection, albeit with greater upside exposure, while juniors get far more upside leverage. A later blog post will go into greater detail around these dynamics.

With this understanding of how SMART Alpha operates, you can begin to see why these new junior and senior assets could be compelling:

  • An asset could drop 90%, but if it does so over the course of enough epochs, a senior user might see no drop in the nominal value of their deposit
  • An asset could see significant volatility over the course of the epoch, but if it finishes it in the green, a junior user will have gone unscathed
  • As long as a user remains deposited in the pool, they are only charged a fee when their side “wins” the epoch and may only incur a taxable event upon exiting the pool (🚨again, consult with your own counsel first🚨)

Next Steps

Future posts between now and product launch will drill deeper into the following concepts:

  • What will secondary liquidity and lending conditions look like?
  • Who is SMART Alpha for?
  • How would SMART Alpha have performed in the past?

About BarnBridge

BarnBridge is a suite of risk tokenization protocols for DeFi. Its applications allow users to select from opposing pools and take positions on risk factors like interest rates or asset prices. Its first application, SMART Yield, offers fixed and levered variable yields on stablecoins deposited into underlying lending markets like Aave, Compound, and C.R.E.A.M. Finance. Its application suite has expanded to include SMART Exposure, a position rebalancing solution, as well as SMART Alpha soon, which will allow users to calibrate their exposure to price movements in an underlying digital asset. BarnBridge is currently live on Ethereum and the Polygon Network.

Keep up to date with the BarnBridge community via the following channels:

Announcing SMART Alpha was originally published in BarnBridge on Medium, where people are continuing the conversation by highlighting and responding to this story.

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