The Structural Lack in Traditional DeFi

As we all know, DeFi, as a product of the crypto world, has a distinct Web3 attribute. It is often seen as a decentralized version of traditional finance. Therefore, businesses such as savings, lending, asset management, EX, insurance, and funds in traditional finance can usually find their corresponding forms in DeFi.

However, bonds, which is also basic financial instruments, has not been able to obtain a truly decentralized expansion on the blockchain due to its own nature.

Accurately, the issuance of bonds requires a fairly complex data structure, but the industry lacks a technical standard that supports the issuance of bonds with compound structures. Prior to this, the issuance of bonds was usually supported by the ERC-20 standard, but the characteristics of ERC-20 itself made it grinding for bond products in the traditional financial space to be reproduced on Web3.

On the one hand, the ERC-20 standard does not have a complex data structure. Therefore, when issuing bonds under this standard, smart contracts need to be deployed separately for each bond according to the type of bond. In the meantime, compatibility between different types of bonds is almost impossible. This is arguably at odds with the complex data structure needs of bond issuance. Therefore, it is nearly impossible to issue bond products with ERC-20 tokens providing liquidity pools based on existing DeFi protocols.

On the other hand, due to the high gas cost, it is onerous to support the storage of bond return and redemption logic on the chain.

Thus, if you want to be compatible with bond instruments with complex data structures on the chain, a new standard that supports complex data structures and multiple redemption functions is essential.

The Birth of ERC-3475

In August of 2022, the Ethereum Foundation passed a brand new proposal - EIP-3475. At the core of this proposal is a new application standard - ERC-3475. Under the ERC-3475 standard, any user can customize and issue decentralized bonds and financial derivatives with complex structures, such as futures, options, share warrants, swaps, and more.

The proposer of this proposal is D/Bond, a decentralized bond ecosystem platform.

D/Bond is a decentralized bond ecosystem platform, which is dedicated to building a truly decentralized bond ecosystem for the DeFi market through its proposed ERC-3475 standard.

In the traditional financial market, the core value of bonds is to provide users with a relatively stable safe-haven investment approach, even if the market is in a deep bearish state, it can maintain the price pegged to the US dollar, But at present, it is still arduous for the crypto market to achieve this while this is the thing D/bond is working on.

As the proposer of the EIP-3475 proposal, D/Bond provides a suite of DEX, wallet and visual bond design tools based on the ERC-3475 standard. Any institution or individual can design their own bond products for financing through a visual programming interface, and the technical and usage thresholds are rookie friendly.

Based on the ERC-3475 standard, not only standard bonds in the traditional sense can be created, but also financial derivatives with more complex models such as forwards, futures, options, binary options, warrants, and swap transactions can be created. Users can also pack existing bonds into derivatives covering different risk-reward combinations and trade them on D/Bond DEX.

The basic principle of EIP-3475 is to enable the ID of each bond category to represent a new configurable token type, and to correspond to each category one by one, making it feasible to issue bonds with multiple redemption data.

The complex data structure of ERC-3475 enables ERC-3475 tokens to have the potential to store more bond information, hence supporting developers to build more complex logic for bond redemption and return mechanisms. At the same time, these features also give ERC-3475 tokens enough flexibility to support a variety of redeemable bonds.

Under the ERC-3475 standard, each bond will be assigned an independent algorithm, and it is needless to deploy additional smart contracts. This idea of managing multiple bonds in one contract is not only efficient, but also more economical, and the gas cost will be greatly lessened.

Additionally, under the traditional model, automatic market makers (AMM) usually need to use separate smart contracts and ERC-20 LP tokens to manage trading pairs, which will not only reduce the overall liquidity of LPs, but also waste unnecessary Gas fees, and may also cause transaction delays due to network congestion.

The ERC-3475 standard is completely different. It uses a multi-layer liquidity pool to support larger LPs to create many trading pairs. Since each bond stores all the necessary data, ERC-3475 does not require issuing a separate contract when adding a new LP pair, which not only greatly improves the liquidity of LP, saves Gas fees, but also avoids the risk of being attacked to a certain extent.

Multi-layer Liquidity Pool

In regard to the design of bond instruments, D/Bond has designed a multi-layer liquidity pool, which adopts the strategy of graded bonds and is divided into floating rate pools and stable rate pools. The stable interest rate pool has high stability, high security, and low interest; the floating interest rate pool is the opposite, but the assets of the floating interest rate pool can guarantee the redeemability of the assets of the stable interest rate pool.

Asset-backed bonds are a fairly subdivided sector in the traditional financial bond market. Therefore, the bond layering of D/bond is not actually the bond itself, but the subclass MBS of the asset-backed bond in the bond subclass and the ABS in the ABS. The idea of EIP-3475 is to resolve a single default risk by boxing all bonds into one pool.

Specifically, D/bond's multi-layer liquidity pool can indeed achieve some results in resolving a single default risk, but the systemic risk still cannot be resolved. Because in essence, the logic of the crypto market differs from that of the financial market.

Hypothetically, if the issuer of the bond is a project that already has financing needs, it itself lacks funds and valuable collateral. In the traditional financial market, perhaps they can choose to mortgage physical assets, such as real estate, production equipment, etc., as price anchoring.

But in the crypto market, the collateral will inevitably be changed to a digital currency with high volatility. At this time, there are problems in the underlying logic of the bond itself. Hence, for the D/bond or ERC-3475 standard, its core value should be considered at an earlier time.

For that reason, even though the adoption of the EIP-3475 proposal seems to be only a bond issue in the DeFi sector, it involves one of the core issues of the entire crypto market-the issue of the credit rating system.

Currently, the credit rating system in the crypto market is quite scarce, so there is no good cornerstone for the issuance of mainstream credit bonds. Even if it is issued, most market users dare not participate or even run away from it. As a result, mainstream projects are not interested in the sector. If this cycle continues, the application scenarios of credit bonds in the crypto market will only become even narrower.

Ultimately, from this perspective, the popularity of credit bonds in DeFi may not only focus on the level of "technology", but more from the perspective of "DAO". But judging from the current situation, there is undoubtedly still a long way to go to forge the credit rating system of the crypto market.