While designing the Signals Protocol, we decided it would be important to offer some sort of “rage quit” mechanism in which supporters who had locked up tokens could exit the system early without defeating the purpose of the token lock.

We were then accepted into the Uniswap Hooks Incubator, and decided it was the perfect place to explore this concept. What if the tokens locked in a Signals Board could take the form of an NFT, and be traded on an AMM?

If we could create an NFT that represented the right to redeem the tokens once they become unlocked, that NFT could be thought of as a bond with no interest (also known as a zero-coupon bond).

The solution we built during the program borrows liquidity from a normal Uniswap pool to power our AMM for bond NFTs. We introduced an on-chain pricing algorithm so the AMM could provide accurate pricing for each bond instead of relying on supply and demand to determine the price. It even used the new Uniswap v4 Hooks to adjust fees for traders on the Uniswap pool, based on how much profit the AMM had generated. We called it the Bond Marketplace AMM.

Our solution was perhaps a bit over-engineered for providing a way to autonomously buy and sell NFT bonds, but we got a glimpse of how we could build new and powerful systems using bonds instead of simple token locking. At the end of the program, our innovation won us top prizes from the Uniswap Foundation and Arbitrum Stylus.

The power of bonds

Locking tokens is an essential building block for various crypto systems, including Signals. In many of them, however, it might be possible to allow the tokens to be transferred in their locked state without negating the point of them being locked.

One example is when on-chain organizations lock tokens into a vesting schedule when issuing grants or other funding. While effective at curbing short-term sell pressure, these mechanisms immobilize capital, leaving participants unable to respond to market conditions or life events.

We received a grant from Optimism’s Public Goods Retro Funding Round 6 (PGRF6) denoted in OP tokens, and when the grant was issued the price of OP was $1.70 per token. The price was roughly the same when our stream started 4 months later, but by the time the stream ended the token price had slipped to $0.64.

This wouldn’t have been a problem if we could have afforded to hold onto our tokens until the market recovered, but due to our financial situation we were forced to start selling as soon as the stream started, resulting in us receiving 32% less value than what we had budgeted for.

Optimism has distributed 60 million OP thus far, so we can only assume many others have had a similar experience to us.

What if we could have sold our locked tokens, while honoring Optimism’s preference that they not be sold on the open market?

Replacing traditional lockups with bonds

Some bond NFT (and token vesting) implementations already exist. One great example is Hedgey, which offers lots of customizable features for vesting and other parameters.

For our marketplace project, we created a simpler type of bond NFT without all the bells and whistles. We found that our use case was better served by a more basic token that simply represented ownership of the underlying, locked asset.

This allowed us to design an on-chain pricing algorithm that could determine the price of a particular bond based on the amount of underlying tokens and the time left to maturity. This became an essential component of our AMM, which could now price bonds autonomously in a way that guarantees any bonds purchased can be redeemed in the future for more than the price paid.

A user could sell their bond into the AMM for the going rate as determined by the algorithm. Over time the value of the bond increases, meaning if the bond were then resold by the AMM at any point, profit would be generated. If the bond reached maturity before being resold, it could be unlocked by the AMM, achieving maximum profit for liquidity providers.

Our Bond Marketplace AMM uses hooks to leverage Uniswap’s position as a market leader to gain access to much deeper liquidity than we would be able to access on our own. This was an early exploration into the concept of rehypothecation of liquidity.

Offering a level playing field for risk

Since bond properties are all available on-chain, anyone can write their own pricing algorithm to use with our system.Professional market makers could deploy strategies that cater to DAOs, yield farmers, and other buyers. Market forces could identify the optimal pricing strategy. This dynamic creates a true market for locked capital, one that can finally bring efficiency, flexibility, and expressiveness to what has traditionally been a rigid, top-down process.

Exploring the market dynamics

A bond marketplace like ours caters to the needs of all participants in the system:

Bond holders can sell their bonds before the underlying tokens are unlocked, for a market-determined price. Following our retro funding example above, this would have allowed us to access liquidity at a known exchange rate without having to risk future market volatility.

Bond buyers can essentially generate yield on their long-term token holdings, by using those tokens to buy discounted bonds and then simply waiting for the bonded tokens to unlock.

Bond issuers still achieve their goals that rely on locked tokens. In the example of DAOs paying out locked rewards, the underlying tokens are not being sold on the open market, which protects token price.

By tokenizing locked commitments as NFT Bonds and allowing them to trade freely in a secondary marketplace, we maintain the level of commitment while acknowledging the financial risk.

A new primitive for DAOs

Bond marketplaces can also open up powerful new tooling for the DAOs who are issuing bonds. DAOs can act as buyers of last resort, offering partial liquidity to contributors in volatile conditions. They can also shape controlled buyback programs, putting up protocol-owned liquidity to gradually reacquire their tokens at a discount, without requiring complex OTC deals.

What’s next?

For Signals, we believe using a bond NFT model could improve our system by allowing supporters of an initiative to sell their locked position based on shifting sentiment. Monitoring market activity could add a new layer to the metrics Signals exposes.

What token-locking systems have you seen that could be improved by using bond NFTs?

Tweet at us and let us hear about it!

Acknowledgments

Atrium Academy *Navigating the Uniswap v4 codebase would not have been possible without our Instructors and the DevRel support provided. Special thanks to @AtriumAcademy for providing us with support necessary to reach this point. *

We highly endorse and recommend the program to anyone considering deploying on Uniswap.

Uniswap The v4 hook design allows vendors like ourselves to leverage Uniswap’s position as a market leader to gain access to much deeper liquidity than we would be able to access on our own. This was an early exploration into the concept of rehypothecation of liquidity.

Arbitrum We had the chance to scratch the surface of what is possible with Arbitrum Stylus. The runtime unlocks calculations that facilitate a new family of algorithms would even struggle on a L2 blockchain.

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