T-Bonds are a new form of DeFi instrument that allows tokens to be locked into a non-fungible token (NFT) and sold to unlock liquidity in projects while discouraging large sell-offs. This article goes into depth about the advantages of T-Bonds for issuers and buyers and the robust financial market they can create. For a basic overview of T-Bonds, see: An Introduction to T-Bond NFTs.
The Advantages of T-Bond NFTs
To create value, T-Bond NFTs must present advantages to both the issuer and the buyers over current offerings. Fortunately, there are distinct advantages to all parties. This document discusses these and uses the use case of Telos system tokens TLOS to further illustrate.
Advantages of T-Bonds to Issuers
When a project creator releases new tokens to fund the development of a new feature or other system improvement, the traditional route of selling liquid tokens will see many of those newly released tokens sold on exchanges to quickly capture the benefit of any discount the buyers receive. While issuers may offer a smaller discount to these buyers due to the instant liquidity, they must expect that the tokens they sell will quickly lose value and may need to sell more than they otherwise would in order to reach the funding requirements needed to reach their milestone. Meanwhile the token price may drop as soon as these tokens are sold on markets, negatively affecting all token holders.
When using T-Bonds, the dynamics change considerably in later stages. While the initial amounts sold may be considered roughly equal between approaches (the T-Bonds will offer a larger discount but not need to sell the same overage as the token sale approach for a situation that’s essentially a wash), later stages diverge significantly. Since the fungible tokens in the T-Bonds are locked in their NFTs they cannot reach liquid markets. (They will sell on secondary markets and have some impact on token price but much less than a flood of new liquid tokens.)
In both cases, once the development milestone that the token sale was meant to enable is reached, there should be some expectation of improved token price resulting from improved project fundamentals. However, because the T-Bond sale does not facilitate a large drop in token value due to the market sale of many new tokens, the value increase can be expected to be more significant. When the T-Bond tokens do become liquid, there is also likely to be a drop in token value, but less severe and from a higher base level than if it had preceded the rise in token value from achieving the milestone. This evaluation does not include either the general increase in token prices across the board or the following of market trends by technical traders — both of which could be expected to further benefit the T-Bonds model over the traditional liquid token model. In short, by allowing the project to reach its milestone before the tokens sold to enable this, the token price is likely to be better supported overall.
Using T-Bonds as a Developer
Any project will be able to use the T-Bond NFT open source contracts to issue T-Bonds on Telos. These could be an alternative to ICOs but it also presents the unmatched ability to raise subsequent funds for projects that have raised previous rounds, without crashing their current token price.
Consider the fictitious ABC DAO, which launched some time ago with a token sale. The liquid cash on hand for ABC DAO is exhausted and they need funds to pay developers and marketers for their next big milestone, which all believe will raise the value of the project and token. ABC DAO has reserve tokens, but if it sells them as liquid ABC tokens, the market value of ABC token is likely to drop as buyers quickly lock in profits — knowing that other buyers will also be selling their tokens quickly and creating a race condition where prices decrease. (Illustrated in Figure 2.)
Instead, ABC DAO decides to issue T-Bonds for locked amount of ABC tokens with maturity rates of six months to ensure that their milestones will be completed and have a chance to increase the market value of the token before they are sold off. ABC DAO can eliminate the early sell-off of tokens and experiences a price increase when the new developments are released three months later. Once the T-Bonds mature at six months, there is also likely to be some sell-off of tokens, but it happens from a higher base than if it had occurred before the milestone delivery. The outcome of the milestone is no longer an unknown performance risk and ABC token’s positive price momentum is likely to have an additional halo effect on the ongoing price.
The Telos Use Case
The initial use of T-Bonds on Telos will be to enable the listing of TLOS tokens on several new exchanges of greater prominence than those TLOS is currently listed on, and to expand liquidity pools for these exchanges to resolve the illiquidity situation which is seen by many to be responsible for the persistent languishing of the TLOS price despite a regular stream of good news about usage, dapp adoption, and technical advancements.
As a blockchain governed by its users, Telos must first enable these sales and allocate funds to the initiative using a Telos Amend proposal before T-Bonds can be funded. This voting requires a 29-day (5 million blocks) voting period. Provided the proposal is approved, TLOS tokens will be used from the ‘tlosrecovery’ account which holds TLOS tokens that are currently allocated only to be added to the Telos exchange reserve fund (‘exrsrv.tf’) at some point in the future. Part of the proposal limits the use of these sales to funding new exchange listings and liquidity pool participation.
The milestone Telos is trying to reach is to be listed on more and better centralized exchanges, decentralized exchanges, and DeFi automated market makers (AMMs) such as Uniswap with ample liquidity. By using T-Bonds the Telos community can sell some of these TLOS reserves in a locked form with the intent of reaching these milestones before the tokens become liquid.
Advantages of T-Bonds to Buyers
T-Bond buyers receive a number of advantages. The first and most obvious is the price discount to face value for anyone who holds to maturity. Some buyers consider themselves long term holders and actually like the discipline of tokens that are not liquid and easily traded. Of course, T-Bonds will have a secondary market, which provides the advantage of giving liquidity to anyone who ultimately does decide to sell prior to maturity. Another advantage is that there is no counterparty risk that the issuer would renege on providing tokens at maturity, since they are already locked in the T-Bond.
The traditional bond market is made up of many kinds of investors with different time horizons — from those who intend to hold for 30 years, to those that may hold just a few weeks, days or hours. Bonds allow hedging against uncertainty and speculation on future interest rates. This could also be true of T-Bonds, as the Telos case illustrates. There’s reason to believe that T-Bonds could become a strong DeFi market in their own right.
The Telos Case
The Telos use case for T-Bonds helps easily illustrate the value of T-Bonds for hedging against or speculating on relative interest rates because Telos also has a built-in alternative interest-bearing option: the REX resource exchange.
Telos users may stake their TLOS to REX in order to earn rewards. These rewards come from the rental of Telos CPU and NET resources, some fees on RAM and TLOS distributed to users from the exchange reserve fund, which constitutes most of the rewards. Based on tokens allocated by the Telos Economic Development Plan (TEDP) and TEDP2, funds flow into REX staking rewards each month and are divided pro rata by all accounts staking. As a result, the REX rewards are quite high — around 15% APR at this writing and scheduled to increase as the TEDP2 increases the amount going to REX instead of block producer rewards, the Telos Foundation stipend and other uses. However, REX rewards will always be variable both because as more TLOS are staked, the rewards are shared by more stakers, and because the Telos voters have the power to revise the token allocations or even eliminate them any time in the future based on the outcome of a Telos Amend proposal.
Example: Consider a TLOS buyer, Arun, who wants to buy TLOS tokens and stake them to REX for rewards. At the current price of about 2 cents per TLOS, Arun could buy 83,334 TLOS for $1,666.67 and stake them to REX with the intent of having 100,000 TLOS at the end of a year if the REX yield is a consistent 20% APR over that period. If REX rewards are actually, higher, Arun could do even better, but if they are lower, then he would have less at the end of the year. For example, if REX only averages 16% APR then he would have 96,667 TLOS.
Betty also wants to end up with 100,000 TLOS in one year. Instead of liquid tokens, Betty buys a T-Bond NFT with a face value of 100,000 TLOS and a maturity date of one year from the purchase date. The T-Bond has a cost of $1,666.67 based on 2 cents per TLOS, giving an effective discount of 16.67% (equivalent to a 20% APR).
Betty knows that her T-Bond will yield exactly the 100,000 TLOS face value on its maturity date because these TLOS tokens are locked up by the T-Bond. She cannot receive any more or less if the Telos REX yield changes over that period of time. Betty also does not get the benefit of being able to vote with her T-Bond as Arun has with his TLOS staked to REX.
T-Bond yield compared to static REX rewards
Now consider what happens if Betty wants to sell her T-Bond after just six months instead of holding to the maturity date. She can list it for sale on a secondary market, like the AreaX NFT Market that is expected to be live for trading all Marble NFT-standard tokens (which include T-Bonds) by the Telos T-Bond launch date.
Carlos is an investor who wants 100,000 TLOS in six months and has two alternatives: he could either buy liquid tokens and stake them to REX or purchase Betty’s T-Bond and hold it to maturity in six months. Assuming that the REX yield has been a steady 20% APR over the past six months and seems likely to continue the trend in the future, the present value of 100,000 TLOS six months in the future is essentially the same via either method except for the value of lost of voting rights over that period. Some value will be assigned to this by the market, and for these examples, 2.5% APR or around 0.2% per month will be used.
Arun’s tokens staked to REX at 20% APR for the past six months have earned about 1.53% of their value in rewards each month and are now worth 91,287 TLOS. Betty’s T-Bond had the same rate of appreciation as it neared maturity, but a small discount must be made for the lack of voting rights, if she were to sell today — perhaps 200 TLOS per month (the actual rate will be determined by the market.). Six months would discount the value of the NFT by 1,200 TLOS from its present value. Carlos and Betty could make a trade for 90,087 TLOS giving Betty an effective yield of ~17.6% APR for six months and Carlos an effective yield of ~23.2% APR if he holds it until the maturity date.
T-Bond yield compared to variable REX rewards
REX staking rewards, however, are certain to change over the course of a year because of the number of people staking and the number of tokens that the Telos voters decide to dedicate to rewards. To illustrate this, consider an extreme case where halfway to the maturity date of Betty’s T-Bond, the Telos voters decide to eliminate REX staking rewards. At this point, Arun’s staked tokens no longer earn any new rewards. The value of his tokens in another six months will be the same as they are currently. In other words, the present cost/value of owning 100,000 TLOS six months in the future is also 100,000 TLOS since there is a 0% APR on REX staking now.
Betty’s T-Bond six months in the future will be worth 100,000 TLOS. In the previous scenario, she couldn’t expect to sell her T-Bond for more than the 91,287 TLOS that Carlos could have instead staked to REX to receive 100,000 TLOS in that time. In fact, there was also a discount required because the T-Bond TLOS could not be voted. However, with no better alternative, the present value of Betty’s T-Bond is now 100,000 TLOS minus the voting discount. To Carlos a reasonable market value for Betty’s T-Bond is 98,800 TLOS because it is still a discount that pays him an effective interest rate of ~2.5% APR for the six months he holds the T-Bond to its maturity date.
In this scenario, Betty has decided to sell the T-Bond for a market value of 98,800 TLOS which yields her an effective return of ~37% APR over six months. Carlos buys the T-Bond because voting is not important to him and he can gain a certain 2.5% APR for six months over what it would cost to buy liquid TLOS at their present value and 0% rewards from REX. Both are making sound financial decisions given the present conditions.
T-Bond values contribute value to a secondary market because of the fluctuations between their fixed rate of return and the fluctuating rates of return for competitive options. When there is another alternative with a steady rate of return, the T-Bond will gain market value at a predictable rate as it nears its maturity date. Any discount a subsequent buyer would pay could be easily calculated by comparing it to the present value of the best-paying alternative of equal risk, such as REX staking rewards.
When the alternative is variable, however, the current market value of a T-Bond rises if the alternative yield goes down or falls if the alternative method’s yield increases. The current market value of a T-Bond that pays an effective rate of 20% APR will lose value if REX rewards rise to 25%.
This ability for T-Bond market values to change based on the yield of alternatives such as REX make it possible to make speculative gains (or losses) on the T-Bonds as more potentially profitable financial tools. Anyone buying a T-Bond is essentially betting that the REX rewards will drop to a lower value, or else they would be wiser to hold those TLOS in REX and earn a higher yield. As conditions change, other traders may have different opinions about REX staking rewards relative to T-Bonds. This can drive a healthy secondary market.
The T-Bond Secondary Market
The T-Bond secondary market provides an additional level of financial tools for traders and investors. Where traditional crypto exchanges only trade on the current price action of different tokens relative to each other, T-Bond NFTs allow future rates of return to be traded as well, either against the same token or different tokens. As more projects issue tokens using the T-Bond NFT open source contracts on Telos, these NFTs can even trade directly against one another for more complex DeFi transactions. Future developments are expected to include maturity conditions other than a simple date, allowing T-Bonds NFTs to unlock their fungible tokens when a certain condition is reported by an on-chain oracle. This could be another token reaching a specific price or a milestone delivery being accepted by a project’s users. It’s also expected that future derivative projects will themselves be bundles of T-Bond NFTs.
T-Bonds are built on the Marble NFT standard which includes the ability to lock up fungible tokens on Telos until a maturity condition occurs. Any NFT marketplace that supports Marble NFTs can be used to trade T-Bonds on the secondary market. The AreaX NFT Market built by the block producer Persian Telos will be the first such marketplace but more are expected as T-Bonds become more accepted. The AreaX NFT Market allows non-custodial escrow of NFTs where owners list them for sale and purchasers make offers, temporarily locking tokens as an offer that can be withdrawn by the buyer at any time. If the NFT seller accepts an open offer, the purchased NFT is transferred directly to the buyer in a swap for the offered fee. This ensures safety for all buyer and seller assets with an easy trading experience.
About the author: Douglas Horn is the Telos architect and whitepaper author and a Telos core developer. He is the founder of GoodBlock, a Telos block producer and blockchain development company currently building the dStor decentralized data storage system.