By Manny Rincon-Cruz @mrinconcruz & EeFi Richard @coinhun77349652
Special thanks to Manny, this is an updated version! All I want is to show you an accurate picture of Elastic Finance, and in this case, ButtonZero. My apologies if there are misleading or inaccurate info in the previous article.
As the latest revolutionary borrowing platform launched by Buttonwood Protocol, ButtonZero's core contract “Tranche” is also used by Ampleforth protocol as a building block of SPOT. Now let's acquaint ourselves with the latest achievement of graded bonds: ButtonZero.
What is ButtonZero?
It offers users the ability to borrow cash (USDT), using their cryptocurrency holdings as collateral (ETH, wBTC, AMPL), at a fixed rate with zero coupon payments, zero liquidations, and zero margin calls—hence why it is called simply “Zero”.
Let's get familiar with some concepts:
Over-collateralized borrowing: the amount borrowed is less than the collateral value. For example, ETH with a value of $100 is collateralized for a USDT loan of less than $100.
Zero-coupon bond: a bond that makes zero interest payments. Instead of paying interest, zero coupon bonds are sold at a discount to their face value at maturity. Upon maturity, bond holders can redeem these bonds at face value. For example, I sell, for $80 each, bonds that can be redeemed for $100 in one year. The face value is $100, the purchase price is $80, and the discount is $100-$80 = $20, which is 20% of the face value.
Zero margin calls: With collateralized borrowing, the value of a debtor’s collateral assets must remain a certain level above the value of their loans—this is often defined in terms of a percentage margin. E.g. a loan of $100 with %50 margin must have assets of at least $150 backing it. So when the value of their collateral falls below the margin, the debtor is “called” to add more collateral or repay their loans. This is the “margin call.” If the debtor fails to restore their margin, a liquidation will be triggered. Zero margin calls mean that there are no margin calls.
Zero liquidations: liquidation is when a creditor(or creditors) sell a debtor’s assets to repay the debt. For example, the companies that lent to Three Arrows are now selling the fund’s assets to cover those loans. On DeFi margin-lending platforms, like Aave and Compound, the smart contract liquidates assets through special auctions. Zero liquidation means that there are no liquidations.
Tranches: each token is “cut up” into three different tranches in the way of low risk + medium risk + high risk, namely A-Tranche (like a low risk bond), B-Tranche (like a medium risk bond), Z-Tranche (like high risk equity).
When the borrower of ButtonZero deposits collateral, corresponding A-Tranche, B-Tranche and Z-tranche will be created through the Tranche smart contract and returned to the borrower.
The borrower obtains loans by treating A-Tranche and B-Tranche like zero-coupon bonds, and selling them at a discount for USDT on ButtonZero or other trading platforms. A-Tranche and B-Tranches both have face values of $1, so they are sold with prices between $0 to $1.
The borrower retains their Z-Tranches, which represent the upside of their collateral.
To repay the loan early and unlock their collateral, a borrower could re-purchase A-tranches and B-tranches, which along with their Z-Tranches can be redeemed for the collateral.
A creditor on Button Zero “lends” by buying A-Tranches and B-Tranches, and then redeeming them at maturity.
“Double” AMPL, i.e. Z-tranche with double exposure
At present, the default ratio of tranches is A-Tranche: B-Tranche: Z-Tranche = 2:3:5, which means that if 1000 AMPLs are deposited as collateral, the system will return:
● 200 A-Tranches (1000 * 0.2)
● 300 B-Tranches (1000 * 0.3)
● 500 Z-Tranches (1000 * 0.5)
With the fluctuations of AMPL price, tranches’ supply change as follows:
When the price of AMPL rises, the number of A/B/Z-Tranche tokens will not change, the value of each A/B-Tranche tokens will not change, while the value of each Z-Tranche tokens will increase.
When the AMPL price drops slightly, the number of A/B/Z-Tranche tokens will not change, the value of each A/B-Tranche tokens will not change, while the value of each Z-Tranche tokens will decrease.
When the price of AMPL falls by 90%, the number of A/B/Z-Tranche tokens will not change, the value of each A-Tranche tokens will remain at 50%, there will still be the same number of B-Tranche tokens and Z-Tranche tokens, but they’d be worth $0.00.
Z-Tranches always bear the biggest changes of token supply. Since Z-Tranches account for 50% of AMPL but bear the biggest change of token supply, Z-Tranches can be regarded as a double leverage of AMPL. When the market price of AMPL falls by 50%, the number of Z-Tranches will return to zero. When the market price of AMPL rises by 50%, the number of Z-Tranches will double. The above logic is not limited to AMPL. It also applies to tranches synthesized by wBTC and ETH. The market price of wBTC and ETH will also affect the number of tranches synthesized by them.
A borrowing platform in the era of Web 3.0
There is one sentence in the Button Zero White Paper that impressed me: "In its natural, uncorrupted form, Web 3 is addresses and tokens." It implies that the core of Web 3 lies in digital addresses and tokens—not accounts. As far as I am concerned, Web 3.0 is readable, writable and self-owned, because tokens themselves are owned. In contrast, in traditional finance we have accounts that correspond to individuals, but these accounts are changed and managed by third parties.
Button Zero is a borrowing platform in the era of Web 3.0 because it doesn’t have “accounts”, unlike today’s popular DeFi margin-borrowing platforms. Instead it replaces them with something called “double-token debt.” Let’s dive into what this means.
In AAVE, a debtor borrows against the value of his collateralized assets. For instance, a debtor can deposit ETH with a value of $100, and receive a loan in USDT with a value of $40. The actual process is as follows—he first obtains 1 aETH by depositing 1 ETH. He then locks that aETH collateral and receives in return an idiosyncratic, non-fungible token that represents his specific collateral and debt position. Another user might also deposit 1 ETH to borrow, and he would receive another idiosyncratic borrowing position token. As far as the AAVE protocol is concerned, these are distinct users—it has to track each of their individual loans and collateral to make sure that they are within the appropriate margins.
This is called Single-token Debt, because while the lenders receive fungible tokens representing their loans—the a-tokens—the debtors receive non-fungible tokens which represent “accounts” of individual borrowers. It is a straightforward structure because it parallels how a lot of traditional lending is done. But there are some issues.
The biggest one is that this system relies on margin calls and liquidation to minimize debt defaults. The value of the collateral is calculated according to current market prices. So if the market price is volatile, margin calls and liquidations will be triggered. This makes it unsuitable for long-term borrowing—after all, who can guarantee that the market will not suffer from volatility within the year?
In contrast, ButtonZero's Double-token Debt structure divides the collateral into different tranches—Z-tranches are kept by debtors, the other tranches are sold to creditors. This means that the protocol does not track collateral and loan values by individual debtors, and thus cannot use margin calls or liquidations.
Creditors bear more risk in this system—similar to how a bank carries some risk when it offers a mortgage. So they will likely ask for higher interest than they do on Aave or Compound. On the other hand, this is debt that can be used for longer periods of time without risk of margin calls or liquidations—so debtors might be willing to pay those higher rates for peace of mind.
Interestingly, both the borrower and the lender can freely sell and buy their tranches in the secondary market, facilitating the reallocation of debt to new investors. Because debtors also have fungible tokens—their Z-tranches—there can be a liquid secondary market in a way not possible with Aave or Compound.
What’s next?
Due to the limited length of the article, the instructions and different borrowing strategies of ButtonZero are not covered. Supplements will be made once its documents and products have been further improved.
More about ButtonZero: https://docs.prl.one/buttonwood/learn/buttonzero
More about ButtonZero's products: https://app.zero.button.finance/