(by Pablo | POKTscan)
The excessive emission of POKT tokens in the past is know by almost all community members. Focusing the supply reduction efforts only in future emission will not shield the desired effects as long as the emitted POKT is still circulation freely in the market. Also, the new emission control proposals are pushing stakers out of the system, creating new liquid POKT. This newly freed POKT can go to the markets, creating sell pressure or go to staking, creating more POKT.
We propose to create a third place to absorb this focus: a bond. This is not a new concept, and bonds exist in almost all economies, so its natural to think that Pocket can have its bonds as it controls it currency. Even some in our community arrived to similar solutions in the informal chats (from completely different places), proposing to “lock up” tokens until Pocket Network V1 for a set reward.
Implementing bonds will enable the DAO to control the POKT liquidity, create a risk-free interest rate and even reduce future emission of POKT.
We will only make a short description on what is a bond, how it is defined, its parts and characteristics. We refer the reader to [1] for further theory on the subject.
We close this thread with a small set of conclusions on why this is pertinent to the Pocket Network.
Let’s start by defining the word bond.
Bonds are debt securities. They can be issued by a public institution (a State, a regional government or a municipality) by a private institution (industrial, commercial or service company) or by a supranational institution (European Investment Bank, Andean Development Corporation, etc.) with the objective of obtaining funds directly from the financial markets, sometimes the objective is to be able to carry out new projects with these funds and other times it is to regulate the amount of money available in the market. Through its execution, the issuer commits to repay the principal together with interest.
Parameters to take into account in a bond
A bond is defined by the following parameters:
- Price: The value at which bonds are traded in the secondary market.
- Coupon rate: The percentage of principal paid on each coupon.
- Yield to maturity: The rate that makes the present value of the future cash flow coincide with the price of the bond, (it is the rate that the bond will effectively pay regardless of the coupon structure it has)
- Duration: is the average time that the investment lasts, weighted by the present value of each of the future cash flows. The duration allows us to obtain a first order approximation of the variation of the bond price, if we know the variation of the interest rate. If we aspire to give stability and predictability to the ecosystem, the investment in POKTs bonds should not have a duration of less than six months, this as a very minimum hypothesis.
- Convexity: Allows us to obtain a second order approximation of the variation of the bond price, given the variation of the interest rate price.
Some characteristics of the bonds.
These characteristics are very important in order to create an effective bond. Knowing and observing them is important to the DAO.
Depending on the currency in which they are issued
In our case we would be talking about bonds denominated in POKTs, this is so because the objective of issuing DAO bonds is to control the existence of POKTs if bonds denominated in dollars or any other type of currency, digital or fiat, were issued, we would not be achieving the objective of influencing the amount of POKTs offered
Depending on the risk
- Default risk: this depends on the reliability of the issuer, its history and its present situation, in our case, the default risk should be almost null, since the bonds are denominated in POKTs and the DAO is the only entity capable of issuing POKTs, it would not make sense to default. It would first increase minting and DAO allocation in order to be able to pay. Defaulting is not an option.
- Liquidity risk: beyond the form in which the POKT-nominated bonds are issued, the DAO should make every effort to ensure that they can be traded in secondary trading on any of the exchanges where the same POKTs are usually traded, thus avoiding large differences between the prices offered and the prices demanded.
- Interest rate risk: This risk is unavoidable, as the interest rate increases the present value of the bonds decreases and as the interest rate decreases the present value of the bonds increases, this is true for any type of bond and it is a risk impossible to mitigate.
- Inflation risk: this risk is associated with the change in the price of the relay, measured in POKTs. the influence of this component on the price of the bond will depend on the behavior of the DAO.
- Exchange rate risk: here we face the real weakness of POKT as the exchange rate of POKTs vs USD has been falling for more than a year now, even if we are making an attempt to turn the situation around, the rate to be paid should be attractive enough to tempt investors who have long seen their POKT stocks worth less and less USDs.
- Reinvestment risk: it is possible that the rate paid for the DAO in the future will be different from the rate paid in the present and the interim cash flows cannot be reinvested with the same return, this risk is intrinsic to any bond, and cannot be mitigated
Depending on the interest rate
It can be fixed or variable, both ways can achieve the objective of influencing the amount of POKTs in circulation, but we believe that the fixed rate may be more convincing, as it may be more attractive to those who want a less volatile income.
Depending on the coupon structure
- Zero coupon: These are bonds in which the principal and interest are paid in full at the end of the life of the contract. These bonds have no reinvestment risk.
- Bullet: These are bonds that pay the principal at the maturity of the contract but periodically pay interest, as they have some type of return before maturity they are usually more attractive to the investor.
- Redeemable: These are bonds in which principal and interest payments are periodically made on the debt balances
Preliminary general conclusions:
The bond or bonds to be issued in POKTs do not have the intention of raising funds to pay for DAO’s own expenses, that is a spurious issue, even if it is possible to pay for some kind of development that allows the growth of the ecosystem, the purpose should clearly not be financial, it should be limited to clearly establish an interest rate in POKTs and seek to approach the optimal amount of circulating POKTs, For this it is not fundamental the coupon structure or if we are talking about fixed or variable rate wines, although we have our preferences, but it is important that the duration is as long as the market admits and that the acceptance is as wide as possible, for this it is fundamental the diffusion of this investment instrument and that the interest rate is appetizing for the market, without exceeding, obviously, the expected return for staking in a node, with all its costs
The acceptance of bonds denominated in POKTs by the community, not only can be beneficial for the amount of POKTs that are withdrawn from the market at present, decreasing the supply of the same, and leaving us to consider the impact on the POKT quotation in USD, but also has consequences in the future. In the very rare case in which the debt in POKTs could not be renewed even in some percentage, the increase in the future money supply of POKTs would be less than the increase that would be obtained if the POKTs captured by the bonds had been allowed to stake in the nodes. Which can be achieved only by setting the interest rate of the bond below the expected yield for staking in the nodes.
References
[1] Dumrauf, G.L., 2014. Bonds, a Step by Step Analysis with Excel. Kindle Edition.