Author: Kirill Naumov, HASH CIB Research Analyst

Original Title: 《Why We Invested in Solv Protocol》

Compiled by: Hu Tao, Chain Catcher

The influx of talent and capital into the cryptocurrency space has led to a boom in blockchain-related innovations. Many projects have raised millions of dollars to expand their businesses and promote their services. Despite the push for decentralization in the financial sector, most venture capital deals are done on paper. Typically, developers and investors sign a Simple Agreement for Future Tokens (SAFT), which outlines the terms for the allocation of project tokens to investors after the Token Generation Event (TGE). SAFTs often involve vesting schedules and other unlocking details.

With the ban on ICOs, the process of raising funds for cryptocurrency startups has become overly complex, exclusive, and centralized. Currently, projects lack effective fundraising mechanisms before public offerings. In addition to legal and regulatory challenges, developers and early investors must track their agreements, which are only recorded on paper. Furthermore, long lock-up periods and vesting schedules reduce the liquidity of such investments. Ultimately, this does not keep pace with advancements in the traditional fintech sector.

On the other hand, for established projects with predictable cash flows, fundraising options are often limited to concentrated sales to institutional investors at significant discounts, resulting in substantial dilution for token holders. Consequently, the funds raised by the project are lower, and the illiquid assets purchased by investors may be worthless by the time the lock-up period ends.

The growing popularity of Decentralized Autonomous Organizations (DAOs) further complicates fundraising activities. Once a startup becomes decentralized, it can no longer sign SAFTs or raise funds in traditional ways. Therefore, DAOs are centralized until all development is complete and the platform is stable. This delays decentralization and undermines the very purpose of creating a DAO. Looking ahead, it makes a lot of sense for DAOs to raise funds through crypto-native financial tools.

Project Overview

Solv Protocol aims to improve project fundraising through financial NFTs known as Vouchers. Vouchers utilize the fundamental principles of ERC-721 NFTs to record investment allocations, bond issuances, deposit receipts, and cover notes. However, Vouchers are built on the ERC-3525 token standard, allowing them to be freely split and merged. Solv Protocol has developed and released the ERC-3525 token standard, making it available for all future financial NFTs, unlocking countless possibilities for DeFi innovation.

ERC-3525 is a semi-fungible token standard that is fully compatible with ERC-721, as each ERC-3525 token can be represented as a unique ERC-721 entity with its own attributes. By adding a "unit" attribute, developers have managed to create semi-fungibility—distinct unique assets that can be split and merged at will. For certain applications, especially in gaming or finance, ERC-3525 is the perfect solution, as otherwise, achieving its goals would require creating countless ERC-20 contracts (for each individual property or asset) or proposing solutions to the illiquidity and indivisibility of ERC-721.

Solv Vouchers, based on the ERC-3525 token standard, bring liquidity to locked assets. For example, by selling a Vesting Voucher that promises to allocate future tokens, funds or investors effectively sell their stake in the project before it goes public.

Solv Protocol provides simple and customizable tools for startups and DAOs to raise funds. For instance, if Vouchers share the same underlying characteristics such as lock-up periods, vesting schedules, APY, etc., they can be freely split and merged.

Currently, projects like Perpetual Protocol, Unslashed Finance, Paragons, DODO, Highstreet, ColdStack, and ClearDAO are using Solv Protocol Vouchers. With a total value locked (TVL) of $69 million, Solv Protocol continues to launch innovative products and rapidly onboard projects.

Recently, Solv Protocol introduced Convertible Vouchers, which are convertible bonds in decentralized finance. This powerful NFT structure enables high-risk DeFi protocols to raise funds without dilution or liquidation risks, protecting investors from price volatility of project tokens. The design of the Convertible Voucher retains all the convenient elements of Solv Vouchers (splitting/combining, adjusting release patterns, and customizable settlement dates).

Additionally, it adds an acceptable trading range for the underlying tokens. If the token price falls below or rises above the trading range, holders of the Convertible Voucher will receive tokens as payment equivalent to the face value of the Voucher. This design can protect projects from excessive token dumping when early investors' allocations are unlocked.

Bright Future

The ERC-3525 token standard of Solv Protocol is a universal standard for financial NFTs, opening the door to numerous potential implementation cases, such as decentralized bonds for pool-based DeFi projects, structured products, and accounting systems.

DeFi Bonds

In traditional finance, sustainable businesses raise funds by issuing corporate debt instead of diluting equity. As decentralized finance matures, stable decentralized applications will explore opportunities for debt financing, which is currently unfeasible in the DeFi ecosystem.

The ERC-3525 semi-fungible tokens of Solv Protocol can serve as a registry of bond ownership and payment guarantees. For example, a project might lock a multiple of the debt value in team tokens as collateral for issuing its Vouchers, and if it misses scheduled interest payments or principal repayments, the lender will automatically receive the locked collateral. The terms of the bond will depend entirely on the project's growth stage, sustainability, and security. We estimate that, assuming DeFi project valuations remain stable, the DeFi bond market could reach hundreds of billions of dollars by 2024.

For instance, let’s explore the case of Yearn Finance. Almost all YFI supply has been generated, and the project cannot attract investment through token dilution. If Yearn developers want to expand, they will explore options for raising funds. As a late-stage mature project with sustainable cash flow, Yearn provides a perfect example of the potential application of Solv Vouchers in debt financing.

To implement Solv Vouchers, the Yearn community needs to:

1. Propose and vote in favor of a governance proposal that includes parameters for raising funds through Solv.
2. Establish a Solv pool to earn a certain percentage of protocol revenue and distribute income among Voucher holders. Solv coupon payments will be prioritized from protocol revenue, and once covered, the protocol will continue its token buybacks, similar to how bonds and stocks operate in traditional finance.
3. After a period of fundraising and coupon payments, the protocol will repay the principal.

During the bond term, YFI collateral from the Yearn treasury (currently holding about 4,000 YFI) will be locked to prevent coupon payment failures.

Solv Protocol's bonds will allow established projects with real and predictable cash flows to attract cheaper and more stable financing while improving the capital structure of the protocol and ultimately enhancing its own valuation.

Structured Products

We expect structured products in DeFi to rise in the coming years. The splitable NFT standard of Solv Protocol can serve as a platform for their development. Vouchers can be used to combine assets and configurations into lock-based structured products to offset volatility risks. Given the interest from qualified investors and hedge funds in gaining exposure to cryptocurrencies without volatility, there is significant market potential for creating structured products for crypto investments.

Some tools for complex structured products include ERC-20 tokens, long/short tokens, fixed income allocation tokens, and weighted index fund tokens. While projects like Ribbon Finance are already trying to disrupt this market, we see untapped potential in creating structured products that offset risks using Solv Protocol Vouchers.

For example, the Solv NFT standard would be a perfect platform for investment tools that protect DEX liquidity providers from impermanent loss. Combinations of out-of-the-money put and call options can be created to offset any losses liquidity providers may incur due to price fluctuations within a specific range. As the market matures and institutional clients allocate funds into AMM liquidity pools, the demand for decentralized hedging tools will increase. We expect the Solv Protocol's splitable NFT standard to prove very suitable for developing hedges through options and other applications of complex structured products.

Accounting Systems

Finally, the ERC-3525 standard can be used to develop accounting systems for complex pool-based DeFi projects. The ability to split and merge NFT tokens will allow for the creation of a liquid market for user pools. Many newer DeFi accounting systems cannot meet requirements using the original versions of ERC-20 or ERC-721. Instead, projects like Uniswap V3 develop internal accounting system solutions, spending time and money while taking on significant risks.

As more decentralized exchanges adopt concentrated liquidity and more complex DeFi protocols emerge, the ERC-20 standard will be replaced by standards that can store more information. Using a universal framework, the framework that Solv plans to build will be more efficient than developing internal accounting systems using the old ERC-721 standard (for both users and DeFi developers).

Final Thoughts

As a pioneer in the financial NFT market, Solv Protocol has a wealth of potential technical implementation solutions, and its strong strategic partnerships well illustrate the market leaders' thoughts on the project and its future.