First Principles

The Buttonwood Foundation provides frameworks and tools for rebuilding DeFi from first principles

Complex systems can often be reduced to simple, formal sets of primitive arguments and operations. A classic example is the reduction of all mathematics to formal definitions of arithmetic containing the natural numbers, addition, and multiplication.

Similar frameworks exist for thinking about finance, and date back to the rise of more general-use computing in the 1990s. Longstanding societies of experts have produced various formal frameworks and functional languages for reducing all of finance into a small set of simple contracts and operations. DeFi takes this idea to the extreme, allowing instruments to be openly built and shared. With DeFi, an instrument can be composed merely by incorporating other instruments on the blockchain.

The Buttonwood Foundation's mission is to provide the framework and tools for accelerating this vision of the future. It has sponsored the creation of two simple protocols--Buttonwood Tranche and Button Tokens--which can be composed into a wide variety of instruments including yield splitters, long and short options, non-callable debt, fiat-free stablecoins, and many more.

Tranching in TradFi

Buttonwood is built upon the insight that there is a foundational operation missing from DeFi: tranching.

Tranching means splitting an asset into portions with different risk--that is, breaking an asset into its less risky portion and its more risky portion. Most financial products are actually just some form of tranching or compositions of tranching. For example:

  • Ownership of a business is broken down into debt and equity.

    • Debt-holders own a senior (safe) tranche of the business. They get paid out first, before equity holders. However, their upside is limited to the debt + some interest.

    • Equity-holders own a junior (risky) tranche of the business. They get paid out last, if the business is sold or goes public. In return for this extra risk, they are rewarded with all of the upside that the business generated.

  • Home mortgages help tranche a house between a lender and borrower (homeowner)

    • The lender has a senior claim to the house. If the borrower stops making payments, the lender can repossess the home and sell it to make back their losses. If the borrower sells the home with a balance on the mortgage, the lender gets paid back with the proceeds first.

    • The borrower (homeowner) has a junior claim to the house. If the house is sold for a profit, they get all of the profit after paying back the lender. If it is sold for a loss, they incur the loss.

Tranching in DeFi

Buttonwood has generalized the concept of tranching with its new DeFi primitive: Tranche. Using this primitive, we can rebuild a wide variety of financial products in a simple, robust, and composable way:

  • Bond markets and liquidation-free debt (see ButtonZero)

  • Convertibles (see HourGlass)

  • Fiat-free stablecoins (see Ampleforth's SPOT)

  • Options markets

  • And more :)

Where to next?

Detailed explanations about Tranche

Detailed explanations about ButtonZero

User guide for Mooncake

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