[Covenant Finance] LTIPP Application - FINAL

SECTION 1: APPLICANT INFORMATION

Applicant Name: Anthony Fahden

Project Name: Covenant Finance

Project Description: Covenant enables borrowing and lending against any tokenized asset through liquid, tradeable debt markets. Covenant is built on a new DeFi primitive called tradeable perpetual debt, which blends the flexibility of peer-to-peer lending with the deep liquidity of peer-to-pool lending.

Team Members and Roles:

  • Alan Hampton (Protocol Engineer/CEO)
  • Mark Cinali (Engineering/Product)
  • Tony Fahden (Engineering/Growth)

Project Links:

Contact Information

Point of Contact: Tony Fahden

Point of Contact’s TG handle: @fahdena

Twitter: @CovenantFi

Email: t@tazz.finance

Do you acknowledge that your team will be subject to a KYC requirement?: Yes

SECTION 2a: Team and Product Information

Covenant markets allow users to trade debt backed by any tokenized asset. We have been building the Covenant (fka Tazz) protocol since mid-2022. We graduated from AllianceDAO’s ALL11 cohort in Oct 2023, completed our first audit with 0xMacro in Feb 2024, and have been testing our live beta app on Arbitrum mainnet since August 2023. We also recently deployed our latest (audited) contracts on Arbitrum mainnet in early March 2024, and plan to integrate them into our new test app in late March 2024.

Covenant is making final preparations to launch a set of permissionless debt markets on Arbitrum. We are also preparing for a launch in partnership with one of the largest DeFi protocols (top 100 by market cap) in March 2024 to enable the DAO to borrow against its governance token, with non-mark-to-market liquidations. In the coming months, we plan to expand this use case to a number of major protocols on Arbitrum.

Our team consists of three engineers who met while working at Palantir:

  • Alan (CEO) - PhD in AI from Caltech, previously worked on structured products at McKinsey, and started a fully licensed bank.
  • Mark (product/engineering) - studied Applied Math, Economics at Brown, and was previously a product and engineering lead building AI agents.
  • Tony (growth/engineering) - Dartmouth alumnus, 2X Olympic rower, and long-time on-chain degen.

Covenant consists of the following audience segments:

  • Borrowers - individuals looking to borrow against high-yield and/or longer-tail assets + protocols looking to borrow against their treasuries, with flexible liquidation parameters.
  • Liquidity Providers - active Uniswap V3 market makers + passive price takers (lenders) looking to buy and hold debt tokens.
  • Arbitrageurs/Lenders - entities looking to take advantage of liquidation opportunities and market mispricings.

Covenant enables a market for trading debt backed by tokenized assets. Arbitrum incentives would help us solve the cold-start problem of attracting enough initial liquidity to enable stable, sustainable market dynamics. Specifically, incentives would help us create large enough Uniswap V3 pools to minimize friction (and price impact) for initial borrowers and lenders to trade debt tokens, and would help us offset the risk of users providing liquidity to a new protocol with a novel design. Once off the ground, our high native yields + native incentives + unique offerings will help us sustain and attract new liquidity as we expand borrower use cases to other asset classes on Arbitrum.

What novelty or innovation does your product bring to Arbitrum?

Tradeable debt markets that accept any type of collateral opens up huge, exciting opportunities for the Arbitrum ecosystem. Traders can speculate on a new asset class, borrowers can leverage a wider range of collaterals, and passive lenders can access more efficient, wider ranging sources of yield for the first time.

Liquid, tradeable debt markets:

  • Covenant enables liquid, tradeable debt markets. Unlike other lending protocols, debt has a market price, and the price of the debt sets the interest rate. TradFi tradeable debt markets are massive ($119T globally), but have no corollary in crypto yet. Unlike TradFi tradeable debt, which is often illiquid and traded OTC, Covenant‚Äôs tradeable debt is perpetual, which allows more concentrated liquidity and more liquid markets (similar to perpetual futures).

Borrowing/lending against any tokenized asset:

  • Covenant can mint debt backed by any on-chain asset, and is uniquely suited to support borrow/lend against longer-tail assets. This is because, rather than relying on a predetermined risk curve, the market determines the price of debt tokens and the debt interest rate. Since Covenant debt markets are liquid by default, this expands the possibilities to borrow/lend against new asset classes (even illiquid ones) without compromising liquidity.

Unique credit structuring & use cases:

  • Covenant‚Äôs unique debt pricing mechanism enables it to support novel credit structures & use cases, such as enabling borrow/lend against collateral that is not subject to mark-to-market liquidations & even undercollateralized borrow/lend use cases.

Improved rate efficiency:

  • Borrow-lend spreads on other lending platforms are huge, particularly for longer-tail assets. On Covenant, regardless of how illiquid or long-tail the collateral is, the difference between the borrow-lend rate is just the DEX pool fee + small protocol fee redirected to LPs.

Is your project composable with other projects on Arbitrum? If so, please explain:

Yes. Covenant is built on top of Uniswap V3, so composability is a core concept. Covenant debt is a liquid, ERC-20 traded by default on Uniswap, but can be swapped elsewhere, potentially used as collateral, and has a market price by default (via Uniswap V3 oracle). Additionally, Covenant can accept any type of on-chain collateral, and is thus maximally composable with respect to what it can underwrite. Our initial markets will incorporate Pendle PT tokens, Lido wstETH, Origin oETH, and ARB as collaterals. In the future, we also plan to accept NFTs as collateral.

Do you have any comparable protocols within the Arbitrum ecosystem or other blockchains?

Isolated lending markets that can support borrow/lend against liquid, long-tail assets: Silo Finance & Fraxlend.

Protocols enabling speculation on rates: Pendle.

Protocols with greater rate efficiency: Morpho.

How do you measure and think about retention internally? (metrics, target KPIs)

General metrics:

Daily Active Users: A time series metric representing the daily count of unique addresses interacting with the protocol’s contracts.

Daily Transaction Count: A time series metric representing the daily number of transactions interacting with the protocol’s contracts.

Covenant-specific:

For each market:

Total locked collateral: A daily time series expressed in USD of collateral locked.

Total Debt Issued: A daily time series measured in USD for the value of debt tokens minted.

Uniswap Pool TVL: A daily time series, presented in USD for all assets in Uniswap pools.

Uniswap Trading Volume: A daily time series, presented in USD, of Uniswap swap volume.

List of Borrowers: A list of current and past participants who have borrowed from the protocol during the incentivized period. The list should include borrower addresses, their current borrowings in USD, time-weighted borrowings in USD, and the duration of their borrowing participation.

Default/Liquidations: Minimize the rate of defaults to ensure platform trust and financial health.

Do you agree to remove team-controlled wallets from all milestone metrics AND exclude team-controlled wallets from any incentives included in your plan: Yes

Did you utilize a grants consultant or other third party not named as a grantee to draft this proposal? If so, please disclose the details of that arrangement here, including conflicts of interest (Note: this does NOT disqualify an applicant): NO

SECTION 2b: PROTOCOL DETAILS

Is the protocol native to Arbitrum?:

Yes, we have been testing our beta application on Arbitrum since August 2023, in large part due to low transaction costs, which are essential to our trading platform. We also plan to focus our expansion efforts on Arbitrum moving forward, in large part because of the robust DeFi ecosystem that exists there.

On what other networks is the protocol deployed?:

Optimism

What date did you deploy on Arbitrum mainnet?: [Date + transaction ID. If not yet live on mainnet, explain why.]

Aug-29-2023, txn hash: 0xba48fae0f45062460e840dd87db01283abea302e12f72d3782a16f7c8272ac71

Do you have a native token?: [Yes/No/Planned, link tokenomics docs]

No

Past Incentivization: What liquidity mining/incentive programs, if any, have you previously run?

As our protocol was pre-audit and in beta testing, we have not run liquidity mining or incentives to date. In fact, we have actively discouraged liquidity via caps and other mechanisms while we were unaudited.

Please share results and dashboards, as applicable?

N/A

Current Incentivization: How are you currently incentivizing your protocol?

Uni v3 LP incentives:

  • Although this is not currently live, we have audited contracts (see attached 0xMacro audit report) that we plan to deploy this week that will enable us to charge protocol fees to borrowers and redirect them to liquidity providers who stake their Uniswap V3 LP positions (to natively incentivize market making for our system).

NFT Rewards Boosts:

  • We recently started distributing NFTs that boost Covenant rewards (e.g. by 50%). This has been used to incentivize testing during our beta, but we also see this as a potential mechanism to help incentivize participation in new pools.

Covenant Rewards:

  • Although this is not yet live, we are finalizing a rewards program (a points system) to reward users for lending and LPing, very similar to how we are thinking about our Arbitrum grant proposal.

We see these mechanisms as a way to sustainably incentivize liquidity in our debt markets (post-launch), especially as new markets find their long-term equilibria.

Have you received a grant from the DAO, Foundation, or any Arbitrum ecosystem related program?

No

Protocol Performance:

As our product was pre-audit until February 26th, and out of an abundance of caution, we have discouraged users from transacting with large amounts on our beta deployments. Usage has been focused on gathering user and product feedback, which we have incorporated into our newly designed test app.

Protocol Roadmap: [Describe relevant roadmap details for your protocol or relevant products to your grant application. Include tangible milestones over the next 12 months.]

  • Q1 ‚Äė24:
    • Launch ‚Äúprotocol debt‚ÄĚ market with major DeFi protocol to enable tradeable debt backed by protocol treasury
  • Q2 ‚Äė24:
    • Launch protocol debt markets in partnership with 1-3 additional protocols, with a focus on Arbitrum protocols
    • Launch 3-4 permissionless debt markets backed by high-yield, longer-tail assets
    • Launch debt market to borrow against Covenant debt tokens, to provide leverage & easier access to indexed exposure for LPs
  • Q3 ‚Äė24:
    • Expand to 5-10 total protocol debt markets
    • Upgrade protocol to enable borrow/lend against NFTs
      • Expand high-yield, longer-tail permissionless borrow markets to include ERC-721 LP tokens
      • Launch market to borrow/lend against tokenized RWA
  • Q4 ‚Äė24:
    • Expand protocol debt markets to 10-15 total
    • Launch protocol debt partnership with major L1

Audit History & Security Vendors:

Covenant has recently undergone an audit with 0xMacro, published on February 26th, 2024: Covenant A-1 | Macro Audits | The 0xMacro Library

Security Incidents: N/A

SECTION 3: GRANT INFORMATION

Requested Grant Size: 75,000 ARB

Justification for the size of the grant 32:

Target Goals

  • Target TVL: Aim to bootstrap approximately $10M in locked borrower collateral, comprised of high-yield, longer-tail assets.
  • Target Debt Minted: $7M
  • Goal DEX Pool Liquidity: Establish $1M in liquidity to foster robust trading environments.

Expected Impact and Calculations

  • Assuming a $2 ARB price, 12,000 ARB over an average of 4 weeks on aggregate DEX Pool Liquidity target of $1M yields an annualized APR of ~31.4% USD to bootstrap new Uniswap V3 markets:
    • 12k ARB x $2 x 52 / 4 / $1M = 31.4%
  • Assuming a $2 ARB price, 63,000 ARB over ~7 weeks on the target $7M lender interest for high-yield, longer-tail assets yields an annualized APR of ~13.3% USD to bootstrap market for lenders:
    • 63k ARB x $2 x 52 / 7 / $7M = 13.3%

Grant Matching:

We plan to administer co-incentives in the form of points, the system for which we are finalizing.

Grant Breakdown:

Note: We intend to reward LPs and debt traders. We are not rewarding borrowers because there is higher natural demand for borrowing, and it also serves as an anti-sybil measure. Depending on the debt market, a borrower, with incentives, could loop their borrowing, capturing an inordinate share of rewards.

Following amounts are denominated in $ARB.

Weeks 1-2: Launch market 1 (Pendle LRT PT tokens as collateral vs ETH money, mark-to-market liquidations)

  • LP Incentives: 2k (1k per week)
  • Lender Incentives: 6k (3k per week)

Week 3-4: Launch market 2 (wstETH and oETH collaterals vs USDC money, non-mark-to-market liquidations) + grow market 1

  • LP Incentives: 4k (2k per week)
  • Lender Incentives: 12k (6k per week)

Week 5-6: Launch market 3 (ARB collateral vs USDC money, non-mark-to-market liquidations) + grow markets 1 & 2

  • LP Incentives: 4k (2k per week)
  • Lender Incentives: 18k (9k per week)

Week 7: Grow markets 1 & 2

  • LP Incentives: 1k (1k per week)
  • Lender Incentives: 9k (9k per week)

Week 8: Grow markets 1 & 2

  • LP Incentives: 1k (1k per week)
  • Lender Incentives: 6k (6k per week)

Week 9: Grow markets 1 & 2

  • Lender incentives: 6k (6k per week)

Weeks 10-11: Grow market 3

  • Lender Incentives: 6k (3k per week)

Funding Address:

0x5de2fdf135a4F50f38A54f594c39632f40E38951

Funding Address Characteristics:

‚ÖĒ Gnosis Safe multisig.

Treasury Address:

N/A

Contract Address:

Our LP staking contract has been audited but not yet deployed for our Arbitrum app instance. It is in the audit report linked previously in the proposal: Covenant A-1 | Macro Audits | The 0xMacro Library

SECTION 4: GRANT OBJECTIVES, EXECUTION AND MILESTONES

Objectives:

Our primary aim is to facilitate the launch of initial Covenant Finance debt markets on Arbitrum, enabling new trading opportunities against non-traditional assets. This will not only diversify the asset pool but also enhance the overall liquidity and functionality of the Arbitrum ecosystem.

Execution Strategy:

Incentives will be distributed via our LP staking contracts, which we will simultaneously use to distribute protocol-native fees to market makers. This requires users to stake their LP positions into our LP staking contract & periodically claim rewards (after the conclusion of each epoch). ARB rewards will be distributed across LP staking contracts in proportion to pool liquidity.

Lender incentives will be distributed through their own staking contract, which we are finalizing. The rewards will be distributed pro-rata to the amount and time staked.

Incentives will be distributed to liquidity providers across different Covenant debt markets to accelerate liquidity bootstrapping:

  • Incentivize market makers for high-yield, longer-tail asset markets to accelerate liquidity bootstrapping
  • Incentivize lenders for high-yield, longer-tail asset markets to build up TVL

The Covenant team will allocate 100% of ARB rewards towards incentivizing liquidity for its new pools, and will monitor on-chain contracts to ensure funds are delivered to the correct parties.

What mechanisms within the incentive design will you implement to incentivize ‚Äústickiness‚ÄĚ whether it be users, liquidity or some other targeted metric?

ARB tokens are needed to bootstrap initial market liquidity. Once incentives have been exhausted, and there are enough users to support functioning market dynamics, users will remain because:

  • Market makers are incentivized to provide liquidity via protocol-native fee rewards. These will continue even after the ARB incentives expire, and although the pool sizes may shrink, these rewards help guarantee sufficient liquidity for each market.
  • Borrowers can unlock novel debt arrangements by leveraging new assets (e.g. high-yield, longer-tail token) and existing assets in new ways (e.g. borrowing against protocol treasuries), with flexible liquidation types, including non-mark-to-market liquidations. Therefore, borrowers who use our platform should have high retention, even after incentives expire, given the stickiness of the liquidity we built up and the lack of alternative ways to get leverage on their assets.
  • Lenders should enjoy higher yields on Covenant given the unique exposure it gives them to novel borrow/lend use cases. This means that even when ARB incentives expire for lenders, most will be incentivized to hold onto their debt token positions because rates will naturally increase (to offset the lost ARB incentives). In addition, the aggregated liquidity lowers lenders‚Äô risks since they can trade in/out of their positions at any time.

Specify the KPIs that will be used to measure success in achieving the grant objectives and designate a source of truth for governance to use to verify accuracy.

  1. Daily Active Users:
  • Source of Truth: Covenant contracts and Uniswap, to be presented via Dune.
  • Justification: Daily active users indicate user growth and breadth of reach.
  1. Daily Transaction Count:
  • Source of Truth: Covenant contracts and Uniswap, to be presented via Dune.
  • Justification: Daily transaction count measures adoption and popularity. A high daily transaction count will be a primary indicator for the popularity of trading debt, a primary use case of Covenant.
  1. Total Locked Collateral:
  • Source of Truth: Covenant contracts (holding amount verifiable on Arbiscan)
  • Justification: Locked collateral serves as a primary indicator of the protocol‚Äôs adoption and liquidity. An increase in locked collateral signifies enhanced trust and understanding of Covenant protocol and its mechanism design.
  1. Total Debt Issued:
  • Source of Truth: Covenant contracts, to be presented via Dune
  • Justification: Total debt issued serves as an indicator for borrower adoption. An increase in total debt issued signifies borrower demand and adoption of Covenant‚Äôs mechanism, as well as corresponding LP demand.
  1. Uniswap Pool TVL:
  • Source of Truth: Uniswap, to be presented via Dune
  • Justification: Uniswap Pool TVL indicates the liquidity available for a respective Covenant market. An increase in pool TVL indicates a more liquid debt market and the ability to accommodate greater borrowing and trading.
  1. Uniswap Trading Volume:
  • Source of Truth: Uniswap, to be presented via Dune
  • Justification: Trading volume indicates user adoption around borrowing and debt trading. An increase in volume can signify both greater borrower demand, as well as users realizing and taking advantage of trading opportunities.
  1. List of Borrowers:
  • Source of Truth: Covenant contracts, to be presented via Dune
  • Justification: List of borrowers indicates important patterns in borrowing behavior, namely growth, distribution, duration, and stickiness.
  1. Default/Liquidations:
  • Source of Truth: Covenant contracts, to be presented via Dune
  • Justification: Liquidations indicate the health of Covenant‚Äôs markets. Seeing liquidations at a low level, and promptly performed when needed, indicates a healthy market and borrowers who understand the mechanism well enough to avoid them.

Grant Timeline and Milestones:

We would implement a phased, 12 week rollout. Facing a cold start problem with respect to liquidity, but also a novel mechanism design that requires a ramp-up in user understanding, we would ease into $ARB incentives for market makers, and cease distributions after the market has had time to reach an equilibrium in which there is enough liquidity and user activity to support unassisted market function.

Timeline:

  • Weeks 1-2: Initiate the incentive program with a deployment of 8k ARB. This phase focuses on rolling out a single market and enabling users to become familiar with the mechanism design.
  • Weeks 3-4: An additional 16k ARB will be deployed to facilitate growth of our first market and the launch of a second. We aim to have $2M in locked borrower collateral by the end of this period.
  • Week 5-6: 22k ARB deployment. With a strong cohort of seasoned users, we would aim to use this stage of incentives to launch a third market and continue growth in our first two. We anticipate Covenant‚Äôs mechanism will be well understood by users after this point. With all markets deployed and with users familiar with the mechanism and its trading opportunities, we hope to have $6M in TVL and $4M in debt minted.
  • Weeks 7-11: 29k ARB deployment. We view roughly the latter half of incentives as a growth driver, to be tapered off in the final weeks. On the final week, only the youngest market, market 3, would receive incentives.

How will receiving a grant enable you to foster growth or innovation within the Arbitrum ecosystem?

Tradeable, perpetual debt is a new financial primitive, so Arbitrum users will be interacting with an innovative, novel application in the strictest sense. Because Covenant makes it possible to collateralize any on-chain asset, particularly longer-tail assets, a wide set of capital has a new use case, which means more user activity on Arbitrum. It’s worth noting, in addition to maximizing the number of users on Arbitrum, our launch also attracts new capital to Arbitrum, as users with collateral unserved by incumbent lending protocols will have to bridge over.

Do you accept the funding of your grant streamed linearly for the duration of your grant proposal, and that the multisig holds the power to halt your stream? Yes

SECTION 5: Data and Reporting

OpenBlock Labs has developed a comprehensive data and reporting checklist for tracking essential metrics across participating protocols. Teams must adhere to the specifications outlined in the provided link here: Onboarding Checklist from OBL 27. Along with this list, please answer the following:

Is your team prepared to comply with OBL’s data requirements for the entire life of the program and three months following and then handoff to the Arbitrum DAO? Yes

Are there any special requests/considerations that should be considered? No

Does your team agree to provide bi-weekly program updates on the Arbitrum Forum thread that reference your OBL dashboard?

Yes. We plan to publish Dune dashboards with the required information but these have not been implemented yet, as we have been in beta testing and tracking user activity manually.

First Offense: *In the event that a project does not provide a bi-weekly update, they will be reminded by an involved party (council, advisor, or program manager). Upon this reminder, the project is given 72 hours to complete the requirement or their funding will be halted.

Second Offense: Discussion with an involved party (advisor, pm, council member) that will lead to understanding if funds should keep flowing or not.

Third Offense: Funding is halted permanently

Does your team agree to provide a final closeout report not later than two weeks from the ending date of your program? This report should include summaries of work completed, final cost structure, whether any funds were returned, and any lessons the grantee feels came out of this grant. Where applicable, be sure to include final estimates of acquisition costs of any users, developers, or assets onboarded to Arbitrum chains. (NOTE: No future grants from this program can be given until a closeout report is provided.): Yes

Does your team acknowledge that failure to comply with any of the above requests can result in the halting of the program’s funding stream?: Yes

3 Likes

Hello @CovenantFinance ,

Thank you for your application! Your advisor will be @JoJo.

Please join the LTIPP discord and ping your advisor in the general chat so they can create a new channel and start communicating with you.

Hi @cliffton.eth , can I ask for your help in marking this draft as Final? Discourse permissions are blocking me from doing so. Thank you.

Hey there I’ve amended the title post to reflect that this proposal is FINAL. All the best!

While concerns about execution capability and current adoption rates have been raised, the proposal’s unique product offering and integration capabilities with native debt tokens demonstrate potential for innovation. Despite falling short of certain criteria for grant approval, the project’s clear vision and reasonable grant size make it a promising candidate for future consideration. Overall, the proposal presents an intriguing opportunity for the DAO to support the growth of Arbitrum’s DeFi ecosystem.