Loan-Directed Retroactive Grants

[nuttycom]

Loan-Directed Retroactive Grants

This post describes a system for retroactive, grant-based funding of public goods. This is an idea that i came up with while reading Kevin Owocki’s new book, “Onchain Capital Allocation Handbook” while on the plane out to the Z|ECC Summit. I’m posting this in my own capacity, and this proposal is not in any way associated with my role as a core team engineer at ECC.

Several proposals currently being considered by the Zcash community specify that in the future, some proportion of the Zcash block subsidy will be held in a “lockbox” to be later allocated to the funding of protocol, wallet, and other ecosystem development activities. If one of these proposals is selected, this part of the block subsidy will be held in a protocol-controlled balance, with a disbursement mechanism that is yet to be determined.

It is desirable that the funds available via this disbursement mechanism be allocated efficiently. In this proposal, I suggest that a system of private user lending, combined with retroactive funding, can aid in both funding efficiency and provide an opportunity for ordinary Zcash users to earn a return on their Zcash holdings.

The system proposed below (with the exception of the funds disbursement mechanism) can initially be implemented entirely off-chain. If it proves a workable approach in this environment, it may be possible to encode some of the rules of this system into the consensus mechanism or into a dapp of some sort at some point in the future.

Funding Body

This proposal assumes the existence of a funding body or committee that is collectively able to determine whether a retroactive grant should be awarded. The constituency of such a funding body, and the specific mechanism for disbursement is not specified and should be agreed upon separately.

Grant Proposals

An entity that is interested in obtaining a development grant first creates a grant proposal that describes the intended development effort and specifies the values of three variables:

1. The proportion of the grant that the grantee will attempt to raise as loans from Zcash holders.
2. The proportion of the grant that will be awarded as a completion bonus to the grantee.
3. The proportion of the grant that will be awarded as a return on the investment of the lenders from step 1.

Loan Commitments

After the grant proposal is published, the prospective grantee then solicits loans, denominated in ZEC, from individual and/or institutional Zcash holders to cover the value of proportion (1). This capital is intended to serve as operational funding for the entity while they’re working on the objectives described in the grant proposal. Loans can be structured either such that the funding is provided to the grantee all at once, or in a series of tranches with the completion of individual grant milestones.

The ability of a grantee to obtain such loans will be a strong indicator of community sentiment with respect to the likelihood of success, both in terms of the ability of the grantee to achieve the desired objective and in terms of the likelihood that the retroactive grant will ultimately be approved by the funding body.

Proposal Acceptance & Funding Reserve

In the event that the grantee is able to obtain the desired loan commitments (which might either be contractural, or made via an extension to the Zcash protocol) it may be desirable for the funding body to set aside funds for the future fulfillment of the retroactive grant, such that lenders can be confident of a future return in the case that the grant objectives are achieved. While not strictly necessary, such a bi-directional commitment between lenders and the funding body (potentially with the funding body defining specific measurable conditions of success) can help to ensure that the proposed grant is likely to be fulfilled if completed.

Grant Completion & Disbursement

Upon completion of the agreed upon scope of work, the funding body disburses the grant as follows:

• The completion bonus is disbursed to the grantee.
• The value of proportion (1), the loan amount, plus the value of proportion (3), the investors’ return on investment, is disbursed to the individual lenders in proportion to the amount of funds they previously loaned to the grantee.

Incentive Alignment

The proposed system has several advantages over either a purely retroactive or purely proactive system of grant funding. Under this system, both the grantee and the funding body obtain good information about the viability of the grant proposal from the willingness of lenders to commit funds to the effort; lenders can gain some assurance of repayment if the funding body accepts the proposal, and even in the case that a grantee fails to fully complete the proposed work, it may be possible for lenders to recoup some of their potential losses by hiring others to complete the work or even complete it themselves. For existing entities that have sufficient funds in reserve, it may be possible to self-fund the loan value of the grant, although in this circumstance the funding body does not gain information about the level of community support for the proposed work. There is likely to be competition among prospective grantees for who can provide the best returns to their investors, in terms of both the percentage of the overall grant and grant timelines, leading to better capital efficiency.

[earthrise]

This sounds great! I’d love to use my ZEC to bet on which projects I think will be successful and earn a return that way.

[Steelzec]

This is a great idea but need some clarifications, since it is a loan and not equity, how does it protect the loan provider in case of non delivery of project within stipulated time

[nuttycom]

The lender is taking on risk with the potential of earning a reward, the same as with any loan. However, the timeframe of the delivery is something that would likely be flexible; what changes if a project is delivered late is that the rate of return is worse. For example, say that I fund a project that offers a 15% return with a 6 month timeline, but the project ends up taking 9 months to deliver. I still end up getting my 15% return, but instead of my annualized rate of return being 30%, it’s 20% instead. And then, of course, the grantee takes a reputational hit; they will be less able to raise funds in the future.

If a grantee abandons the project entirely, then the lenders’ funds are more at risk, but they might be able to hire some other party to complete the work under the grant and in doing so recoup part of their losses, because it’s the lenders who are paid on completion by the funding body, not the original grantee.

If, on the other hand, the grantee is able to deliver in less time than originally planned, the effective rate of return is better than was promised to the lenders, and that’s really good for the grantee’s reputation.

Ultimately, TANSTAAFL (There Ain’t No Such Thing As A Free Lunch). There is no reward without risk. Reliable grantees can propose lower rates of return to their lenders, because lenders can be more confident that they’ll get their money back. It works as a proper market for talent.

[skyl]

There seem to be a lot of complicated decisions to work out. I’ll have to read it a few more times and think about it over days and weeks. Do you have an idea how this could be implemented in Free2Z in the simplest possible way as an MVP?

[nuttycom]

If there’s some disbursement mechanism for the lockbox, everything else is possible to do offchain with some strong trust assumptions and social consensus. Starting from small value grants, with some simple infrastructure, can possibly work.

[Steelzec]

I appreciate your intention, but i doubt the term ‘loan’. a loan is always backed by some kind of security incase of default. And there is a possiblity an influential dev can do short zec by defaming project. This can better work if they borrow btc or eth and payback in zec.

[nuttycom]

Unsecured loans are literally the most common sort: credit card loans are entirely unsecured. That doesn’t stop them from being loans. Same thing goes for payday lending. Of course, unsecured loans usually bear higher interest rates, because the frequency of default is high and so the honest borrowers pay in interest to cover the losses from those who default.

[Steelzec]

They lend for a month or so, it can be worked but small bag holders may not take part bcz of the risk factor… And if big influential bag holders pay for development they will bend the project towards their goals. We will end up like BTC development.

[pitmutt]

I think we would need a way to track who (by using a Free2z login, perhaps) has contributed to the fundraiser and how much, so the grantee and the lockbox owners would have a list of the funders that will need repayment.

[skyl]

I wonder if this implies another use case for taddresses …

[pitmutt]

I was thinking about that too, but viewing keys, and/or signed memos can probably take care of this on the shielded pool.

[nuttycom]

@skyl

I wonder if this implies another use case for taddresses …

This is actually a use for IVKs and authenticated reply-to addresses.

The grantee publishes an IVK for the account they plan to use to receive the loan. When the loan amounts are actually sent, they should use an authenticated reply-to address to identify the sender.

To fully build this out, here’s an interesting addendum: Suppose that the lenders’ wallets can create a partially signed transaction using a 2-of-2 FROST multisig spending key. When enough such transactions have been published to fund the requested loan amount, the lenders then complete the signatures and publish the transactions. There could be other approaches to using the multisig addresses here, potentially with a trusted third party holding one of the signing key fragments, but the 2-of-2 with two rounds of lender interaction, one to commit and one to finish signing, is the simplest thing that could possibly work.

There are more complex possibilities as well. Suppose that with extended memos, you can embed an entire partially signed transaction into another transaction’s memo. That would allow the broadcast of the partially signed transactions to be on-chain.

[skyl]

These are the exact kind of practical use cases I want to see built from the protocol, to the sdks, to the documentation, to the interfaces. 50% lockbox

[Milton]

Would the grantee be legally obligated to pay back the loans if they abandon the project?

[nuttycom]

That would depend upon whether the lender and the grantee chose to enter into such a contract. My hypothesis is that this kind of overhead would dramatically reduce participation and discourage small-scale lenders; also, if the lender doesn’t take on as much risk, I would expect that to dramatically reduce the rate of return they could demand.

This question is one of the reasons that it wouldn’t make sense to bake this type of mechanism into the protocol at first. People should be free to experiment with different approaches that suit their budgets and degree of risk tolerance. That’s what markets are all about.

Personally, for example, I would be highly confident in offering an unsecured loan to some of the existing teams and/or individuals in the ecosystem. As an example, I might fund a realistic proposal structured as 50% loan, 35% completion bonus, 15% return to me as the lender with a 6-month timeframe for some well-defined objective. If I were more skeptical about the team, I might instead look for a project asking for a 30% loan, 50% completion bonus, 20% return with the loan amount delivered in monthly tranches with observable milestones being met; a scrappy individual or startup living on ramen could do great things with 6 months of living expenses and earn a healthy reward at the end.

[nuttycom]

In reading through https://hackmd.io/@metaproph3t/ryMF-9W6T it looks like others are contemplating related ideas: this link goes into some ideas about “futarchy” (i.e., prediction-market-based) governance.