Solar-Backed Crypto: Next-Gen Funding for Next-Generation Energy

Backed by kWh generated from solar energy projects and used as a project financing source, the Zuva token has the potential to power the next phase of expansion in solar build initiatives.
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In its first two decades, the internet altered how we access information (e.g. Wikipedia) and how we exchange information (e.g. Facebook). The next iteration, known as Web 3.0, is changing how we create and exchange value. 

Token Economy, the landmark book by Shermin Voshmgir, explores the full potential of Web 3.0 to transform the economy and society. In this article, we will briefly introduce Zuva, our token backed by our pipeline of cash-flowing solar assets across Southern Africa. 

The Problem We are Solving

The first sentence of Leo Tolstoy’s novel Anna Karenina is: “Happy families are all alike; every unhappy family is unhappy in its own way”.  Much like Tolstoy’s happy families, the favored global venues among investors – those happy economies – all have similar core qualities:

  • Trustworthy government
  • Highly liquid capital markets
  • Low opportunity cost of investment
  • Overall ease of doing business

Interest and volume of foreign direct investment is heavily impacted by deficits in one or more of these qualities.  Across Africa, there are severe issues across all four that will continue to make it an unattractive space for general investment, regardless of the explosive growth opportunities and huge potential consumer markets that exist.  These issues are so severe that last year, Diasporans remitted $50B back to their home countries – 2x more than the sum total of foreign direct investment across the continent.  Even worse, liquidity for small business is challenging – between double digit interest rates and 50%+ collateral requirements – and there is a ~$30B funding gap for financing energy production.

This massive energy financing gap has resulted in severe power shortages.  Energy availability is another critical barrier to economic growth across Africa.  Research has repeatedly shown a strong link between electricity availability and GDP growth in emerging economies – countries with supply shortages consistently and severely underperform.  More than 3⁄4 of commercial and industrial energy users across Africa deal with regular power outages.  And particularly in southern Africa, daily rolling blackouts have become a normal part of life over the past several years.  Even in a country like South Africa, one of the largest and most well developed economies on the continent.  In desperation, most countries within the Southern African Development Community (a group of 16 countries from DR Congo all the way south to South Africa) have introduced legislation to significantly remove barriers for independent power producers to bring clean energy projects online.  Most notably, South Africa has removed all license requirements for solar projects 50MW or smaller.  All of these issues have created massive demand for decentralized power – and over 50% of firms have at onsite power generators – a greater percentage than on any other continent.

In our view a blockchain based model of financing onsite solar energy provides an effective solution to both the lack of liquidity available for private sector capitalization and the overall lack of investor trust in the government’s economic policy transparency.  It provides an excellent complement to a traditional fund management approach, particularly as institutional debt will be difficult to obtain at this early stage.  Until we can show clear track record for success, our solar projects will either need to be unlevered, or we ourselves will need to provide leverage through the capital (largely retail) that we raise as equity.

Our overall business model provides a safe path to invest in clean energy in Africa for those who lack the resources or connections to do directly.  Even for Diasporans (particularly those who do not have the income or wealth to invest as accredited investors), we provide an alternative to the steep custodial risks taken and heavy fees paid by those who make informal investments via remittance.

What are Asset-Based Tokens (ABTs)

Cryptocurrencies are often treated with skepticism as they are volatile and do not appear to have intrinsic value. However, first-generation coins such as Bitcoin represent only the initial steps in a broader revolution taking place in financial markets.

The original motivation for Bitcoin was to create a means of making payments without the need for a trusted 3rd party. Later developments have made it possible to go beyond payments to create decentralized equivalents of lending, insurance, and security exchange. 

This ecosystem of blockchain-based solutions is known as Decentralized Finance or DeFi. It rests on two foundations:

  • Smart contracts: allow agreements to be executed automatically and with precision, eliminating bureaucracy along with its associated costs and slow settlement times. 
  • Tokenization: allows formerly illiquid assets to become divisible, tradable, and therefore accessible to a wider pool of investors via fractional ownership.

By associating a real-world asset, such as an artwork, building, or infrastructure project with a token using a smart contract, it is possible to create an asset-backed token – the cryptographic equivalent of a share certificate or title deed.

Asset-backed tokens (ABT) enjoy the benefits of the blockchain protocols on which they are created (speed, low cost, and reliability). They also have intrinsic value, unlike crypto-native currencies like Bitcoin that are based entirely on code. This creates a floor price and offers stability that crypto-native tokens (i.e. relying entirely on code) lack.

How ABTs are being used

The most common form of asset-based token is the stablecoin: a crypto token that is pegged to a government-issued currency, most commonly the US dollar, or algorithmically to a basket of other cryptocurrencies. The most popular stable coins – USDT, USDC, BUSD – are all USD-pegged. Stablecoins are important for the crypto markets (especially in DeFi) because crypto-native tokens such as BTC and ETH remain extremely volatile.

While stablecoins remain the most common ABT and financial instruments remain the most common form of asset used to back them, anything of value can be tokenized. Digital assets such as health data, song rights, and digital art are natural candidates for tokenization, given that they are non-physical.

Physical assets are the emerging frontier in ABT’s evolution, with art as a growing use case. The first artwork to be tokenized was Andy Warhol’s ‘14 Small Electric Chairs’ (valued at $5.6m). In 2018, 49% of the painting was made available for sale by the Maecenas platform, with the price decided by an Ethereum-based smart contract.

While Maecenas is a dedicated art marketplace, platforms such as Smartlands and AlphaPoint enable owners to issue digital shares for other traditionally illiquid assets in sectors such as manufacturing, logistics, and agriculture. As well as providing liquidity for existing assets, ABTs have the potential to serve as a means to raise capital for projects.

The benefits of ABTs

Just as social media fundamentally changed the publishing industry – by reducing the cost and speed of publishing, thereby radically increasing the liquidity of information – ABTs are predicted to bring about a similar explosion of liquidity in capital markets. 

Smart contracts replace complex, documentation-heavy processes involving multiple legal teams. This lowers costs for capital raisers. Tokenization enables fractional ownership, widening the pool of investors.

As investors become more comfortable with the higher levels of stability ABTs provide, the crypto economy as a whole will benefit from the influx of capital (both retail and institutional) and its associated legitimacy. Cryptocurrency holders will be able to diversify their holdings with lower-risk investments.

Application to solar power initiatives

In the case of a stablecoin, the value of a token is linked to the value of a currency (e.g. 1 coin = 1 USD). 

In the case of Asoba DeFi’s solar ecosystem, we are introducing the Zuva token.  Zuva is Shona – the predominant language of Zimbabwe – for “sun.”  The value of each token is backed by the energy capacity of the pool of solar assets. The token will therefore have an intrinsic value backing its value expressed in terms of the pool’s output: as a starting point, each Zuva is backed by 1 kWh of solar energy production.  This intrinsic value represents the price floor for each token which, depending on market demand,may trade at a premium without a price ceiling.

Tokenization offers a number of additional benefits for solar project finance:

  • Faster capital raising: the greater efficiency of token-based funding means that it will be possible to raise funds for larger projects such as utility-scale solar plants with greater upfront capital requirements (e.g. licensing fees, component costs, land acquisition).
  • Store of value: tokens can be used to reflect cash inflows from existing projects (Power Purchase and Leasing agreements), in addition to being used as a means of assigning ownership of future cash flows.
  • Liquidity option for equity investors: investors who purchased equity using fiat currency can convert their (less liquid) equity for tokens, acquiring liquidity for themselves without having to remove liquidity from the system.

Tokenomics and Mechanics

A common issue with algorithmic stablecoins that are pegged to baskets of other cryptocurrencies is exposure to volatility in the reference assets. Stablecoin ecosystems such as OlympusDAO (DAO stands for Decentralized Autonomous Organization) have constructed a common approach to maintaining some level of price stability against that volatility. Various mechanisms enable the protocol to preserve the value of tokens, preventing them from falling below a floor.

The bear market has exposed deficiencies in the treasury management of the teams behind many of these DAOs.  However, that does not discredit the concept itself.  Further, our hypothesis is that backing the token with real world assets that are tied to real world supply/demand dynamics provides a firmer floor than algorithmic stablecoins whose floors are based on the value of token pairs.

Centralized Protocol Actions

If energy capacity is reduced due to panel depreciation or any other reason, the protocol can purchase and “burn” outstanding tokens, decreasing the Zuva supply and maintaining the intrinsic price floor. If more capacity is added, the governing protocol can provide discounts to entice liquidity providers to create (“mint”) more tokens and reverse the process.  Only when new solar projects are added to Asoba DeFi’s portfolio with there be more Zuva minted.  Therefore, the supply of Zuva is pegged to the total kWh generation capacity of the whole portfolio of solar projects.

Staking and Bonding

Even though the protocol controls the treasury and the supply of tokens, it is important to reward investors for long-term commitment and discourage speculation. Investors are incentivized to contribute to the stability of the coin via two strategies:

Staking means to commit one’s Zuva tokens for a given period in exchange for fixed reward (known as Annual Percentage Yield or APY). This provides the protocol with token liquidity, and stabilizes the price. For investors, staking is a way to earn passive income, which can be re-staked automatically (‘auto-compounding’).  Staked Zuva, or sZuva, maintains a 1:1 price ratio, meaning you will always obtain 1 sZuva for 1 Zuva.

Most OlympusDAO forks provide rewards by minting additional tokens and distributing them to investors who have staked tokens.  This approach is inherently inflationary, and as we have seen in very prominent DAO’s including Olympus itself, creates additional downside price volatility for the token during bear markets.  The rampant leveraging in many of these ecosystems leads to cascading liquidations and sharp price declines when market price corrects.

Tokens backed by real world solar production are able to provide rewards without resorting to Ponzi-like inflationary tactics. Instead, our solar projects sell power to consumers via Power Purchase Agreements.  Consumers – primarily large cap companies, commercial farms, municipalities, and national power grids – commit to 20-25 year agreements and pay a predetermined fixed amount monthly for their consumption.  Cash flows from these payments can then be distributed to token holders of sZuva.

Further, since rewards are coming from real world asset cash flows, we have the ability to reposition assets if/when we feel the need to increase Total Locked Value behind the token. 

Bonding allows investors to purchase excess supply of Zuva held by the protocol with either fiat or other cryptocurrencies at a discount, and receive the tokens after an agreed vesting period (e.g. 30 days). The investor is incentivized to remain invested rather than cash out. Meanwhile, the funds used to make the purchase provide the treasury with liquidity in other currencies, diversifying the reserve.  Typically, we would raise TVL from bonds if we saw returns opportunities that we felt comfortable taking balane sheet risk to jump into.

Zuva is backed by, rather than pegged to, the underlying reserve asset. This means that there is a floor beyond which the value of it cannot fall, but it will likely trade at a premium in the earlier stages when the supply of the token is increasing and the kWh from new solar projects are made available to back the token.

The DAO governance model

Another way in which the DAO model differs from the traditional stablecoin model is the governance structure. While DeFi decentralizes finance, the DAO model decentralizes the corporation. 

In the DAO model, smart contracts replace many of the standardizable elements of the day-to-day management, while key decisions that affect the protocol’s strategic vision are taken collectively by the DAO’s token holders. By aligning the protocol with the incentives of the community, principal-agent dilemmas can be avoided.

Managing the stability of the currency is a question of monetary policy. Just as in the world of central banking, this requires periodic judgments that cannot be automated.  This means that there are clear limits to the types of decisions that can be reliably left to DAO vote.  DAO’s that decentralize all decision-making have historically been poor at rapidly and coherently dealing with emergent threats to the stability of their token.

Another area that requires specialist knowledge that cannot be fully decentralized is in the selection of solar projects whose kWh generation backs the Zuva token, as well as structuring the detailed mechanics of bonding, staking, and rewards.  Decision-making here is delegated to subject-matter experts within the management team who act within the framework of the strategic vision supported by DAO token holders.

Liquidity

Markets live and die based on liquidity.  In simple terms, liquidity is a measure of how many buyers and sellers are present, and whether transactions can take place easily.

In a liquid market, a seller will quickly find a buyer without having to cut the price of the asset to make it attractive. And conversely a buyer won’t have to pay an increased amount to secure the asset they want.  Typically, protocols offer rewards (via staking) that encourage investors to provide liquidity and fuel the protocol’s ecosystem.

In typical protocols, there are a few common challenges:

  1. Large liquidity providers (known as “whales”) may suddenly exit liquidity pools in pursuit of what they perceive to be higher rewards in other protocols or to avoid impermanent loss that happens with sudden token price shocks.  There is no long term commitment, so the level of liquidity may be highly volatile
  2. Flood of sell pressure by liquidity providers taking profits when they receive staking rewards.  Either constantly as rewards are provided, or in single large sell-off events by whales that cause a cascade of follower sales and steep token price drop

A key to countering these common challenges is for the protocol itself to own as much of the liquidity as possible.  Successful DAO’s such as Klima see the protocol owning more than 80% of liquidity in its major liquidity pools.  This ownership is primarily accomplished via the bonding mechanism.

Protocol owned liquidity is treated like a treasury and managed like a hedge fund.  This hedge fund is run with an investment strategy and target yield provided in return for liquidity provider staking in the long term.

Liquidity Provider Expectations

The approach to liquidity developed by OlympusDAO and guiding that of Zuva is based on game theory concepts.  Within the context of the DAO token market that has mint/bonding mechanics, there are three possible actions that a market participant can take: staking, bonding, and selling. 

 

3,1, and -1 represent the level of conceptual rewards received for each action, where stakers get the highest reward and sellers get penalized.  The Nash table above represents the possible combinations of actors and their respective rewards in the interaction, with both actors staking (3,3)

Locking Liquidity

Taking the (3,3) concept one step further, Zuva adopts the ve(3,3) approach pioneered by Andre Cronje.  In this case staked tokens are subject to a lockup period. Rewards and voting power that veToken holders get is proportional to how long they are locked for. The closer the date is to when a holder can unlock, the lower the rewards and voting power that holder can get. veTokens are a good way to reduce sell pressure, maintain price stability and cut down the token’s circulating supply. 

Due to how this works, yield-seeking token holders have a stronger incentive to hold rather than buy and sell for price action. For example, 2 years into a 4 year lockup the staking rewards will have reduced by half and to 0 by the end of year 4.  Investors seeking to maximize yield therefore have strong incentive to regularly renew the lockup for staked tokens.

We recognize that many retail crypto investors will find the concept of locked staking unattractive.  And that is by design.  We strongly prefer investors who make decisions based on a strategy, a thesis, or a specific conviction about the energy sector and who are willing to commit liquidity over longer periods to achieve the returns they are seeking.

Trust and Trustlessness

The final and most important component is that of trust.  Trust on the part of investors and liquidity providers that not only are projects being executed halfway across the world, but also that they are generating power that someone is paying for.

A key factor behind why so many tokens in the crypto space without “real world” utility or assets behind them still manage to attract liquidity is that the underlying blockchain provides a transparent mechanism for enforcing the contracts behind transactions. Power and trust is distributed (or shared) among the network’s stakeholders (e.g. developers, miners, and consumers), rather than concentrated in a single individual or entity.

Since our portfolio consists of projects installed in countries that most liquidity providers have and will never visit, the market faith in the value of Zuva depends on the extent to which we can make the actual process of minting new tokens fully backed by kWh production trustless and recorded on the blockchain.  The most straightforward way of doing this is recording kWh production directly to the blockchain at the moment of generation and triggering token minting once the kWh “mining” contract is executed.  We are considering making these tokens non-fungible, so as to more transparently associate kWh generated and recorded on the blockchain with the specific power purchase agreement governing its production and consumption.

Ideally, the payments made by electricity buyers towards the power purchase agreement would also be recorded on the blockchain so that a clear path can be drawn between kWh generated, token minted, power consumed, and then paid for by the user.  Even better if the power purchase agreement itself was a smart contract.  Steps 1-3, from power generated to power consumed can be tracked and implemented on the digital ledger. Local currency regulations will determine the extent to which the entire process can occur digitally.  Most countries in which we plan to operate will likely require payments made by energy buyers to be manually onramped in order to provide blockchain record of purchase transaction.  But regardless of the specific mechanics, proof of electricity generation and customer payment can be provided in a trustless manner so that project status and actual backing of each minted token can be verified.

An Uncorrelated Passive Income Stream

Asset-Backed Tokens are in one sense nothing new – simply digitized versions of age-old financial instruments. Combining them with traditional capital sources represents a near-term opportunity both to secure funding, but also to ensure a new paradigm of stability for both investors and project financiers.  Projects like KlimaDAO, the broader Toucan protocol, and even Thor Node show a glimpse of how DeFi can turn cryptocurrency from a speculative digital money into a tool for retail investors to profitably support important and necessary social-economic transformations.  

As we continue to expand our portfolio of solar projects in the coming year, we plan to phase in Zuva tokens as an integral part of our long-term capital and governance structure. With the ability to create a store of value for project cash flows, we can more effectively monetize the energy as it is generated. The fundamental approach would be to leverage a DAO as a fundraising mechanism, where funds would be used to finance revenue generating solar projects across Southern Africa.  

Our belief in tokens backed by income-producing solar assets is based on the desire to create a token ecosystem that is uncorrelated with the price movement of Bitcoin or the stock market, as well as one that fundamentally incentivizes production of clean energy.