DUNKbonds

How this all Works

Bear with me. I'll probably add some drawings to help explain this, but I'm pressed for time.

First, The Honor System

DUNKbonds does not actually take, hold, or pay any money. It's merely a scoreboard, and according to the honor system, you should own up to any charitable giving you might incur through DUNKbonds. Huh? Read on. Better yet, read how this all got started.

Bonds and Goals

Goals are either going to be met or not.

Bonds, in a traditional sense, are like a loan. Ideally they pay back, but sometimes the debtor defaults.

Buying a DUNKbond on a goal means you're sort of lending money, and debtor owes you the full face value of the bond, but what if the bond is tied to the outcome of the goal?

If the goalsetter meets his goal, bonds pay back in full.

If the goal isn't met, the bonds go bust and don't pay back.

When you buy a DUNKbond, you basically pledge that you'll donate to charity if the goal is met, but if it isn't, you're off the hook.

That all sounds like a bet against a goal being met, and that's exactly what it is.

The Secondary Market

Where it gets interesting is when you buy used bonds based on your expectation of whether or not they'll pay back.

If you think a goal is 50% likely to be met, your expected value of that bond is 50% of its face value, so you might try to buy one for 50% off (or, even better, less than that).

The trading price of a bond is how the market feels about the goal.

Now, someone has to sell the used bonds, right? Right. That's where the other side of the bet comes in.

Since bonds are a bet against, what about a bet for the goal?

Swaps

Think about the word Bond. It's an agreement between two parties in which a creditor will lend funds to a debtor, and the debtor will pay back the creditor.

When someone buys a bond, they become a creditor. Someone else is the debtor, and the debtor has the exact opposite interest than the debtor.

The debtor wants the goal to be met so he doesn't have to pay back his creditor.

If buying a DUNKbond is a bet against a goal, how do we bet for it? By being a debtor. In finance, (I'm botching this and taking some liberty here), the opposite of a bond is a swap.

Buying a swap happens in two steps:

First, you buy the rights to sell a bond and become its debtor.

In our case, if a goal bond costs $10 face value, then for $10 you get the right to sell a bond. You can sell the Bond-end of it for $4 or $6, or $8 to someone who wants a bond. You just have to pay back $10 if the goal isn't met. Yes, in your best case, you're down a few bucks, and in the worst case, you're down a few plus $10, but remember, this is all about losing money to charity. You just want to lose less than the market.

The point is that if you feel good about a goal, buy a Swap. The way I'm working it is that you don't pay anything until you sell the bond end of it. They're linked, the bond-sale and the swap.

That probably didn't help much, but I'll get back to this later on.