Green assets as collaterals for stable coins

We agree that liquidity is a desirable property for reserve assets @markbarendt. To the extent that trade offs have to be made to include some illiquid but impactful assets they need to be made clear for the Celo community to vote on. Like a bank Celo needs to develop capabilities for asset liability management - ALM (Liabilities = cStables, Assets = Reserves). All collateralised stablecoins need to be good at this.

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Thank you for posting this thoughtful summary - very useful! It’s also great to see that you mention the legal challenges around tokenizing RWAs, looking forward to learning more about your approach with Untangled.

Regarding the liquidity-impact tradeoff, I spent some time thinking whether a tiered liquidity setup would help. On a high level, it could work something like this:

  • We (logically) split the reserve into a core reserve and an impact reserve
  • The core reserve holds highly liquid assets (e.g. the current crypto assets) and has sufficient collateral to cover all outstanding cStables.
  • Let’s define two collateralization thresholds for the core reserve x and X with x < X, let’s say x = 1.5C and X = 2C where C = USD value of stables in circulation, i.e. we aim for 150%-200% overcollateralization with the core reserve (numbers are just examples, TBD)
  • If the core reserve value R exceeds X, the difference R-X is ‘transferred’ to the impact reserve and invested e.g. in real world assets
  • As long as x < R < X, the impact reserve is not touched
  • if R falls below x (trigger event), impact reserve assets are liquidated to boost the core reserve

Would love to hear your thoughts on this

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This actually seems like a good first step towards a multi-collateral Mento design. Collaterals can be batched into different reserve buckets based off of risk scoring with interactions between buckets. Something to think about.

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Good morning @Slobodan

So with regard to the collateral percentage there are more considerations than just a generic percentage of the total.

It’s time for a reality check.

One of the things that has come into focus because of recent events and discussions is that the Celo assets in the reserve poses the same risks to this protocol that Luna posed for Terra. In a de-pegging situation the value of Celo could go to essentially zero.

So, it’s the non-Celo assets that actually act as the reserve that could repay the coin holders.

Given that risk I have suggested in another discussion that the Celo assets not be counted as part of what we consider the reserve that is backing the stable coins.

At this minute the total reserve value is $268,632,850
The Celo portion value is $104,220,663

That means the non-Celo reserve is $164,412,187
The outstanding supply of stable coins is $100,592,110

The current ratio of non-Celo assets to outstanding supply is at 163%

That’s not the end of the assessment though.

In the current market conditions it is not unreasonable to fully expect BTC and ETH to drop considerably. Estimates for BTC during this bear cycle suggest that we could see prices for it in the neighborhood of $20,000, so roughly a one third drop from today. It is reasonable to expect ETH to drop more than that but for today I’ll keep the math simple.

Non-Celo $164,412,187
Minus 1/3 $54,804,062 to consider value at a reasonable probability of market price in the near future
Net probable value of non-Celo assets available to cover stable coin debt $109,608,124

The realistic colateralization percentage after correcting for market conditions and real risks is roughly 109%.

So in reality, Celo isn’t over collateralized.

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Some supporting info regarding the risks of using/considering the native coin as collateral.

A report released Thursday by Terra backers Jump Crypto, the crypto arm of investment firm Jump Capital, shows based on recorded blockchain transactions that big investors with several million UST each liquidated their stocks early in the depegging process, driving the price ever downward and leaving smaller holders with practically nothing.

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More on liquidity and liquidation

We also think the x<R<X framework is a good starting point. It has been tried and tested with protocols such as Maker. We call X collateral ratio and x liquidation ratio. By definition x should be more than 100% as we would need to provide some incentive, essentially a discount to ‘fair value’ of underlying assets, to enable a quick sale during a liquidation event.

If cStables are collateralised by crypto natives then there is plenty of data within the Celo network and other similar protocols to model the value of x, X. The UST debacle reminds us of Black Swan events even though, strictly speaking, it was an undercollateralized (algorithmic) stablecoin that was built on an unsustainable foundation.

if R falls below x (trigger event), impact reserve assets are liquidated to boost the core reserve

As R fluctuates with underlying crypto collateral and the value of cStables in circulation, boosting R through liquidating impact (RWA) assets could be problematic. Typically RWAs can’t be liquidated quickly but celo could employ a combination of strategies:

  1. Creating a safety margin: say liquidity need for a time horizon of 1 week, when the most liquid RWA can be liquidated
  2. Creating a liquidity strategy within the RWA portfolios: essentially making conscious tradeoffs among the impact/liquidity and yield
  3. Working with real world asset funding protocols to create highly liquid exposures to impact assets

1 above could be implemented with the value of the Celo token in the treasury. However it is much more sustainable to use protocol profits or surplus to fund safety margins. For this reason, celo needs to consider assets yields when making asset allocation decisions.

2 above has been covered in this post. Again all three properties and their tradeoffs should be considered.

3 above starts with selecting quality assets to form the impact reserve. The asset onboarding process needs to follow good practices as being proposed in this thread. It is important to note that once the asset has been onboarded the on-going monitoring is robust enough to ensure all asset risk parameters are in check. Having real/near real-time, on chain asset tracking, net value calculation and reliable oracles is crucial.

Even AAA assets have a non-zero probability of default. A proposer of impact assets (to be included in the reserve) needs to have a pre-approved liquidation process. Typically, these assets are sold under ‘true sale’ to a Special Purpose Vehicle (SPV) whereby an independent administrator or trustee is instructed to liquidate the assets (perhaps with the help of a professional liquidator) when certain conditions are met. This sort of liquidation procedure is well functioned within traditional finance/securitization. The challenge here is to create a legal structure that can work with a DAO as a DAO may not have a legal status.

Legally speaking, impact asset tokens come in two main forms:

  • token representing a claim on the actual impact asset
  • token representing a claim on the proceed of the impact asset in the event of a liquidation

Both of these are securities: equity in the former and debt in the latter. An equity token might be subject to registration with various authorities before being included in the reserve. Price discovery would need to happen on a licensed secondary market, and in the US, subject to various transfer restrictions. There is also an issue regarding custody of the token, establishing a control location for sovereignty over the custodied token and compliant liquidation mechanism.

Under the second form, assets would be sold to an SPV in the manner described above. Each of the assets are tokenized as an NFT with adequate metadata to enable oracles to price assets on an ongoing basis and in the event of a liquidation. This second form is arguably simpler as it involves less parties, at least in the US. The liquidation process is still manual as described above.

Solving for the trilemma of impact tokens

Both of the above are securities so unless they are registered or exempted and listed there are no secondary markets in DeFi. What if there is a token with exposure to underlying impact assets but are not subject to securities’ restrictions? This token would then be traded freely on DEXes such as Uniswap.

This could be done by separating between Liquidity Pool and Asset Pools. Under this construct, liquidity providers would deposit their funds into Liquidity Pool and receive an LP token in return. A permissioned asset originator would sell/upload their asset NFTs to an Asset Pool (a smart contract) to which Liquidity Pool automatically allocates funds under certain conditions.

Liquidity providers can timelock their LP tokens to receive extra allocation of LP tokens and a governance token. The payment waterfall of Liquidity Pool would follow the timelocking of LP tokens e.g., no time lock/immediate, maturing in 1 month, 3 months, 6 months etc. With a suitable design, these time locked LP tokens can follow the ERC20 format, making them composable with the rest of DeFi. A secondary market for these tokens e.g. pairs of LP token/timelocked LP tokens could be enabled.

Neither the Liquidity Pool nor LP token holders are lenders of record. The Liquidity Pool participates in the economics of Asset Pools by virtue of the protocol design (i.e. the smart contract). This would be a leveraged and structured product and in normal financial services the dealer managing this would be regulated. But if the entire mechanism is automated and controls are at the end points - at the originator validation/auditor node and investor onboarding nodes - the internal mechanism can be completely DeFi.

If cStables reserve holds the above LP tokens, not only it is exposed to underlying impact Asset Pools, it could quickly sell the LP token on any DEX when needed. If the LP token also provides yield this could be a solution to the impact asset trilemma.

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So for RWA collateral, how do I flash loan stuff and get that liquidated in a single transaction onchain? Or does that liquidation process require someone to hold principal risk?

For RWA collaterals is there also oracle risk and liquidators need to have their own assessment of the true value of the underlying?

Cus as soon as you introduce principal risk and the oracle pricing risk into the equation, you will need to add in some huge buffers / liquidation bonus.

It also severely restricts the number of people who will even bother to become liquidators.

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There are two types of liquidation:

-liquidating asset tokens takes time and can only be triggered in certain circumstances.
-liquidating Liquidity Pool LP tokens are subject to prevailing secondary market conditions and are unrelated to the asset tokens above.

Hence why the construct that separates the 2 types of tokens while allows users to take a view on the ‘price’ of liquidity and credit risks through secondary market trading.

Oracle risk could be minimised through ‘market to model’ or a transparent asset pricing mechanism. Many RWA assets have predictable cash flows and observable discount rate. These can be inputs into on chain net asset value calculation.

As to principal risk, this can be managed through off chain legal agreement with reputable counterparties. Note that here we refer to liquidator of asset tokens.

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Do you have models/spreadsheets that demonstrate the concepts you are talking about so that the general population of Celo users can understand what’s happening.

I feel like these RWA liquidations will become a exclusive club and not really accessible to ordinary users.

Mark to market is also tricky cus what if I don’t even trust the financial data reported by the auditors? (Even the big four accounting firms have been caught fluffing up their reports)

Not against this idea and there are a few crypto startups doing this, just not a very open and transparent game to play.

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Type 1 liquidation does require professional liquidators as here we are talking about distressed asset liquidation. That’s said, depending on asset classes, there are many participants in the distressed asset market within TradFi. Also as we mentioned above, the type of liquidation should not happen too frequently.

Type 2 liquidation, under the above construct, is accessible to any ordinary user - here we are talking about selling ERC20 tokens on DEXes. Also this type of liquidation or sale will happen more frequently.

Re mark-to-market/mark-to-model - Agree, any system relying on human actions might be subject to abuse. The only way for Celo to completely alleviate this risk is not to be involved with RWAs. That means no exposure to impact assets whatsoever but isn’t this against Celo’s own differentiation? a layer one at the forefront of ReFi?

RWAs bring counterparty risks, no doubt about that. This risk is however can be minimised with staking or dealing with reputable counterparties. An increase in counterparty risk is however compensated for by a decrease in market risk, compared with crypto native assets. RWAs are more stable and arguably less correlated with the rest of crypto. They are many orders of magnitude bigger than the crypto market. With what happened to crypto market in recent weeks, one does wonder what use cryptos actually bring to humanity?

You, the Celo community and we are not against this idea and this sort of discussion is helpful for us in making conscious choice in spearheading ReFi.

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Wow!

If an arrangement can be made for one type of financial asset, then there is no reason it couldn’t be made for another. The legal challenges would seem to be exactly the same.

That makes fiat a viable option for the reserve.

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That seems to be a significant point of centralization.

Is there a way that the accounting can be on chain?

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The accounting is on chain - Net Asset Value calculation is done on chain based on the metadata of Asset NFTs but there will be some centralisation at least in the beginning with oracles.

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I agree that centralization is inevitable at certain points, the transition to fully decentralized systems will take a while.

Okay I’m down for this game, at least can flash liquidate all of the type2’s

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Sure. We will release our white paper shortly and will share with the community.

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Thank you for this framework, Manrui!

My assumption is that high quality land (e.g. rainforest) or shares of a holistic project beyond carbon credits will be high in impact & high in yield because high quality projects will not only produce valuable carbon credits that rise in price over time but also biodiversity credits and the land itself will rise in value. I spoke many times with Kjell from https://www.forestbase.io/ about it and think that something like this could be a great asset. So I would disagree on the low yield part.
But as you point out these assets are currently illiquid. I think by pooling projects & land and balancing pools this can be mitigated to a certain extent. Another possibility that I would like to explore is to bring institutional investors on board. You seem to understand the legal implications well so I’d like to hear your take on it:

Imagine, there was a tokenized rainforest on-chain with a current value of 1.500$/ha but the asset is fairly illiquid. Now the treasury could buy this asset and mint up to 1000cUSD. The one hectare will be in the vault as collateral. Should the on-chain price of one hectare fall to or below 1.000$/ha (+5% safety margin) then it would be automatically liquidated. To achieve that, we set up a smart hybrid contract where big institutional investors commit to buy as many hectares as possible for 1000$/ha.
We assume that the value of the rainforest appreciates over time as high quality offsets will be valued higher and further ecosystem credits can be developed and issued in the next few years. So after five years the price might be 4500$/ha and another 2000 CUSD could be minted because institutional investors would be willing to buy any amount at 3000$/ha now.

This could work similarly with high quality carbon (removal) credits, (insured) futures as well as bio-diversity and other ecosystem credits yet to be established.

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One concept that I don’t think has entered into the conversation yet is that the overcollateralization will not be a forever thing.

What I’m getting out of here is a matter of scaling up, if/when Celo stable coins 10x to $1 billion 100x to $10 billion, at that point there will be essentially no “over” at all.

Those aren’t really big numbers compared to the possible market.

The basic purpose of the coins is to improve the economics of “the people”, that in itself is a huge economic and environmental boon.

The reserve collateral needs to support that purpose above all other considerations IMO.

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I dont think we need to scale cStable up all that much for it to be useful though.
For example, I want to think of cStables as the equivalent of CASH, and the total amount of CASH that needs to be in circulation in the economy is actually quite small compared to the net wealth of everyone.

There only need to be enough cash circulating around to facilitate transaction, and a healthy economy is one where we have high velocity of money and the same $1 cUSD moves between people many times over as part of commerce.

I think if you think of cUSD from this perspective, then it’s still feasible for it to always be over collateralized, because the true store of wealth is going to be stuff like BTC and such (things that are resistant to inflation long term)

Or do you imagine people hoarding millions of cUSD? I just dont see why someone would want to hoard cUSD given that there are much better investments available.

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