Reserve mandate: 1:1 stable value asset basket

Hi all,

the CGP to increase the stable value part of the reserve has passed and the reserve is already approaching the 30% DAI target with, as of May 25th, more than 75M DAI (roughly 27% of the reserve) in reserve custody. This allocation implies that more than 70% of all Mento stable assets are currently backed by DAI alone. When also accounting for the other reserve assets (BTC, ETC, CELO and cMCO2), the Mento reserve is at a 275% reserve collateralization ratio as of May 25th which leaves the Mento reserve well prepared for another market downturn.

The highest mandate of the Celo reserve is the protection of holders of Mento stable value assets (cUSD, cEUR and cREAL). In today’s Mento Community Call, we agreed that, after increasing the DAI percentage to 30%, it would make sense to even go one step further and target a 1:1 backing in DAI for all Mento stable value assets during these extreme market conditions. More precisely, the proposal we ended up with is to instruct the reserve to overshoot the 30% target in DAI if necessary to get to a 1:1 backing of Mento stable assets in DAI. This also implies that reserve rebalancing towards target allocations would only be conducted going forward if it would not violate the 1:1 DAI backing constraint. More specifically, this means that DAI would only be sold for other reserve assets during reserve rebalancing if this would not lead to a less than 1:1 backing of Mento stable assets in DAI. Furthermore, to create a buffer against USD/EUR and USD/REAL exchange rate risk and sudden Mento stable value asset supply increases, the reserve would be advised in this proposal to aim for a buffered 110% collateralization in DAI if feasible.

Please share your thoughts on this as a next step if you have any. If there is a consensus on this being a good addition to the reserve mandate, I would aim for creating a respective governance proposal this week and put it up for a vote.

Cheers and best
Roman

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Copied from Ensuring Celo's Survival - Avoiding a death spiral - Request for Ideas - #12 by markbarendt

My thoughts after the Mento call on Discord today 5-25.

  • I really like the idea of moving toward an external stable coin backing target of over 100%.

  • Given the ‘active management’ required by the real people involved in the multi-sig needed to manage Celo’s Reserve, it seems prudent that a management range for that ‘bucket of value’ be set over 100%. I’m going to suggest that range be something akin to: a minimum of 105% and a maximum of 115% of the value of all outstanding Celo Stable coins.

  • In the short term, until an on chain circuit breaker can be implemented, I do think that a ‘governance instruction’ should be crafted that instructs all the appropriate responsible persons to act as a ‘circuit breaker’ and monitor the status of the reserve the ensure that the non-Celo based assets (BTC, ETH, Dai, …) do not fall below 150% of the value of all the outstanding Celo Stable coins in circulation. At that point the reserve should be ‘locked’ and held for the sole purposes making Celo stable coin holders ‘whole’. The reason for choosing 150% is to ensure there is money available to cover all the overhead costs involved in getting the stable coin holders paid in full.

  • As discussed I am suggesting that in all marketing and reporting about the status of the reserve that there be made a distinction between Celo and non-Celo assets so that a hard distinction can be made from the Terra/Luna reserve in that at Celo ‘outside’ assets alone can cover Celo’s obligation to the Celo stable coin holders.

  • While Dai IMO is a reasonable interim tool for maintaining the 1:1ish ratio, I think Celo’s reserve needs to work diligently toward holding a significant amount assets that are not correlated to the rise or fall of any crypto project and that are proportionally and directly correlated to the real world currencies of the countries where Celo offers stable coins.

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DAI is pretty strongly correlated with crypto market movements, longer-term are we thinking of any stables other than DAI?

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I agree that this might make the reserve seem safer on a first look, but I’m wondering whether that’s really the case. I’m thinking about a couple of questions around this proposal and even the initial passed proposal to increase the stablecoin allocation:

  1. Is DAI really the insurance that the reserve wants? Is it going to be stable in the scenarios that it should protect the reserve against?
    If BTC and ETH would really drop another 70 80 90%, I would expect DAI to get into big trouble too. In complex systems, if you suppress variability, you often get hidden blow-up risk. While DAI will decrease the volatility of the reserve collaterization ratio for sure, might it even increase this blow-up risk? I think DAI can more easily lose all its value compared to BTC and ETH.

  2. How expensive is that ‘insurance’ or hedge the reserve buying?
    In financial markets, if you sell your volatile assets in a crash and buy insurance or hedge assets, it’s often a bad deal if it’s not about your plain survival. Volatile assets are at their worst purchasing power and insurance and hedges at their highest price. If it’s necessary for survival you don’t have a choice, but with these proposals the reserve will sure lose a lot of potential upside.

  3. The product dimension. This would cStables essentially make a stablecoin largely backed by another stablecoin that is mainly backed by another fiat backed stablecoin. This seems to add risk from the different stability mechanisms, but what are the benefits?
    I don’t get why people mint DAI with USDC - why not use USDC directly? I wonder why people would use cStables instead of other (fiat and non-fiat-backed) stablecoins once deployed on CELO. If I personally would have the choice, I would use the stablecoin with the least layering.

Would love more thinking and different perspectives about this.

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@jason thanks for chiming in.

I’d like to see a conversation along those lines too. My impression (given my limited context) is that underlying ideals and current real world realities are clashing a bit.

Centralization/De-centralization, KYC vs permissionless access, a want to stay fully crypto (replace fiat) pitted against a world that does it’s business in fiat, …

The interesting question for me is, what’s more important: ‘crypto idealism’ vs (paraphrased) “Reshaping local economies. Growing local economies to regenerate global ecologies. Building products that create the conditions for prosperity — for everyone.”

@Tobi The big benefit in the short term is one of perception, for people uncomfortable with volatility a real concern has been addressed. That’s ok, it gives everybody room to start dealing with the questions you are asking.

Just asked this on Discord.

So, I’m going to ask a question that has been glaring in my mind. If the reserve were to hold an abundance, say 110% of each fiat currency to back 100% of the outstanding coins; then is there even a reason for having a stability mechanism or a circuit breaker? At that point it seems to me that the de-pegging issue evaporates. It also seems to me that with a little imagination this could solve a fair amount of the regulatory concerns.
Being over collateralized Celo has plenty of ‘cash’ to do this and that would free up a lot of cash that could be focused toward say a real world build out.

Discord

Simpy holding 110% of collateral in the reserve does not ensure that the related stable value asset is pegged IMO - it just makes it easier for the stability mechanism to achieve the peg. Imagine a situation in which Circle has 1 USD in the bank account for every USDC but is not allowing redemptions for a while (might be due to technical reasons). The collateral is there but their stability mechanism (1:1 issuances/redemptions) does not work and a depeg could easily occur in such a scenario.

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I agree with the points you raised @Tobi. The decision for/against a 1:1 DAI backing feels like a close calls to me and overall, my personal opinion is that the benefits for Mento stable value holders outweigh the risks/downsides in these market environments. The most important aspect right now, in my opinion, is to ensure that the reserve does not sell DAI unless Mento stables are well covered by DAI. Otherwise, the reserve could end up selling all DAI currently owned to CELO during rebalancing sessions in a market downturn and effectively cash out CELO holders instead of keeping the safe collateral around. The reserve would very likely not do that as its highest mandate is the protection of cStable holders but the current mandate of target rebalancing, taken out of context, would imply such rebalancing during a market crash. So I would like to avoid any ambiguity here in terms of the reserve mandate.

Also the decision between DAI and USDC is a tough call. Would love to hear more opinions on this - I know you have a strong one @0xhuman ;-). I am still pro DAI because its parameters are goveranable and also because the Maker community feels more aligned. I do not see large differences between DAI and USDC from a regulatory or stability perspective. Both certainly entail some regulatory and depeg risk.

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Good morning @roman

Well, that doesn’t really answer my question.

My 110% question is specifically about holding 110% of the corresponding fiat currency to support 100% of the outstanding Celo stable coins. It’s not about holding synthetic coins that represents the fiat. (The extra 10% is there more to deal with daily fluctuations in exchange and other inefficiencies.)

Essentially I’m suggesting that if Celo’s customers (the stable coin holders) are able to directly redeem their stable coins at 1:1 through Celo at the protocol level in exchange for the appropriate amount of fiat then there is simply no need for a stability mechanism.

Any question about the real value of the stable coins seems to evaporate if Celo acts like a custodian rather than a maker of synthetic money. Am I wrong here?

This solves a lot of the scalability issue in that any inflow of fiat into ‘custody’ can be held in fiat. Trades between Celo stable coins cUSD to say cREAL can be matched for the reserve on the FOREX exchange within a day or two to rebalance.

I believe there are ways to decentralize this even to the level of an individual acting essentially like a banker in remote communities with Celo providing the backend.

The biggest roadblocks I see are cultural, not technical.

Morning @markbarendt ! Maybe I am misunderstanding but where I am not following is this: “if Celo’s customers (the stable coin holders) are able to directly redeem their stable coins at 1:1 through Celo at the protocol level in exchange for the appropriate amount of fiat then …” This is fundamentally impossible from what I understand as only token-representations of fiat (for example fiat-backed stablecoins) can be traded on chain and never fiat itself (unless a real-world central bank actually issues CBDC on Celo that is a true 1:1 representation of the actual fiat). So am I understanding correctly that you are suggesting that Mento stables should simply become fiat backed stablecoins like USDC and Tether?

Hola @roman

Not impossible, Celo just has to be willing and able to accept and disperse fiat as needed directly with the ‘outside world’.

If I need 10 in fiat and a buddy of mine has 10 in fiat I could today buy that bill from him instantly using cUSD. There is nothing that stands in the way of these transactions except the elephant in the room which is that it’s really hard for either of us to exchange fiat for cUSD in either direction.

The cultural heavy lift here is not technical, it is in deciding to do what it takes to interact with the real world. That’s going to take some compromises to some crypto idealism, at least in the short term.

The trading I’m talking about for rebalancing the reserve is akin to how the reserve rebalances now, it just adds an off chain connection to the Forex exchange.

One huge real benefit to Celo here is that with the coins backed in this way it would allow Celo to divorce the duties of the reserve from the mission of the project.

This would free up a huge amount of ‘cash’ that could be removed from the reserve because the need for significant over-collateralization goes away. That in turn allows that ‘free’d up money’ to be invested in ways that might be really cool from a mission perspective but imprudent from a fiduciary perspective. That in turn would make Celo more 'regulatory friendly, reducing a real risk.

Thanks for clarifying, I better understand now what you are suggesting. But from what I know, handing out tokens against fiat requires KYC of every customer as well as all kinds of licenses.

Yes, @roman it would require running headlong into the world of regulation.

The benefits of this idea though is real world utility as a payment system and a coin that essentially cannot de-peg.

The market value of those two ‘features’ are, to put it mildly, significant.

Apt timing, a take from a crypto-semi-mainstream-news source in my ‘inbox’ today.

Vid should start at 15;46

A real world example of the model I’m suggesting actually exists in Traditional Finance, it’s akin to the IMF’s SDR’s (Special Drawing Rights).

Celo could essentially provide a miniature version of the SDR system, Celo would essentially become the backbone (accounting system) of a global exchange system. Stretch that idea a bit harder and the asset class doesn’t even matter.

Agreed @markbarendt that this is a potential long-term alternative - happy to discuss the tradeoffs more going forward!

To circle back on the more immediate question of whether the reserve should target a 1:1 backing in DAI for now: From different conversations, two interesting questions arose that I would like to get opinions on before creating a CGP and putting it up for a vote.

Question #1: Should the reserve rather target:

  • a simple 100% backing in DAI or
  • a 30% DAI allocation + DAI floor at 100% stablecoin value outstanding?

The dynamics are different - in an upward trending market, no additional DAI would be bought when a 100% backing is reached in the first alternative whereas in the second, the reserve would keep on buying DAI to stay true to the 30% target. Both alternatives have their pros and cons around upside potential and downside risk but I personally feel like both are very viable options.

Question #2:

Should the reserve hold USDC instead of DAI (or are specific weighting of the two)? Some community members shared a strong preference for USDC (cc @0xhuman) so would like to get more feedback here. I personally slightly prefer DAI but think it is a super close call and am fine with a move to USDC if there is a community preference for that.

IMO the outstanding stable coin balance should be determined by a ratio: on one side the value of the outstanding coins; on the other non-Celo-based stable assets.

TradFi here in the USA for non-fractional (fully backed) banking and insurance financial products typically uses a ratio of 1:1.08 or greater, so they are all over-collateralized by close to 10%.

As to the choice of assets, my preference is to get as close to fiat backed as is possible (the less synthetic the better) for the time being and to choose at least three stable-ish coins.

In the medium term every effort should be made to vett and diversify into alternative assets like the investment pools at Goldfinch, Centrifuge, and others in that space that are tied to RWA’s.