How MakerDAO can be a competitive lender in the Credit Tenant Lease marketplace

Expanding on the real world asset post from the Foundation yesterday, I’d like to suggest a more specific vertical and process for the community to consider

What is the objective?
It seems clear that MakerDAO needs to onboard large amounts of real world assets in order to meet continual DAI demand. Leaning on my background and existing businesses, I’d like to propose specific assets, structures and counterparties so that we can achieve this in the near-term to help build real-world DAI utility.

How do we do that?
Since I got engaged with MKR coming on two years ago, I have been fascinated by the scope and possibilities that MKR and DAI could bring. That said, governance is a process, and expanding the DAI ecosystem in a “peg-mindful way” just takes time. Further, the launching of MCD and then collateral onboarding process had to be defined.

The above being said, now is the time to really engage to bring to the forefront the discussions of off-chain collateral (e.g. the benefits, the risks, the structure, etc. ). I believe it to be a calling for MakerDAO as a whole.

After researching the matter at length and inspiration from Occam’s razor (the simplest solution tends to the right one), rather than try to completely ignore the existing banking system, we should use it as a guide and then enhance it.

So, let’s do that.

First let me take a step back and introduce what I am trying to do… what I have been doing… and how I am currently engaging with the existing banking system and how Maker can play a role (either as a complement or a replacement).

Background:

Without putting my CV here, I am an engineer that ultimately went to grad school to get a business degree and followed down the finance path. Having had exposure to PE (buy and sell side) / Hedge Funds / RIAs / BDs, I am now in the middle of a commercial real-estate development firm and am now responsible for building the capital side of that business.

Commercial what?
The type of financing that my business engages in is called a Credit Tenant Lease. To offer a brief definition:

“Credit Tenant Lease (“CTL”) Financing is a method of financing real estate in which the landlord / owner borrows money to finance the development or purchase of a property and pledges as security rent to be received from the tenant and a mortgage on the property.”

The type of CTL we engage in specifically are single-tenant net lease space. This means that a credit-rated tenant (rated by one or multiple of the big three rating agencies) leases the property on a long-term basis with certain responsibilities for insurance, maintenance, and taxes etc… Here is a quick primer on this sector of commercial real estate: https://www.cbre.us/research-and-reports/US-Net-Lease-Investment-Report-Q1-2020

Without dragging on about the net lease space, basically it has all the economics of a bond but, it is not a bond in the securities sense. Depending on what is being built, these individual projects are typically in bite size amounts ranging from $1MM-5MM. In addition, there are other tax friendly aspects such as 1031 exchanges that make this structure appealing. In summary, the net lease space has a robust secondary market for investors that are looking for a return while the underlying asset is risk-mitigated; the lion’s share of risk exposure is in the credit quality of the tenant. Developers engage with tenants to build locations and be a part of their expansion plans. That build-out is a developer’s transactional pipeline. Having a pipeline of deals, especially ones that are resilient during a recession, takes a significant amount of networking and track record.

What is interesting is that once a project has been completed, there are buyers waiting to buy the stabilized product. Developers take the risk of purchasing land (in-use or vacant) then engaging with a tenant and getting the project to a store opening (permitting, construction, etc.). Many ask why wouldn’t the tenant just do it themselves?" The answer is that some do, but most (tenants) logically use the developers (and their financiers) as a quasi-outsourced investment bank that allows them to optimize their operational expenses and enhance their Return on Assets and Return on Equity. The key component, however, remains that a credit worthy party is “on the hook” for the term of the lease for rental payments.

The above is a general introduction to CTLs. I am happy to go deeper (below or public / private sessions).

Moving on, how do developers in this space currently get projects financed?

There are fundamentally two ways:

A.) Engage directly with a bank (or financial institution) and get a project/construction loan once the project is “shovel ready.” The borrower would then negotiate terms (price / recourse / term / equity requirement) with the lender. Once the equity is secured, the loan closes and each payment thereafter needs to then go through a draw schedule process to authorize the release of loan proceeds in an incremental way.

B.) Engage with a 100% loan-to-cost financier (like me). They would provide a loan (usually also with draw schedules), typically with conditions that are more friendly to the lender, but the borrower does not need to have any equity in the deal. Costs are significantly higher than going directly to a bank, but they secure the equity.

Here is where initially I saw the gap for MakerDAO, to lend money directly into these projects, and below is why it won’t work as originally conceived.

Each of these projects require diligence, document review, oversight, occasional waiver requests and a high degree of certainty to outcome (e.g. no borrower / developer will want to risk his / her pipeline and take the chance of pissing off the tenant if for whatever reason the MKR community didn’t approve an individual deal. Further, the MKR community is not set up for nor should be lending off-chain directly into projects, regardless of size. We haven’t even started to talk about how to handle trust with this yet? The confirmation of equity, historical expense verification, and property capital allocations and releases just make the entire process untenable for MKR approval. Summary: banks and the current finance space have been optimizing this space for decades, trying to insert MKR here “could” work… but would be constant brain-damage for the borrower and the MKR community cognitive overhead would frankly interfere with the governance process and over time be discarded as a novelty.


So how do we make this work within MakerDAO?
Rather than MKR providing a loan to a specific project, which would require significant MKR oversight and cognitive load, MKR should be engaging with parties as a complement or a substitute to a bank credit facility. We should use market forces and alignment of economic incentives to ensure desired positive outcomes.

At its core, MakerDAO is like a Repo facility, or a credit facility, that can be drawn on or collapsed at will. In the banking world, this is known as a revolving credit facility and can be approved in favor of a given borrower. These revolver agreements are exceptionally well drafted and utilize battle tested legal documents. They represent an allocation of the bank’s reserves, and they are difficult to get if you are a small player.

So how and where can MKR play in the net lease space?
As I outlined above, I am currently building a sister company to the real-estate developer for this net lease space. This sister company will be a finance company that provides 100% loan-to-cost to real-estate developers across the United States with international expansion planned. Loans could be used for refinancing or new construction. That is to say that the business of this company will be to provide loans. This is not an investment company, it is an operating company, a critically important distinction.

In doing so, this lender (“LendCo”) will engage with willing borrowers (“BorrowCo”) to provide their capital needs, but in a massively risk mitigated way.

We plan to mitigate the risk by being the hybrid between a traditional bank, a hard-money lender, and a massively de-risked development firm (if things go sideways). This means that absolutely every payment that goes out has to go through our internal controls for an approval cycle. All projects must have a lender approved general contractor manager (or mgmt firm) sign off on the GC invoice and have associated lien waivers. All GC / engineering / arch. / lease contracts must be in a place that would allow the lender to step in to displace the borrower and step in to his / her shoes should there be issues.

Fundamentally as a lender, you have to work in reverse when designing the structure. We have to assume that everything goes wrong and build the protections in backward such that the borrower is taking the risks. When this LendCo lends money to the SPV for a new developer (BorrowCO), what happens if something happens to the principals of the borrower (e.g. someone gets hit by a bus or has GC issues) that the project can be rescued and then divested). Notice the rescued part. More on that part later (or in another post).

The Lender should take credit quality risk and construction execution risk. This is why economic incentives are critical and picking the right internal controls make all the difference in the world. Further, the developer makes nothing in the project until the project is sold (and the lines are repaid down thereafter).

We solve many issues at the same time by doing the following:

  • Requiring that BorrowCo use a cookie cutter identical operating agreement with each project in its own newly formed legal entity (Delaware LLCs)
  • Require that BorrowerCo give first position senior lien in favor of LendCo and not take any speculative risk.
  • Require that BorrowCo provide certain reporting
  • Require that BorrowCo maintain certain financial requirements
  • Require that BorrowCo and the developer maintain certain assurances in favor of LendCo
  • Requiring that LendCo have an Equity contribution requirement
  • Requiring that LendCo have reporting requirements (quarterly financials / annual audits)
  • Requiring that all loans meet an underwriting criteria (and that appraisals are never older than 6 months)
  • Requiring that certain LTV / LTC / DSCR / developer exit spread / current loan constraints limit the amount of loan proceeds with the remaining being filled with equity
  • Requiring that LendCo use equity first (critical)
  • Requiring that LendCo get approved legal opinions from the borrower on loan enforceability in that jurisdiction (w/ State specific requirements)
  • (just to name some)

Why does this matter?
If we look at MKR as a decentralized governance token, we could step back and look at this in reverse. What happens if LendCo fails? What happens if LendCo had a traditional revolver that collapsed the bank? If we take that bank that failed because it had a credit facility that failed, how would that money be recovered? Answer: An appointed receiver would foreclose on the assets and the bank’s receiver would get the proceeds. For a MKR revolver structure, the trust agreement and trustee would encapsulate the value pursuant to an executed revolving credit facility agreement and return the DAI. That is to say, the revolving credit facility agreement embodies a lien over the entire LendCo. So as a fiduciary over the equity, I must do what is in their best interest (and the revolver is senior to their position)- leaving MKR protected. The Senior money gets paid back first.

Wait… are we not reverse engineering how a CMBS works?!
Yes somewhat, we are. A CMBS is security that a trust company maintains that follows a previously agreed upon trust agreement and should any of the collateral inside that trust fail, the trustee is authorized to divest those assets, recover what they can, and pay the owners of the securities in accordance with the agreements (e.g. tranche). That said, we are in fact actually closer to reverse engineering a bank without a depository aspect.

Point being, when one looks at the cognitive load on providing these net lease loans, it does not make sense for Maker to ever provide these directly. However, it makes all the sense in the world for MKR to be setting up a revolving credit facility for a Lender that has the equity needed to be the buffer for protection for MKR holders. Further, a revolving credit facility agreement provides all of the required disclosures and reporting requirements that the MKR community would need to assess the continual risk which must be delivered periodically per the revolving credit facility agreement. Having an authorized party execute both the revolving credit facility agreement and the trust agreement (when agreed upon), would allow MKR holders to keep control at the MKR level, have the desired reporting requirements on the borrower, and always retain the ability to hit the “red button” (i.e. liquidate the Vault) should any fraud, misconduct, or any other reasons to trigger the provisions in the legal agreements to action accordingly.

It is important to note that the current plan would have LendCo be capitalized w/ 30% equity to be married with 70% debt from a MKR revolver, and THEN lend that out at 100% loan-to-cost to a borrower (for new construction, modified for refinance as the risk is lower). Even during the worst part of the 2008 financial crisis, stabilized credit tenant leases with solid tenants never dropped more than 15-20% of their value before rallying to a 10% premium 6 months later. So if for some reason we had to do a firesale, the equity in LendCo would get hit before MKR. The rates should reflect this risk.

Having been personally on the borrowing side now for multiple deals and growing, the time is right for me to launch a LendCo and secure a revolver. We have a “captive” developer and pipeline of transactions (both as refinance candidates and new construction) as well as another developer (and its pipeline) in the works.

So would you just be doing what a bank would do with a revolver and replacing it w/ a DAI loan?
To an extent, yes. BUT with abstracted community rights enforced (if needed) via external trustee triggered by smart contract (via MKR governance).

Critical components that are essential for this to work:

  • Keep it efficient w/ control at the top (with governance & an executive vote)
  • Rate sensitivity (more on that in another post)
  • Incremental growth (start with a low debt ceiling)

It will be a learning curve for both Maker and LendCo initially and the projects we do are risk distributed, small capital bites in nature (no skyscraper finance here!). Each project is decently small with the aggregate of the number of projects being a reputable amount.

Interestingly enough, for the above structure, the majority of the risk is in getting started. From a practical standpoint, LendCo with one project and one senior lien (as an asset) has more concentration risk than if we have 20 projects in parallel. The concentration risk dissipates the larger the structure gets.

In addition, as the lender, we will require from the borrower a certification that all attempts will be / were made (within reasonable economic constraints) to fulfill sustainable environmental objectives. Initially, this won’t have a huge impact, but over time, it will. Further, our objective will be to take the above construct and expand to lending in the renewables space (save that one for another post!)

Today, it is easy to get distracted by the question about what impact does COVID have on your business. While the answer thus far has been basically zero (as that question is really focused on the tenants, to which all of them thus far have been recession-resistant and covid-resistant), the real focus for the discussion in this post should be about the structure, legal, and risk mitigation.

Once this nut is cracked, the scale and volume of deals will come in from other participants. I aim to be first, but I will most certainly not be the last party to ask for the above structure. Make no mistake! We can deploy decentralized originated capital off-chain and compete toe-to-toe with existing financial institutions. In doing so, we cause a constant flow of capital buying and selling DAI to further strengthen the peg!

The above structure is being done today with banks (but without the trustee component). I recommend setting up a new collateral category called “Revolvers” with a sub-category called “Commercial Real-Estate”. The emergence of off-chain revolvers is about to start for MakerDAO.

I encourage any of you (individual / group) in a public or private manner to reach out to me to discuss the above. When viewed individually, not one item in this is “hard”, rather there are many small parts that look way more complex than they really are until you break them down.

My goal is simple and straightforward. Engage the MKR community directly, bluntly, openly. Answer questions, address concerns, modify documents accordingly, and ultimately get a “deal done” that would grant a decent revolving line of credit in favor of LendCo with all due reporting requirements going to MKR authorized representatives. All of the legal documents to accomplish the above are there (but need customization). Securities counsel has been engaged to draft as needed. The mental gymnastics on how to do this are complete. Now it is time to engage, discuss, debate, document, agree, and build.

Let’s roll !!

(note: apologies for the length of the post. there are many things that got left off of this post including but not limited to tax implications. The above was me trying to keep it short!)

16 Likes

@mrabino1 thanks for posting this and I wish your new company all the best! The mechanics as you describe it sounds remarkably similar to what Centrifuge is doing with regards to tokenization.

Here is just one Centrifuge example, there are multiple others.
[CF-DROP] MIP6 Application: ConsolFreight DROP: Tokenized Freight Shipping Invoices I dare suggest you have a chat with @spin

How would the revolving credit facility interact with Vaults? Are you going to create a LendCo-coin?

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@Planet_X I am in discussions with the Centrifuge team although not clear which direction things will develop. What is outlined about has a similar ethos although drastically different with regard to how MKR holders engage, risks taken, and are compensated. For example, in the above LendCo structure, the company is capitalized with external equity (nothing to do with tokens or an ICO of any sort) and the risk profile is different. Further, the underlying DAI loan (or credit facility) is provided is fundamentally collateralized against the balance sheet of LendCo with an unconditional irrevocable assignment of all LendCo rights in favor of the trust that is setup for the benefit of MKR for this structure. (note: all of LendCo’s rights include the first position lien on the underlying real-estate and the assignment of rents from the lease, etc.

An important note is fully capture that what is outlined is not truly “new” rather it is applying what has been done for CMBS and ABS but for a credit facility and a DAI loan, so the legal component is mostly known (less customization).

The exact technical implementation on the above is still open. Frankly, the tech sequence is probably the easiest part. The real objective is work out the sequence with the community to allow the average (non-crypto centric) business to “apply” for a facility with common reporting. The point being is that MKR governance ultimately will be able to review the required reporting requirements pursuant to the credit facility agreement to determine if LendCo (or others like it) is in breach of its requirements.

The discussion I hope to develop will surround how MKR should / could compliment / supplement / replace the existing credit facility structure that exists in the analog world.

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This seems very exciting, and I wish I had the know-how to ask smarter questions about it. I would say this:

Is a key advantage, especially in the current state of things where much of the DAI minted is immediately locked into other on-chain protocols and doesn’t end up helping the peg as much as it perhaps should.

Can you speak at all to the actual path from where we are now to having something like this available to add to the protocol? What needs to happen? What is the timeline like?

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@LongForWisdom, no worries. I want you and the community to ask questions. The contemplated structure would be to basically replace a credit facility from a bank. Therefore, in my eyes, causing the creation of DAI to then put it in other on-chain protocols is not the objective. The goal is to cause the creation of DAI to be sold for US Dollars to then deploy that USD in the underlying business (like a typical credit facility). In a standard revolver, the bank is collateralized with the assets of the company (and for real-estate they will want a “cut-through” agreement that grants unconditional irrevocable rights from LendCo (basically a pre-negotiated divorce, just in case)). Further, the bank with a traditional credit facility agreement will have quarterly officer certificates and reporting requirements and financial statements (audited) , etc… The goal here is to have MKR abstract the same degree of comfort as banks today with the same rights albeit modified for a decentralized structure.

RE your comments on next steps and the path, and timeline.
At the core, this will require the community to

  • get comfortable with the contemplated structure
  • get comfortable with the underlying collateral
  • agree on the core of the language of the documents
  • decide which metrics should be tracked and the frequency to track those metrics
  • secure an agreeable trustee to represent the interests of MKR holders
  • and nominate a human (on behalf of MKR holders) to execute those agreement on behalf of the MKR community (not me, but I suppose it could be).
    (that is just to start)

Estimated timeframe for all of the above is truly community sentiment driven. We have already started on many of the parts above (including which trust company). That said, I estimate this should take a few months. None of this is truly “new” rather it is the implementation of all of it together that is new.

Once solved, this can be re-used for others that will come after. This is the tip of the spear.

While text and the forums are excellent for consensus, some of this will require a more interactive forum (zoom mtgs) where folks can ask questions directly. We may want to setup additional collateral calls (or add to the end of the governance calls).

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Matt, thank you very much for the contribution. I personally think this is a great use-case for Vaults. Do you happen to have a diagram showing all the moving pieces here? I think that would help a lot.

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In line with @g_dip’s request for a diagram of the structure, I’d like to also request some examples for how the governance flow would work? You mention strict audited reporting, will those reports be publicly available to MKR holders and if so what information could we expect to find in the report.

Once the rough structure diagram and more details on reporting are in place, my next goal would be to try and document all the risks. From a brief read from your post it seems like:

  • Asset risk (greater than 30% downturn)
    • How is the 30% buffer maintained, are you constantly adding and removing equity from the company?
    • Average deal size (how much credit do we need to extend so that LendCo can de-correlate.
  • Counterparty risk
    • Is this completely handled by the legal agreements?
  • Legal/Reg Risk
    • At what points could MKR holders fail to exercise their claim on assets. What is the likelihood of something going wrong here.
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@g_dip @OliverNChalk please see the below rough outline of each of the moving parts (it looks worse than it is). Like DeFi money LEGOs, when you break this structure down into its components, each is relatively easy to get your head around. When you first review the structure as a whole, it can easily be overwhelming (no different than CMBS looked when it first launched!)

Let me address your points:

The credit facility agreement would be executed between two parties (LendCo, domestic & offshore) & the MKR trust representative). The MKR trust representative needs to either be a legal entity or a person appointed to execute the agreement on behalf of the trust (basically limited authority granted to sign). That trust agreement would embody all of the rights for liquidation etc… and allow the Trustee, acting on behalf of the trust to liquidate in the scenarios of X or Y etc. Those would include (but not limited to) MKR governance deciding to liquidate the vault.

However, that bring us back to the credit facility agreement. These agreements are not new. They have been battle tested and are well refined. They typically have two parties (although you could have more)… The borrower and then lender(s)… For large companies, there is typically a participation group of more than one bank (so they diversify their risk). These credit facility agreements include all of the reporting requirement that the borrower must deliver in a timely manner to the Lender (independently reviewed quarter financial statements and annual audits)… In addition, the Borrower must deliver a quarterly (typically) officer certificate from the borrower outlining the entity is in compliance with the credit facility agreement (emphasis on the debt to equity ratios, and others). For a new facility, a bank will ask to see the corresponding support for that statement. Though after a few years, they start to just rely on the quarterly financial statements and annual audits and officer certificates.

Here is a slight rub that we should address directly. For banks, borrowers are protected via strictly held bank privacy rules where information is to remain private. For MKR the reverse challenge presents itself. How can we build a decentralized facility with off-chain lenders where information needs to remain private. Well, mostly private. I believe the answer lies in some form of spot audits with community approved selected representatives that can attest to the compliance of the borrower without disclosing the audit opinion in its entirety. So, instead of transparent finance, this may end up being slightly translucent. Point being is there must be a check and balance. Instead of re-inventing the wheel, the community should use a standard credit facility agreement (emphasis on the reporting section) as a framework to start. We will have to modify many aspects, but it is a great place to start. Similarly, for the trust agreement, a Delaware statutory trust will need to be utilized to ensure the bankruptcy remote protections for the MKR holders.

Going to your questions specifically:

Asset risk

  • The equity is maintained and disclosed quarterly via required reporting to the community. Capital is being raised to ensure compliance here.
  • Average deal size: These are all small “bites” of credit quality. On the small side, a deal might be $2MM with the upper end being $5MM. The key for any lender (or credit facility) is the pipeline and geographic diversification.
  • Counterparty risk is handled with legal agreements and a senior lien in favor of LendCo for the underlying real-estate (to which the end borrower cannot sell the project unless than Senior lien has been released which can only happen when they pay back LendCo
  • Legal Risk - LendCo has a lien on the assets and the trust created has a “cut through” agreement with LendCo. The cut through agreement is basically an irrevocable unconditional assignment of all rights that LendCo has. Humor to tangent for a moment, but I believe it an important one. For every lender that transfers money to a borrower, a borrower is giving rights to the Lender. So for this scenario, LendCo is putting up money to allow BorrowCo to acquire the dirt (but LendCo gets the senior lien). Further, BorrowCo agrees to the loan agreement and the promissory note. further, they give an equity pledge and a completion guarantee in favor of LendCo (and other agreements). Point being is that while capital is now allocated to BorrowCo, LendCo has a bunch of rights enforceable on BorrowCo… and BorrowCo has the motivation and obligation to perform pursuant to those agreements. ALL of those rights are ALWAYS assigned unconditionally and irrevocably to the MKR trust… so should LendCo fail (for whatever reason), the equity at LendCo is the buffer… and then the trust can recover the rest. Those right that BorrowCo gives up only last until the loan has been repaid, as the objective of all lenders is to ensure the repayment of the loan.

What are the chances that something can go wrong? Legally, nothing is guaranteed. However, if we

  • put in strong internal controls
  • ensure that the equity buffer is in play before a credit capital call is used
  • pick good well capitalized seasoned developers
  • require GC mgmt as a function of ALL deals
  • pick good tenants with strong balance sheets

we can significantly de-risk the transaction as a whole for the equity in LendCo and for the MKR token holders.

2 Likes

From a practical implementation, can you talk through how LendCo would mint DAI? Maybe have a think about:

  • Private key risk (if MKR holders extend credit to a particular LendCo address)
  • How does LendCo guarantee it will not breach its equity to debt ratio by taking out a DAI loan?

Then, what does the actual implementation of this look like? I imagine it would be different from the typical collateral vault model and would act more like a line of credit to LendCo?

Can you envision a scenario where the balance sheet of LendCo is tokenized and then used as collateral. I.e. you would have a taken that represents the 30% equity and 70% debt component. Then the vault structure would look a lot closer to the existing ones, or one of Centrifuge’s DROP tokens. I fully understand it might not be feasible but would like to understand why not…

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I am going to intentionally skip the raw technical implementation… and abstract slightly above to focus on the business side. LendCo can only mint DAI w/ a community approved collateral with a known debt ceiling that has not been hit. For the banking world, the debt ceiling is just your revolver credit limit. They function precisely the same. From a practical perspective, the plan would be to have a hardware wallet (with appropriate OpSec and redundancies etc) with a known basically whitelisted ETH public address for LendCo (domestic / offshore) with that address having some known whitelisted ERC20 that is used to cause the minting.

  • Private Key Risk: As a fiduciary (and a paranoid one at that), I have complete alignment and every motivation to have the DAI in that wallet for as short a time as possible before getting it to an exchange to convert it to fiat (and ensuring a regulated exchange is used). Even if initially we are realistically only talking about draws in the $500k area each time, it doesn’t matter to me. Risk is risk until it is someone else’s risk.
  • LendCo equity to debt ratio: As real-world asset collateral becomes more prominent, the historic crypto “privacy by obfuscation” becomes irrelevant. For this structure, the entire community will know who I am and what I am doing. There is no privacy, rather there is:
  • direct consequence which will eviscerate my business if that credit agreement is breached
  • no “guarantee” per se, but there are many ways that we can mitigate the risk.

Ways I am thinking that would help mitigate that risk would be:

  • to always require the equity to be deployed first (as a covenant to the credit facility agreement)
  • grant spot inspection rights to the MKR trust to be able to watch the transfer in person
  • have a known “path” the funds will travel from newly minted DAI to fiat
  • similar to the reporting requirements in the credit facility agreement, at least to get started, it makes sense that a community approved individual(s) review each transaction
  • Criminal recourse. While not fun to talk about, we should. As a fiduciary, I am personally known and on the hook as an officer of LendCo for misconduct.

RE the actual implementation, it would be Vault like others, but with one collateral with a known debt ceiling plus the tech implementation. But functionally, it would be a revolving line of credit with reporting rights and inspection rights that should there be a material breach or concerns about fraud, the community could “hit the big red button” and liquidate the vault. Technically, that would not do anything, per se on the blockchain. However, it would trigger the trustee to follow the trust agreement that governs that MKR liquidation initiated section which would have consequences.

RE the comments on tokenization. Technically is it possible. Yes. That said, given the nature of securities laws and given the size that we are trying to accomplish with this structure, I believe that it will provide less recourse to MKR holders if we go down that path. LendCo is a Series limited liability company with each Series having its own series supplement. By consolidating the assets (the liens and all of the rights from the many borrowers) into one location, a trustee (if a foreclosure is triggered) given the “cut through” agreement will be able to basically slice through the LendCo to foreclose on ALL of the underlying assets more easily than if we try to have hundreds of tokenization structures. Put simple, if that big red button is pushed, it is a parallel foreclosure. Moreover, we would need to find a trustee that would then understand tokenization. With contemplated structure above, the trustee has seen this hundreds of times and knows precisely how to foreclose on real-estate assets and return the most they can in favor of beneficiaries of the Trust (in this case MKR holders).

Further, tokenization of the equity just introduces regulatory risk and KYC risk. I am trying to minimize all of the risks.

2 Likes

Wow. Nice write up and introduction!

I through mutual friends in the SFR markets happen (these players happen to live in our area personally) to be rubbing elbows with much larger players that basically are doing exactly the above but using banks for the revolving credit.

I think the rub is going to happen at these points:

Some of my research with decentralized organizations had legal operations define a ‘position’ that had legal authority and then defined certain people the authority to execute contracts for the DAO. (i.e. contracts for deliverables, to sign off on reporting requirements, be the point of contact for that client vs. a client having to deal with multiple people, etc.) This is very tricky to structure and often times the legal and statutory requirements for the individuals in these positions precluded them from being able to make these kinds of deals the qualifications and/or the legal/statutory responsibilities being a seriously insurmountable hurdle to growing the business dramatically without restructuring the DAO into a CAO of some kind that was legally incorporated somewhere. My research at the time (1990’s was quite limited and no companies I knew of were sizable at the time - I think this is still true today).

Point 2 that is also going to be a significant problem for MakerDAO here.

This is another significant problem I have encountered with MakerDAO generally. How it can do anything in secret. I am not just talking about darkfixes but who do people report issues that need to be dealt with secretly and how does the DAO deal with anything that requires privacy and secrecy.
There is also a general issue about how private information is handled in various geographic jurisdictions, where this information lives, how and who accesses it, etc. Again this one is going to come down to counter party risk and trust which stands in contradition to a fully open and transparent protocol and decision making. I have thought long and hard on this one issue and the ONLY way I can see this is to somehow build trust intermediaries that basically are bonded somehow against trust failures. This really is where the rub will be in finance since capital allocation has to be efficient and ‘bonding’ doesn’t play well against this type of capital use optimization. I believe this becomes magnified in the crypto space because there really are no trust brokers by definition, systems are designed to build in trust in different ways and I don’t have a good idea for how we do this in the above model.

I will say that I have been thinking pretty hard about how to grow this entire space that a solution to the ‘trust’ model is going to be key to moving things like the above on to these chains.

Lastly at least for the moment because I am still digesting the well thought out introduction and explaining your interest here is a question that was brought up in the DROP tokens by someone else.

DAI is backed by collateral that during an ES is distributed with all collateral to DAI holders. I literally don’t think DAI holders can assume they will legally be able to get a piece of this collateral in the event of an ES. I have i my own analysis work a concept that contrary to what a lot of people think here as the Maker system grows in complexity there will be real reasons NEVER to have an ES. It simply won’t be possible or will add such complexity as to not be feasable when considered against other more easily distributed collateral types.

I have been thinking about ways to get around this but for now rather than bring any of these forward will leave this topic open for discussion.

I think conceptually what you are asking is for Maker to grow up enough to literally be a fully functional bank and provide your company the revolving credit line. I think the hardest issues are going to come back to some basics.

Valuation oracle of the collateral against the credit extended to determine if the loan is well collateralized or whether it needs to be liquidated (such liquidations are a rather nasty and convoluted mess in complex banking structures as the risk reaches down through a number of counter parties that have to be deal with through legal system - i.e attorneys in jurisdications with parties that have legal rights to file for claims).

Liquidation counter party risk (i.e. who is going to legally be able to act as the loan insurer here and put up a bond on such a revolving facility) as well as overall DAI market liquidity risk trying to take on these loans.

Reporting issues/trust verifiability (ala who will verify and check data - this inherently increases overall cost to carry out this kind of business).

My last point is a general consideration point regarding goals of Maker. Everyone wants to grow the system here organically. What I don’t think I have ever seen is a kind of loan or vault report that shows what our loan profiles look like. It is my expectation that Maker is dominated by whales that take out the majority of the loans and the little fish are minor players here. Is it the case that the community would rather grow the system here via a few very large players and hope over time this grows out for the smaller players the original goal papers discuss with Maker. Can having a system dominated by a small number of players balance or somehow make things better for smaller players to fulfill one of the primary maker goals of being a bank for everyone or are we stuck with trying to be a bank for the bigger players so that ‘someday’ we can also be the bank for smaller players.

To be clear I don’t think these have to be mutually exclusory but it is my suspicion that practically they will tend to divide classes and every good business man would rather have a growing number of large clients than to try to serve millions of smaller ones. Maker as the fast food McDonalds of loans to the underserved or Maker as the premiere bank providing services to predominantly larger players. I honestly see this practically as two very different types of banks and so I naturally come to a conclusion that the big Maker bank really needs to operate and be open to possibilities that a bank for the masses really doesn’t and so it might be that having two different MCD structures, governance, and maybe even DAI might be appropriate because the players and their requirements might be suffciently different from what is required for the smaller bank to operate. In effect it might be easier for a MCD2 specifically geared from inception to deal with these issues and work with a slightly different asset (DAI2) that could also be used cooperatively with MCD1 might be a better approach to growing the greater MCD Maker DAI ecosystem than trying to lump what is probably legally and operationally something somewhat more complex MCD2 with MCD1 into MCD proper.

While I can hear the gnashing of teeth (no please once Maker and MCD is already enough, yes we can somehow do all of this). Realize that the growing demands on an ecosystem which right now only has one income stream to support all activities (the surplus) and we literally are looking at expanding not just system operations, quality assurance, credit checking, appointing legally bound trust representatives, etc. really has limited resources unless we start minting MKR and paying people with that.

Generally I want to see something like the above succeed, but the operational and practical considerations on some of the key points above I think are going to require not just people with the right qualifications, but a hell of a lot of DAO bandwidth to hurdle.

I would love to see a kind of what needs to be done timeline on something like this. i.e. RWA plan that deliniates all the hurdles that have to be overcome in a sequential or parallel step-by-step fashion. It might also be nice to see a kind of story write up of how someone would envision this would work ignoring what isn’t there now in terms of the things and people/positions needed in the DAO to provide a kind of ‘vision’ for the future on this.

I know these are all big details - but this is a pretty big project and significant work needs to be done within the DAO to accomodate both the personelle issues as well as practical legal and financial issues to get from inception to actual use. I wonder if there is a way to do this in smallish steps. Envision how Maker could do one of these and then look at whether there are issues that come up doing 10 or 100 of them.

All I pretty much have on this off the top of my head. I am excited to see these being brought forward but also daunted by what would be required by Maker DAO to be able to become a legal bank that can offer revolving credit at these kinds of levels. The whole jurisdictional and licensing part of this I honestly can not wrap my head around from a DAO perspective.

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I wanted to add one thing seperately.

Amazing how much detail in your thinking on how this works minimizing Maker risk as well as Trust, liquidations and being open about the details about how you see this working with you and your company LoanCo putting itself forwards as a risk carrier via 30% capital requirements as well as the primary manager. This is exactly how I expect a centralized company to operate generally and how these deals are structured and done. What I wonder is if this opens up whoever LoanCo rep is to a lot of DAO hand holding or whether the structure (from your perspective) would be better to have the MKR Trust representative deal with Maker DAO and you deal exclusively with the MKR Trust representative. However this is structured someone is going to have to act as an intermediary between Maker DAO and LoanCo with a ‘great many things’ a number of them which would have to remain private for privacy reasons.

Finding the right person for such a position will be hard enough, for the DAO to commit resources in an extended time frame (you can’t just have people hopping into and out of the Trust positions like the Governance Facilitator) may place an out of reach high demand on the people in these positions. It is already hard as a centralized entity to do this, but to interact with a DAO that can be slow, fickle, and not demonstrating they have resources to even commit to put up people here may be the primary stopping factor for much of this.

Honestly my reaction to many of the larger projects is that it would be prudent for one or more large MKR holders to step up here as a backing entity for work on such a project since it is going to require highly focused effort putting together a real plan and then presenting and selling it to governance. I have often considered it would have been extremently helpful to have a MKR whale in the compensation plan group since then at least we know we have at least one MKR whale that is in support otherwise a lot of work can literally go away at the drop of a governance hat and I really don’t like seeing smart, well meaning and hard working people do a huge amount of work only to see it stopped in governance for lack of MKR support.

I have to wonder why you personally think this is important enough to get through Maker to risk doing all the work with a not so high probability of success. What do you think Maker can bring to your business that simply getting a revolving bank credit line can’t offer that makes doing all this work rewarding?

I have this nagging thought that if I were in your shoes I’d be lining up one or more bank facilities and just hope that perhaps through everything else you are building that perhaps Maker DAO can at some point be brought on line. I would not want you to have anything here for any reason stop your business from going forward with or without Maker.

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@Maker_Man So many points to address, I am going to focus on the critical ones for now and address the remainder in due course.

DAO needs a point person
For a Delaware Statutory Trust to be formed, it needs the signature of a human being. This would be an indemnified role that the community would nominate a person (via executive vote) in the capacity of “Authorized Person” to engage a Trustee (*) to do the following things:

  • Execute the Trust documents (thus creating a legal structure)
  • Request the Tax ID number
  • File annual tax returns
  • Execute the credit facility agreement

(*) - One important aspect that I may not have addressed sufficiently is that MKR would be forming a Trust to embody its rights under the Credit Facility Agreement (and cut through agreement). The Trustee (which will be a regulated Trust company) will then oversee the trust in a fiduciary “standby” capacity. Thus, the nominated person from the community does NOT do any of the foreclosing nor does he / she run the Trust. That must be outsourced to a community approved and well-established Trust Company. This is no different than an CMBS / MBS / ABS structure. Trusts have long been used for groups of people, a DAO is nothing more than a technologically advanced loose group of people. That Authorized Person would have to be a known KYC / AML approved person for the Trustee to engage.

Whales vs. Fish
From a MKR token perspective, what is interesting about the structure is that every area I can think of, has been de-risked to put MKR (via trust proxy) is the Senior Position to allow for maximum risk mitigation. That said, the risk premium that is ultimately decided-upon represents MKR burn potential. This burn impacts large and small MKR holders alike (of course in differing percentages). That said, this structure is how we can scale DAI without needing to materially change the cognitive load to the MKR community. MKR holders via an agreed upon credit facility agreement outline what reporting information is needed and with what frequency. The analog banking world of course does not have an “Oracle” issue. They push that information flow requirement on LendCo to provide a stream of information (usually quarterly) to allow them be able to determine if the “big red button” needs to be pushed. Point being is that there is a large amount of work up front, no doubt, for me and for the community (to do this with a bank at full speed is ~3 wks of legal engagement). However, once documented, this can be replicated. I am not the only one that is going to ask for this structure. Anyone can ask for this structure (regardless of MKR holdings or none at all). This is attractive to me for my business to engage with MKR fundamentally as the time horizon (open) and cost of capital efficiencies justify the time engagement.

Transparency vs Attestation (thus Translucence)
Totally agree that this is a community challenge that we should address directly. The LendCo has access to certain confidential documents and information that cannot be made public. No real way around that. At the same time, the community needs to get comfort in that reporting requirements have been met and that nothing is in breach. Whether it is community driven or foundation supported, we must find a way whereby an Attestation can occur with a community approved Attester(s). That person or people would need to execute certain confidentiality agreements with LendCo and then affirm to the community along with my officer certificate affirming that everything is in compliance and nothing in breach. I am completely open to hear from anyone a recommended solution on this. Some of this has been discussed RE a dark fix.

Scope of this structure
Yes, this is a big project with BIG ambitions. While the initial debt ceiling will be small compared to the DAI outstanding, over time revolvers like this will be used to interact with the real world and be a pressure relief valve when we have too much DAI purely in the crypto world. We are experiencing the scenario right now where we know we cannot increase the rates on certain crypto collateral as we know it will break the peg upward. That said, we also know that MKR is taking risk that really should be compensated for via the Risk Premiums. The paradox has now led MKR to having almost zero RP across the board and the peg stubbornly above the 1:1 target. Real-World Asset revolvers (like this) are the escape valve to not have the water overflow the dam.

To your point about starting small, the credit tenant lease is specifically attractive for this structure as each transaction is small-ish in size but still represents the full credit of the underlying tenant. A typical credit facility agreement from a bank would start at $25MM and works it way up to whatever is needed and agreed upon between the borrower and the bank (or their participation of banks). As I mentioned at the beginning, counter-intuitively, the larger this structure gets, the more secure the equity and MKR holders are as the assets in LendCo (the loans and the liens) are diversified across more projects / properties.

BorrowCo
The true objective in this endeavor is that BorrowCo at the end of the day has no clue where the money came from other than to say that it came from LendCo. BorrowCo is in not in the finance business, LendCo is. They are in the real estate development business. LendCo engages with BorrowCos and MKR holders. BorrowCo just engages with LendCo, so they never engage with a blockchain. Then to scale this, LendCo is not only engaging with BorrowCo but multiple BorrowCo(s) at the same time. Dozens.

Given the LendCo structure and equity buffer and incentive alignment, LendCo can efficiently deploy capital into the real-world while generating value for MKR at the same time.

As the community digests the contemplated structure, I am assembling the list of “To-Dos” and the estimated time to accomplish them. I do not expect that many in the MKR community have ever seen a credit facility agreement nor have they reviewed a statutory trust doc (or know why we will be using a statutory trust instead of a grantor trust). There will be many questions, to which I endeavor to answer as many as I can.

This will be somewhat “awkward” as in many ways the community should seeks its own counsel to have all of the documents reviewed and at the same time, it should also request that I provide a version for the community to review. (In many ways, I will be negotiating against myself!)

RE the pipeline of deal-flow, there are transactions that I could use this structure on tomorrow. Of course, regardless of community sentiment, nothing is going to happen (nor should it) for a few months. This is important to get right, as it will be replicated, and at the same time, not dwell on perfection. We need DAI deployed in Real World Assets soon!

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