Investing our liquidity in short-term ETF, managing PSMs exposures

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Summary

After polling on the idea to invest in financials assets here, it was incorporated in the RWF strategy (the Scalable off-chain investments bucket). It was also discussed with the RWA Committee this week. This post provides more information on the current status.

The idea

Even with the bull run resuming, we still hold more than 50% of stablecoin on the balance sheet. This is a strength for the peg, but doesn’t generate any revenue, is a concentration risk, and is bad PR.

Institutional vaults and “regular” RWA might, at some point, solve the problem but it is impossible to expect perfect balance sheet management with such tools. You don’t fire DAI supply in short term. We are extending the credit line so we also need a buffer.

Therefore, we will always need a buffer of liquidity (defined as any assets that can be sold in short term to keep the peg (from a few minutes to a few days).

The final idea would work like the diagram below. For each fiat-backed stablecoin PSM we would define a target DC (let’s say 3% of DAI issued) with a min/max range (2.5%-3.5% for instance). When the DC of the PSM is above the the max target, the excess (possibly converted in DAI) would be send to a cryptobroker to be converted to cash, send to a stockbroker and invested in a ETF. We would increase a ETF-A vault in our system. The ETF would be a short term investment grade bond.

The opposite can be done when the a PSM is below a min target. This might require human judgement (MKR executive).

This way, we limit our exposure to fiat-backed stablecoins to a defined level. There is a counterparty risk with the stockbroker and the ETF. Nevertheless, even $1B would be small.

Were are we?

Legal structure/KYC/AML

The idea is to leverage the work done on the RWA Foundations. The first, RWA Foundation, used for SolarX, is incorporated in Caymans and all the corporated servicers have been appointed. They are currently working on getting a KYC/AML package for US Bank (which is not used here). If we pass US Bank KYC/AML we should be good to move to other providers.

There is still the formal Articles of Associations to be implemented and defined the MakerDAO/RWA Foundation communication processes.

The final setup will have a to be rubberstamped by a global law firm.

The legal entity would have nothing to do on the DAI → ETF way (beside accounting). For the other way, I’m not sure a stock broker will be able to take the decision itself or take direction from a third party (i.e. MKR executive). So the legal entity will have something to do.

Cryptobrokers

We have two leads but waiting on the KYC package.

I’m still trying to find a global servicer provider that could take DAI and deal with everything. So far no luck.

Stockbroker

Not much work here aws being done. Waiting on the KYC package and the actual ETF selection to find the best partner. The ETF providers are able to introduce us.

ETF

I had discussion with VanEck and Vanguard at this stage. They all favor the use of an ETF (versus a managed account) for simplicity and cost.

Both are low duration risk (duration < 2 years), with exposure mainly US (but not only which adds diversity). Both are able to provide 100M of volume over a day if we go through a market-maker like Jane Street.

The proposed products are the following:

In order to add an ESG product:

So it’s about scale, reducing/managing the USDC exposure and getting some revenues (but not much in the current environment).

The risk is up to a 5% drop which was seen during the Covid crisis. It was not that bonds defaulted but credit spread increased and there was strong liquidity issues. In normal markets, not much happens. This remains to be analyzed.

We can go higher on the quality ladder but we would get nothing in return (there will be structure/trading fees).

Smart-contract/Oracles

The poll was to go forward with MIP21. I still have doubts it would work at scale, but we can start experimentation with that. I’m drafting a study on how to fix this problem (at least to frame the problem).

Next steps

Assuming there is no strong opposition, we will continue working to move the project forward.

Feel free to provide comment and ideas.

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This is undoubtedly positive, and I see it as news, as the most important DEFI protocol in the market is making a strong impact on the traditional market.

I like the idea, and I would support it wherever I can.

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I recently listened to a podcast about custom ETF baskets. It sound like custom ETFs could be a way to filter by our ESG criteria, but I have no idea if any large players are offering custom bond ETFs at this time.

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Is it fair to say that we are substituting exposure on a money-market type of security (USDC) with another money-market type of security (short term high quality bonds thru an ETF)? Still, I believe there’s a benefit in terms of extra (small) yield, some currency diversification, and reduction of counterparty risk.

It would be still interesting to read a risk/ return analysis that includes duration risk (with rates where they are even short term floating bonds run duration because of the delta effect on the principal repayment), liquidity, and complexity.

I believe that an efficient use of maker’s balance sheet / available liquidity is welcome. But aren’t there crypto-native ways of using such a liquidity? Or wouldn’t those help the peg mechanisms?

Looking forward to hear from the team, keep up the good work guys.

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Investing some of the surplus into ETH itself can be a good idea too since we all believe it’s an asset that holds value very well.

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Thanks for putting this together Seb. Would love to see the DAO start leveraging it’s balance sheet and putting the large amounts in the PSM to productive use, while also reducing counterparty risk. What are you thinking of in terms of initial amounts for these ETFs?

I would also love to start experimenting with DeFi native yield opportunities (depositing USDC directly into AAVE, Compound, yearn, etc). Of course these come with different risks, but we can start small and scale over time and earn significantly higher returns.

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Custom baskets can be expensive. But if you’re strictly reducing breadth of investments to a specific set of ESG criteria, may be the best option to stay adherent. To Luca’s comments, sounds like there was drawdown analysis done for the ETFs selected over the past ~2 years (mainly dealing with March 2020 reaction) - suppose it matters if the liquidity is expected to be used in short-term or if it’s more expected to be accumulating unless some outside scenario determines it would be needed (thus the short-term nature).

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It will be gradual starting with 1M. Currently, the upper limit is $1B assuming a max drawdown of 5% (as the Surplus Buffer is a bit above 50M).

Obviously, we can go lower on risk to have more exposure but that would lead to quite the same result at best in term of revenues. We could also avoid using mark-to-market but it wouldn’t be good for DAI transparency (even if mark-to-market is far from perfect).

USDC is safer on the investment side, less on the operational/regulatory side.

Crypto-ways are difficult to implement. You can buy aDAI but then you are kind of delta-edged at scale so very little impact except on borrow rates.

There is no safe $-denominated asset in DeFi beyond fiat stablecoins (and their lending derivatives).

The etf return seems to be miniscule and not worth the effort. Makerdao is better off depositing the usdc into celsius, coinbase or one of yearns protocol for greater than 4% apr.

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