MIP39c2-SP23: Adding the Deco Fixed Rate Core Unit

Still waiting on a few key CUs to send me their expenses for September, but high level YTD revenue = $82.2M, expenses = $4.6M which is 5.6%.

Kodak had to 4x their cost base to sell digital cameras when there were alternative options to not increase the cost base?

Let’s not forget that there are multiple fixed rate implementations being proposed, including proposals from @akiva and @niemerg. I don’t see why we shouldn’t do a RFP as @SebVentures proposes and pick the implementation with the best customer experience and economics.

I know Maker Governance has no clear way to negotiate with MIP authors, but it’s my view that every CU MIP that is passed should have incentives that are fully aligned with MKR holders. To be clear, I am not against providing Deco significant upside if the product is successful, I’m arguing for capping MKR’s downside.

There is no reason to approve a compensation plan with incentives are not fully aligned with the best interests of MKR holders when we have the flexibility to implement something that fully aligns them. It is simply bad business to make any deal where we’re giving away a call option or perpetual royalty.

Doing so would set a disastrous precedent - should the RWF team revise their compensation plan to include a 15% revenue fee on all RWAs onboarded? Should PE take a 15% cut for every new product they create? Should Growth get a 15% revenue cut for every new IV client onboarded?

CC: @ElProgreso @Planet_X @MakerMan @monet-supply @twblack88

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Thanks for your message, @aes. You’re touching on a lot of exciting topics that are very relevant for DAO.

@SES-Core-Unit is planning on researching and publishing more about these. More news to come soon.

The comments below do not refer specifically to the Deco Proposal.

Product Development - Cannibalization

I’ve heard the Kodak example several times, but I haven’t researched it in-depth. It was just an example (maybe not the best one) to illustrate that we should not stop product development with the cannibalization flag.

Keeping Costs on Check

We are both aligned on this topic, as we have discussed this at length. We even addressed the possibility of spinning up a Core Unit to do this activity on an ongoing basis. This practice should not only be done before the proposal is approved but also continuously.

What each Core Unit is spending and the value they bring to the Protocol should be investigated and brought up to the MKR holders (especially the delegates).

Request For Proposals

I love this idea. I can see a working group or some Core Unit handling those in the future. I have personally participated in several RFPs, and they are not easy to prepare or manage (both from the client and the supplier perspective).

The closest thing to an RFP that I’ve seen was @Davidutro organizing a call and preparing a table comparing the different solutions. I haven’t seen any other effort (sorry if I missed it) to organize and structure these initiatives.

Decentralization and Frameworks

In a decentralized environment, the lack of a perfect framework does (and can) not stop the work from moving forward since there’s no centralized power to do this. We have seen this happening with the MKR Compensation programs, not waiting for the different frameworks.

Note that there’s still no broad agreement on the MKR Compensation for a new Core Unit.

Incentives

You raised excellent points about Core Units adopting a compensation plan to include a percentage of the revenue fee. Should they do it? The answer is probably anything between “absolutely” and “maybe”.

We want Maker to scale, so this sounds like we would be aligning the incentives. The downside is almost evident: a team such as PE might focus more on new (profitable) products than security (and other important topics). Other groups (RWA or Growth) might end up scaling Maker extremely fast.

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The other opposite affects of this: some team members go on to find the next Affirm, Yammer, Palantir, SpaceX, Tesla, LinkedIn, etc., so—yea I like to think some of these Maker team members can go on to be the next PayPal Mafia members—better to incentivize, than to lose to other networks IMO. Good example: Greg D. when on to start RWA Co. — the next David Sacks might be in one of these CUs :))

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Adding layers upon layers of royalties with misaligned incentives is not scalable nor in the best interest of MKR holders - especially at such high levels.

A better approach, which still aligns the incentives of new revenue stream CUs with that of MKR holders is to have additional MKR tokens unlock upon achievement of specific revenue milestones. Doing so provides fully aligned incentives where CU and MKR holders win together. In the current proposal, it is quite easy to envision multiple scenarios where Deco wins and MKR holders lose.

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What we have seen thus far regarding Deco is a spirited discussion of the technical and economic aspects of onboarding it to the Maker Protocol. Deco supposedly will morph Maker into a “fixed-rate lending protocol like Yield or Notional [.].” Such an offering should excite (and worry) us as it represents another step in Maker’s evolution, much the same as Rune’s proposal for the Sagittarius Engine.

Nonetheless, there are glaring omissions from the multiple forum strands related to Deco. I’ll address my thoughts on those topics below.

(1) What are the DECO tokens?

In the white paper, Vamsi describes the Deco protocol as “[making] it possible for users to create two tokens: one that offers a fixed rate of yield over a specific time” and “another [principal] token which the user [can] withdraw from his or her deposit at any time.” (Deco White Paper, p. 1). Deco permits users to partition and trade these two assets freely where “one token represents the original base asset deposit, and the other token represents an ongoing accrual of interest in the yield token.” (Id.)

That basic description sounds like a blockchain replica of US Treasury Separate Trading of Registered Interest and Principal of Securities, better known as STRIPS. The Treasury Direct website describes STRIPS, and contains the following notable bullets, which reminded me of the Deco tokens:

  • When a Treasury fixed-principal note or bond or a Treasury inflation-protected security (TIPS) is stripped through the commercial book-entry system each interest payment and the principal payment becomes a separate zero-coupon security.
  • STRIPS are popular with investors who want to receive a known payment on a specific future date.
  • STRIPS are called “zero-coupon” securities. The only time an investor receives a payment from STRIPS is at maturity.
  • STRIPS are not issued or sold directly to investors. STRIPS can be purchased and held only through financial institutions and government securities brokers and dealers.

Presuming that the Deco tokens are the functional equivalent of STRIPS, they are by default likely to be securities in the US and any sophisticated securities regulator should easily connect Deco and the Deco tokens to the regulated, institutional STRIPS market.

(I bolded, italicized and underlined some notable highlights above in case anyone is wondering…)

(2) What May it Mean for the Protocol?

Per Vamsi’s proposal, Maker will be the sole protocol authorized to issue Deco tokens and act as the “counterparty” offering fixed rate and yield-bearing tokens to any vault user. Thus, Maker will play a similar role with Deco tokens as the US Department of the Treasury plays with STRIPS and do so without involving the regulated financial institutions or government securities brokers and dealers that deal in the STRIPS market.

(3) What are Potential Regulatory Implications?

Offering these unregistered securities (Deco tokens) when there exists a direct parallel to a similar product (STRIPS) in the real world is an interesting choice. Given that several delegates (like @ElProgreso) have already voted in favor of Deco, I want to highlight several ongoing US federal and state regulatory actions against other providers of high interest and fixed-rate products:

I don’t think I need to spell it out but integrating Deco seems likely to raise the “risk profile” of the Maker Protocol at a time where US regulators are becoming increasingly focused on “borrowing and lending” protocols that offer fixed rate products.

Please keep in mind, too, that there may be more issues than I’ve spotted, though I will leave that for real professionals to uncover. And there may be other jurisdictions – the UK, Switzerland and Japan to name a few – that take umbrage with Deco tokens offered to vault users based in those countries.

(4) Why Hasn’t DECO Addressed these Regulatory Issues as Part of its MIP?

In response to Paper Imperium’s question about the regulatory implications of Deco, Vamsi said the following:

Upon approval of the proposal, we will of course, move to formally address the relevant regulatory issues. This is an expensive and time-consuming endeavor which cannot be practically accomplished within the current time frame.

I understand the time and expense of doing this additional work, but why should Deco push to onboard their product without providing any legal or regulatory due diligence on the potential implications for Maker? We need to understand what happens if the Maker Protocol is found to be issuing illegal “Deco” fixed rate securities. Do we claw back commissions paid to the Deco CU? Should the Deco CU be responsible for contributing Dai to a legal defense fund since they are trying to nest so much risk in the project? And why will Deco only agree to undergo legal/regulatory analysis after it’s onboarded? Their strategy puts the cart before the horse.

(5) Does What I’m Saying Even Matter?

Probably not. We are throwing caution to the wind as of late and moving away from the cautious MakerDAO norms that made this protocol “boring” but rock-solid compared to its peers. Perhaps when looked at in light of Rune’s recent proposals and the fears of being out innovated by DeFi 2.0, it’s easier to swallow Deco-related risk. But if integrated, Deco may make the Maker Protocol the issuer of illegal securities, which have a direct and easy-to-understand parallel in real-world finance. Moreover, the Deco CU receives a percentage fee for Deco’s performance + CU salaries + MKR compensation. That seems like an imbalance between risk and reward for Maker, especially since there are so many other fixed-income protocols on the market that Dai and vault holders can access without having the Maker Protocol involved. Indeed, the Deco proposal foists on Maker and MKR holders the risks of issuing STRIPS-like securities. I only hope that the delegates pay close attention to the real risks their votes may introduce.

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My understanding from my limited SEC/ex-SEC contacts is that 100 or more letters went out over the summer. And many of the targets were small non-custodial wallets and the like that didn’t make the news. I certainly can’t confirm the number, but can confirm that some specific projects I would not have expected got love letters.

While I am currently voting in favor of Deco with the view of a much restricted used case, let me assure you and others that I will keep this evolving discussion on my radar.

The safety and solvency of DAI is my first priority, with the protection of MKR holders a near second. I am also firmly of the mind that Maker’s best strategy in these times is to carefully navigate the space of crypto finance that does not encumber it with KYC/AML requirements in the US market. Anything that brings DAI or Maker under the SEC will, of course, trigger that requirement unless we choose to abandon the US financial markets.

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I am late to the discussion.
I have watched the youtube presentation and read the comments of this thread.

This is a very interesting proposal. Very good comments from technical people during the youtube video (e.g., from @Kurt_Barry here). Very good counter-arguments have been made in this thread too.

It’s very hard to choose what to vote for the average MKR holder (like myself). Again, this is a very technical proposal.

However, currently the onchain poll has a vast majority of ABSTAIN (34,603.60 MKR). The YES (7,986.77 MKR) and NO (1,636.83 MKR) are not sufficient to get to the required threshold of 10k MKR.

I honestly hope a decisive YES/NO decision can emerge, as imho a fail due to “ABSTAIN” would not be too serious given the significant amount of work behind this proposal.

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@iammeeoh The above discussion is a good one, and I agree that there should be a definitive answer one way or another.

However, the more I look at Deco, the clearer the “DAO issuing illegal securities” angle becomes. Vamsi and the Deco team are passing the risk of their protocol to MakerDAO since unlike with other fixed-income projects, MakerDAO will be the “issuer” here. When push comes to shove, MakerDAO (and perhaps the named delegates voting “Yes”) may be the target of any regulatory action. Given that there is no Foundation to shield us, is Deco the hill we want to die on, especially with all the competing fixed income protocols on the market and the much more ambitious things the DAO seems keen to explore (RWA? Saggitarius Engine?)

If you’re on the fence here, please vote “No”. At the very least, the Deco team should provide the DAO with legal and regulatory analysis to assuage our concerns about the STRIPS/securities element (if not the potential question of the rate swap that occurs when one converts the variable-rate token to the fixed-rate token (maybe it’s a derivative?)). If they do that, Deco can simply re-apply as many other projects and CUs have done.

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Please note that the names of the community members previously mentioned as contributors have been removed from the opening post. We saw the need for this in order to avoid any confusion about the role that these individuals have had in the proposal for the Deco CU.

The full context for this is provided by this post in the Pairwyse thread. Feel free to leave any comments or questions in the related thread.

We want to highlight again that none of the individuals who were previously included as contributors are responsible for the Deco product, the mechanism design, or the CU proposal. They have merely provided feedback regarding navigating the governance process where we lacked experience with the details and requirements, and have nothing to do with the Deco protocol as such.

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So, onboarding Deco may embroil the DAO in some IP-related dustup? And we are learning about this at the eleventh hour with little over two days left on the governance poll?

@ElProgreso and the other shadow delegates voting in favor of Deco: do you see what’s going on? We have a proposal, clear as day, modeled on STRIPS (which makes all these tokens securities and MakerDAO the issuer of those securities). There is no way the DAO will limit this product to institutions, as Paper suggests – that’s fantasy/wishful thinking. And we’re looking at potential IP-related litigation between Deco and Pairwyse.

How can we go forward with this project, given all the flashing red lights? I urge you to be prudent here and table this for the time being. There’s no immediate need to onboard a project that has provided us no legal/regulatory review, may push the DAO into hot water with the SEC, CFTC or both and has an imminent IP dispute hanging over it.

Lastly, I have to note that this post went up late on a Friday evening, clearly hoping to bury the lead before the weekend so voters do not notice and Deco passes the governance poll.

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Please note that we have made some modest changes to the Deco proposal, for Formal Submission in the November cycle, to bring it into closer alignment with Maker general practices and by accepting a few suggestions.

  • Operational Entity following Integration. Upon completion of the integration of the Deco Protocol, the administrative, operational, and maintenance obligations, including legal, will be transitioned from the Core Unit to a separate legal entity, DecoM, which will function in alignment with Maker policy and procedures.
  • Reimbursement of All Payment to Deco. Deco will reimburse/credit to Maker in Dai all payments before receiving Revenue Share. Maker will pay to Deco 15% of the revenue from the Fixed-Rate CLAIM_FEE token sales only AFTER it has reimbursed the Deco Core Unit, and DecoM operating expenses, advanced by Maker, and any MKR distributions which are to be valued in Dai as of the date of acceptance and approval by Executive Vote Pass and to be utilized through December 1, 2024.
  • Budget. Also, there was a modest increase in the budget for legal.

We again look forward to any questions you may have as we seek to integrate the Deco protocol for Maker.
Best,
Vamsi

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We are putting up this MIP for formal submission.

@vamsi does the model you are pursuing continue to make the Maker Protocol (and, by extension, MKR holders) the “issuers” of the two Deco-tokens?

And if it does, have you done any legal analysis PRIOR to onboarding that you can share with the Maker community stating that the Deco tokens are NOT securities and, accordingly, the Maker Protocol will not be an issuer of those securities if it onboards Deco?

Because, as I highlighted multiple times above (for instance, here), you and your team have not engaged with the real concerns about Deco expressed by me and others (@PaperImperium) over the last weeks, and indeed, you hand waived them away (to paraphrase your team member on the Deco public call: “we’ll get to legal analysis AFTER we’re onboarded and AFTER we’re getting paid”). In sum, how can you differentiate Deco from STRIPS? I don’t think you can but I’d love to be proven wrong.

Anyway, if we are going to be concerned about legal/regulatory risk with the Centrifuge model (@rune) why would we ignore a more easily ascertainable risk (Deco) staring us in the face? I hope the delegates (@ElProgreso @PaperImperium @twblack88) who may be inclined to support Deco take heed of the risk it will introduce. I will vote against it with every MKR I have because integrating Deco into Maker will make the DAO a target for the enforcement actions currently roiling the industry (you can read my earlier post for more color). I have to counsel caution here; onboarding Deco is short-term, sugar-high thinking especially when other fixed income models are coming to market that DO NOT make the Maker Protocol an issuer of illegal securities.

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We need to ask ourselves, though, how reasonable it is to expect a team that hasn’t received any investment, and hasn’t received any compensation from the DAO, to fully fund the legal research themselves? Deco is already bringing a lot to the table with all the code that has been written and open-sourced before the approval of their core unit. If I were in their shoes, I definitely wouldn’t fund the legal research on top of that without the slightest guarantee of being reimbursed for it.

Legal research absolutely needs to be done; it is critical. But a core unit isn’t approved for eternity. So I would think that, in principle at least, it makes sense to get started with this and see what the research produces. If the product turns out to be unfeasible, they will need to pivot or stop the project.

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Then Maker needs to hire some lawyers. This isn’t because Deco should hire the attorneys for us. But Maker cannot get into deals like these with zero legal review.

I know you’re not the one holding this up, so don’t take this as a comment towards you, but the DAO needs to grow up and get some legal advice. It is unconscionable that we have not remedied this. This blind spot is the weakness most likely to destroy or cripple Maker. This is not a game, where we can just start over and play again. We need internal or external legal advisors for the US and EU at a minimum.

Until then we are left with improper, imperfect solutions. I have an ex-SEC attorney advising me that in its original incarnation, “this is an IO strip. Which is a security.” She was explicit and clear. Given the lack of other securities-law advice, the burden is on justification of any time and expense to continue. (Attn: @ElProgreso @MakerMan @twblack88 @monet-supply)

So either MakerDAO needs to hire legal to actually provide an opinion (the best option), or we need to come to terms with SEC oversight and prepare appropriately (worst option), or Deco needs to provide a legal argument that these do not represent PO and IO strips (bad solution to rely upon the lawyers of counterparties, as we discovered with Centrifuge)

This proposal really has to be tabled for now unless we are purposefully seeking a collision course with US regulators.

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I think your opinion (which is respectable) has been expressed very clearly in the past, and is being discussed (your own dedicated thread) and taken seriously.

No need for paternalism.

Furthermore I have noticed, more than once, you coming out with sentences like:

or

or

I have been contacted by other DeFi Protocols trying to hire me …

In my opinion, these vague references are not the best way to expand the “Scientific Governance” discussion. We need facts (and they are rare and hard to get, unfortunately). In the other thread you got this wise answer:

and it will not be changed by quoting “I have a friend who told me”.

TL&DR: The DECO team has put up a serious proposal. Yes, there are legal concerns. Everybody is free to vote as they wish, but let’s keep the discussion open and flexible.

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Going to chime in here because I see this debate being contentious.

First I see absolutely NO reason Maker needs to lay off rate risk with any model. In fact laying off rate differences DOES NOT solve the liquidity issues involved (ala Impossible Trinity). Also my own personal analysis as well as my current lawyers are that any fixed rate instruments are going to be the first line of attack (at least in the US) where they will all be labeled as securities. Is anyone paying attention to how Coinbase pretty much halted their own fixed rate plans because of brewing issues not just with legislators over this but with regulators?

Seriously folks with proper planning there is a vision where Maker can manage fixed rates itself. There are no changes to the protocol required. We can use a bonding model on both sides to guranantee performance not just by borrowers but by the lenders (i.e. MakerDAO) People (ala borrowers) have to realize that we have to manage monetary policy with DAI and even large borrowers are not going to get terms so easy from banks, and certainly not with such long terms with high risk. We have to have ‘some reasonable’ flex in longer term rates. I believe we can accommodate both the needs of large borrowers for ‘some terms’ on fixed rates with very simple changes to how governance handles them, and the contract terms.

I have so many issues here with these fixed rate MIPs it isn’t funny.

My real problem here is that we have people doing work for something I don’t see will do shit for the protocol in terms of the real liquidity problems that are going to pop up and the fact that I see people pushing for these players to be ‘accomodated’ while we figure out whether this is going to work or whether any of these ‘solutions’ will actually solve the problems long term fixed rates on large vaults is going to create in monetary policy. Then we have the legislative and regulatory hurdles that appear to be unappreciated.

Because I believe there are a number of key economic issues that won’t be solved by adding any sort of mechanics to ‘lay off’ the rate risk, and what I personally see (and my own consultant lawyers see) as serious and significant legislative and regulatory hurdles I am planning to vote no to any of these fixed rate additions to protocol.

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DM me if you need names.

Hi Wouter, I agree, in principle, that some development needs to go forward despite legal and regulatory ambiguity or lack of a clear answer. But that’s not the case here. The Deco tokens (Interest Only and Principal Only) are securities modeled on a financial instrument traded and regulated since 1985.

That’s great that Deco is bringing somewhat of a ready-made solution to the table (though their representative seemed to contradict that position on an earlier call). If they were launching as a standalone product, like Yield or Element, that would be great, too, and I would cheer them from the rafters and use their product. Yet integrating with Maker such that the DAO and MKR holders issue the Deco “Interest Only” and “Principal Only” securities is unacceptable. Vamsi and Co. put nearly all the risk on us and get paid a healthy sum of Dai and MKR to do it, while the DAO has to deal with the inevitable US regulatory fallout. That’s unfair.

The Deco team is trying to execute a clever ploy here. They know the institutional inertia with Maker governance is such that if they are onboarded, the likelihood of them being offboarded is low. Moreover, even if we offboard them, Deco will still get paid for months until the offboarding process is complete. Why go through all of that trouble when Deco tokens are clearly securities and onboarding them places a target on our backs? It makes no sense.

Also, you do not have to be a former SEC lawyer or securities expert to figure this out (I’m certainly neither of those things). I googled “interest tokens," "principal tokens” and “zero-coupon bonds” and stumbled upon STRIPS. A few hours of reading later and I came to the conclusions you see above.

And lastly, hand-wavey “of course there aren’t legal/regulatory/structural issues” answers are what got us into bed with a certain RWA provider who shall go unnamed in the first place (I wrote about them many moons ago). I’m adamantly expressing myself here in hopes of heading off another one of these “own goals”.

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Just to be fair … I don’t think there are amorphous “legal concerns.” It’s clear as day – the interest-only and principal-only Deco tokens are securities and Vamsi’s proposal will have the DAO as the issuer of those securities. It’s not a debate and it’s telling that the Deco team’s only response to these issues (and other ones) is “we’ll address this after you onboard us and pay us.”

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