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.