[PAXG] Collateral Onboarding Risk Evaluation

Legal Disclaimer: This communication is provided for information purposes only. This communication has been prepared based upon information, including market prices, data and other information, from sources believed to be reliable, but Maker has not independently verified such information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any digital assets and the use of finance-related terminology are for illustrative purposes only, and do not constitute any recommendation for any action or an offer to provide investment advisory services. This content is not directed at nor intended for use by the MakerDAO community (“MakerDAO”), and may not under any circumstances be relied upon when making a decision to purchase any other digital asset referenced herein. The digital assets referenced herein currently face an uncertain regulatory landscape in not only the United States but also in many foreign jurisdictions, including but not limited to the UK, European Union, Singapore, Korea, Japan and China. The legal and regulatory risks inherent in referenced digital assets are not the subject of this content. For guidance regarding the possibility of said risks, one should consult with his or her own appropriate legal and/or regulatory counsel. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any decision. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

  1. Summary Proposed Risk Parameters
  2. Overview
  3. Metrics and Analysis
  4. Risk Parameters

Summary Proposed Risk Parameters

Risk Premium: 4%
Liquidation Ratio: 125%
Debt Ceiling: 5 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 100 Dai

Overview

PAXG is a tokenized representative of physical gold issued on Ethereum as an ERC20 token. Each token represents one fine troy ounce (t oz or a 31.1 grams) of a 400 t oz London Good Delivery gold bar custodied by Paxos Trust Company and stored in Brink’s vaults. Essentially PAXG is a centralized stablecoin soft pegged to gold which represents a form of RWA on Ethereum. PAXG was incepted in Aug 2019 and in Sep, it was approved by NYDFS as a regulated gold-backed digital asset.

Subscriptions and redemptions to PAXG are possible via Paxos UI (directly linked to the London gold spot market, operational during open hours) or via ItBit and other CEX/secondary market exchanges. Subscription is possible with USD or Unallocated Gold (Loco London unallocated gold account required). In addition, redemption is also possible via Physical gold bars in London. North America based users can redeem PAXG into physical gold products via Alpha Bullion. All possibilities to subscribe and redeem PAXG are associated with specific fees based on the way of the subscription/redemption. As the PAXG relies on the London gold market for the underlying asset, the subscriptions and redemptions are not available during the market downtimes including holidays and closed hours. Physical gold redemption is time consuming and costly depending on location of delivery, which means that the main market for Keepers to sell their PAXG purchased on a Collateral auction would be various spot markets unrelated to Paxos and the Paxos USD spot market in their wallet UI for large transactions, which is not available during London gold market downtime. Since Paxos and its products are regulated, full KYC is required for any primary market activity. The price of PAXG on a primary market is based on the INTL FCStone price feed, representing the real-time London gold market.

PAXG has a subscription and redemption fee based on a schedule for all primary market trades on their wallet UI or gold pages, which includes sales/purchases in USD, physical gold or unallocated gold which is always charged in the token itself. Trades on secondary markets are subject to exchange fee schedules. In addition PAXG has a on-chain 0.02% transaction fee which is charged each time the token is sent on the blockchain. Over time, the feeRecipient address received 28.15 PAXG. The fee was put in place to negate the cost of storing the underlying assets and the fact that the underlying asset is not a yield producing asset. This fee can potentially hinder usability of the asset in DeFi.

Metrics and Analysis

Supply & Market Share

PAXG has been consistently increasing in supply since inception of the project and currently stands at 34,655 tokens or ~$67m at a current price of $1.93k. During 2020 the supply was increasing with an average monthly growth rate of 34%. On the chart below, you can see the total supply of PAXG and corresponding “circulating or free float supply” (23,864 tokens or ~$46m), as a portion of total supply is held in Paxos controlled addresses. Note that tokens held by Paxos addresses are mostly assets in their custody belonging to different customers, thus majority of this supply is also considered circulating or free float supply.


Source: CoinMetrics

Price Volatility

Price of PAXG is very consistent with LBMA gold reference price, on average it is trading with a ~0.65% price premium. The slight price premium is expected due to additional fees and risks associated with the tokenized asset.


Source: CoinMetrics & LBMA

PAXG is less volatile compared to ether or bitcoin as visible below. The chart shows rolling daily volatility for a period of 30 days.


Source: CoinMetrics

Daily Volume Traded

PAXG does not have any single secondary market with a high trading volume, but across different exchanges and trading pairs it does accumulate some trading activity. In 2020 PAXG had an average daily trading volume of $434k considering Kraken, Binance platforms, FTX, Gemini, Uniswap v1,2, Bithumb and the following trading pairs; USD, EUR, ETH, BTC, USDT and BUSD.


Source: CryptoCompare, CMC

Kraken was historically the dominant exchange but in June this year FTX also offered PAXG and Binance in September, achieving substantial market share. Trading PAXG on-chain is unfavorable as there are fees associated with on-chain transactions explained above. Nevertheless Uniswap achieved ~7% of all trading activity in the past month.


Source: CryptoCompare

Token Deposits on Trading Venues

PAXG deposited in CEX venues is mostly consistent with reported trading volume in proportions. It seems that a large portion of deposits on Kraken are holders with low trading activity.


Source: Nansen

Downside Risk

In the daily negative returns count comparison with bitcoin and ether, we can see that PAXG is significantly less likely to sharply drop in price in a day, but it still has more negative returns compared to LBMA pm reference price. In the second chart, only days when the gold market was operating were considered. The largest daily drop for PAXG was -8.4% on Nov 17, 2019, on this day the gold market was in a downtime. The largest drop for gold in the observed period was -5.13% on Aug 11, 2020, a few days after reaching new ATH above $2k.


Source: CryptoCompare & CoinMetrics


Source: CryptoCompare & LBMA

Based on historical gold prices in recent history, gold never fell for more than 15% in one day. In Jan 1980, it dropped for 13%, in Feb 1983 it dropped for 14% and in April 2020 it dropped for 9%. Gold is a very safe asset in regards to sharpe price drop probability.

Presence in Open Finance and Other Venues

PAXG has a low presence in DeFi. Among DEX/non-custodial trading venues, PAXG is only actively traded on Uniswap. Among other DeFi services, PAXG is only present on dForce as currently the only reserve asset for another gold token; GOLDx (currently ~241 PAXG tokens deposited).

Contrary to the DeFi space presence, in the CeFi lending space PAXG is listed on the majority of the services; Crypto.com, Celsius, Nexo, BlockFi and others.

Low presence might be related to on-chain fees explained above, but the reason can also be in general low traction for precious metals on blockchains in the past. As we saw with WBTC, the financial ecosystem can develop very fast on Ethereum.

On-chain Transactions

Number of daily on-chain transactions is increasing, averaging at 133 daily transactions. The average daily transaction size (USD) is fairly constant over time, averaging at $3.6k daily. The average daily median transaction size is $11, the median value is low due to all the on-chain tx fee collection transactions.


Source: CoinMetrics

Regulatory & Counterparty Risk

  • PAXG is operated and custodied by Paxos Trust Company, the gold bars are stored in Brink’s vaults. The vault provider is also insured for loss of the gold held.
  • Paxos as a trust company and custodian is regulated by the New York State Department of Financial Services (NYDFS).
  • PAXG is also approved and regulated by the Department of Financial Services (DFS).
  • Withum (auditing firm) is performing monthly attestation reports of the issued token amount and underlying assets held found here.
  • In the case of Paxos bankruptcy, the assets held for behalf of customers in the custody are not subject to liquidation mass.
  • Paxos legal and compliance team response on Maker forum with further information can be found here.

Oracles and Liquidations

  • Despite PAXG being a centralized stablecoin representing a real world asset, we recommend that PAXG oracle is used instead of the underlying asset oracle, as PAXG did experience a larger number of negative returns compared to the underlying. Additionally PAXG is not hard pegged to the underlying assets and the underlying asset has a market downtime days and hours which further supports the PAXG oracle over the underlying asset.
  • We recommend liquidations to be turned on at launch.

Proposed Risk Parameters

Risk Premium: 4%
Liquidation Ratio: 125%
Debt Ceiling: 5 million
Auction Lot Size: 50,000
Minimum Bid Increment: 3%
Bid Duration: 6 hours
Max Auction Duration: 6 hours
Liquidation Penalty: 13%
Dust: 100 Dai

We recommend liquidation ratio at 125%. Despite gold being historically unlikely to sharply drop in price for more than 15% daily, we recommend a bit higher LR to compensate for additional possible price dynamics caused by the PAXG token itself. The token tends to diverge from the underlying price slightly, but during London gold market downtime which prevents redemptions and subscriptions it could diverge more as primary-secondary market arbitrage is not present during this period. We recommend a risk premium of 4%, which is consistent with other custody based assets. Additionally, there are currently no DeFi/non-custodial venues where PAXG or even similar products can be utilized. The legal risk is comparable with other centralized stablecoins, while Maker is already exposed to counterparty risks related with Paxos and is thus not a large risk addition to the system. We recommend the initial debt ceiling to be set at 5m dai. PAXG will be an interesting new collateral type to Maker’s collateral portfolio in terms of asset type diversification and hopefully will become more used in the wider DeFi ecosystem.

Lead Researcher: Marko Stemberger

Sources:

16 Likes

Just a heads-up on PAXG–they’re Raising funds going into 2021–heard analysis they can one day have over $50 Billion AUM, if Institutions take on at least a 5% exposure to digitized Gold (apparently Gold is not yet, accepted in “institutional circles”). hence, long-term upside is possible.

Full Disclosure: I don’t own PAXG and will prob. never own it directly.

Is that a big market?
How many millions inside the vault can we expect?

There is 45M in token. Is that really worse the time?

The Gold Market? It’s almost 10 Trillion USD my dude.

Assuming we All believe everything & anything will get tokenized–from your favourite footballer, to your favourite actress/actor–I gotta believe digital Gold will be a nice percentage of that 10 Trillion USD. Probably why Paxos is looking raise cash from VCs.

1 Like

Well, PAXG is not the whole gold market.

BTW great work.

For me it seems a niche market. Even if I like it, and actually I would love it 6 months ago. But now I believe, we need big market to sponge the 400M usdc + the other 400M plus.

2 Likes

I saw that the onboarding of PAXG was delayed due to ‘technical reasons’.

Is this related to all the transparency issues around the supply of PAXG and the gold that is supposed to back it? They are apparently minting huge sums more tokens than they have gold backing as indicated by any available data source. Archive in case it’s deleted again.

Has Paxos every provided or committed to provide complete bar level transparency data?

Summary of the issues:

  1. Their Chainlink gold reserve data feed says they have only 60,161.14 troy ounces of physical gold backing the tokens. This feed says it’s updated every 24 hours.

  2. Their attestation reports which are often released one month or more late show a different number that doesn’t match either the Chainlink data feed or the minted supply.

  3. The number of tokens minted on the blockchain is around 30% more than the gold backing indicated by the Chainlink data feed.

  4. Their largest holder address with almost 20% of total tokens shows no backing according to their own data.

  5. There is no clarity in the details around their storage fee which is only very vaguely explained in their ‘Terms and Conditions’.

Has there been any official response to any of this?

It was suggested that the difference between Chainlink and the Ethereum blockchain minted supply is tokens locked up in a smart contract that are unbacked however that isn’t possible for a number of reasons:

  1. There is no smart contract address that holds enough tokens to make up the difference, there aren’t even two smart contract addresses that could make up the difference together, unless you counted an exchange wallet which would obviously not be legit.

  2. The largest address which has no gold backing according to Paxos’ own data has constant transactions in and out of it.

  1. They are constantly minting new tokens, over $2 million worth just a couple of days ago, there would be no reason to mint new tokens if they already have a huge supply of excess unbacked tokens to bring into circulation as they add more gold.

Either Paxos is circulating unbacked PAXG or the data reported by their Chainlink data feed is false. In either case, how can you trust this token?

1 Like

I can’t speak to any of the backing stuff (which does sound potentially concerning.) But yeah, there are actual technical reasons that it is hard to add PAXG, mainly because it is one of those tokens that includes a fee on transfer. That doesn’t play super well with the Maker contracts.

That said, this technical blocker has been resolved recently, so we may see it onboarded soon.

3 Likes

Interesting, How did they resolve it?

Doesn’t the backing issue have to be resolved in order to be reliable collateral?

I am also quite interested in the solution for the transfer fee problem.

PAXG Collateral Onboarding Risk Evaluation Update

Trading activity; Volume and On-chain Liquidity

Trading activity of PAXG increased since the last analysis; average daily trading volume across selected venues in the past 6 months was $4.17m, which is almost a 10x increase from past figures in October.

Source: CryptoCompare

Despite the large relative increase in volume, the PAXG did not increase its DeFi presence significantly. The asset is only present in Uniswap v1 and v2, there were few trades on 0x. Average daily trading volume in Uniswap in the past 180 days was $107k. The total liquidity in the pool increased but is still relatively low compared to market capitalization of the project - currently at $2.5m.

Source: Uniswap.info

The main usage of PAXG is still dominated by centralized lending services such as Nexo, Celsius and BlockFi, as addresses related to those services hold the most tokens besides Paxos related addresses and exchange related addresses. Nexo is currently offering 8% APR, Celsius is offering 5.92% APY and BlockFi offers 5% APY, where the last two display rates after compounding, which means that currently Nexo is the best option, when only rates are considered. This also corresponds with asset allocation, as Nexo holds more PAXG compared to other two services. We can expect that Nexo will probably be one of the largest users of PAXG vault.

Proposed Risk Parameters

Risk Premium: 0.2%

Stability Fee: 3%

Liquidation Ratio: 125%

Debt Ceiling: 5 million

Auction Lot Size: 50,000

Minimum Bid Increment: 3%

Bid Duration: 6 hours

Max Auction Duration: 6 hours

Liquidation Penalty: 13%

Dust: 5000 Dai

Newly calculated risk premium is based on the model here. Even though some metrics did improve for the better, we recommend proceeding with the same initial DC of 5m dai which can be later adjusted based on market traction and improved on-chain liquidity. We have changed the proposed SF from 4% to 3% due to increased liquidity metrics and expectation of primarily institutional usage. We expect that main users of this collateral type will be institutional entities such as Nexo. The dust threshold was adjusted to mimic the rest of the assets in the system.

There are some open concerns in the community regarding the management of PAXG Treasury, relevant to total emission of the asset and its corresponding circulating supply. We have contacted Paxos in order to resolve the concerns and are still waiting for the reply. The risk team would appreciate it if the Paxos team can respond to the forum post directly as we want to maximize the transparency of the matter. Additionally, we recommend that the Maker community waits until the issue is resolved before proceeding with the PAXG inclusion.

4 Likes

Hi, it’s Ilan from Paxos. I’ve popped in and out of the community while we were going through the onboarding process for PAX. I firstly want to say that we’re excited for PAXG to be onboarded to Maker and will gladly answer questions the community raises. I’ve sent these specific concerns voiced above to the team and have a formal response copied below.

Thanks for the thoughtfulness and questions around PAX Gold. Trustworthiness is built into our ethos and into every product we deliver. PAX Gold is regulated by NY Department of Financial Services (NYDFS) and attested monthly by renowned external auditors.

Regarding Chainlink questions, we discussed with Chainlink that their user interface can be confusing for tokens that receive periodic attestations, which is customary for regulated tokens including PAX Gold. Paxos updates our Chainlink API endpoint monthly with the auditor, attestation date, and quantity of underlying gold. Chainlink is working on improving the user interface to make this clear. PAX Gold is fully backed at all times one-for-one with underlying London Good Delivery bars.

Regarding the Paxos.com gold bar lookup, this is a tool for individual users to look up gold bars that are allocated to their PAXG holdings. Users that custody gold with Paxos can login to their Paxos account to view the gold bars corresponding to their account.

5 Likes