[PC-DROP] MIP6 Application: Paperchain DROP: Tokenized Music Streaming Invoices

Is it really not possible for the system to liquidate DROP tokens? If this is the case then the entire risk needs to be balanced by the stability fee and collateralization ratio, which would be higher than they otherwise would need to be than if there was a liquidation option.

I was criticizing @Planet_X’ “Alternative Design” without actually correcting this in the their description of the current design. So maybe let me do correct that:

It is very much possible to liquidate DROP tokens of course. We are talking to keepers who are be interested in participating auctions and there is a market for DROP token holders. Taking ConsolFreight as an example, there are 8 parties that bought DAI 250k worth of CF-DROP a few weeks ago because they are interested in directly investing in these assets.

@Planet_X suggested that because there is not a liquid market there was no way to price an asset. I think that is what led to the confusion. You can value a portfolio of loans and give it a price, this can be used to derive a DROP token price. This is similar to getting your house appraised to refinance your loan, the bank won’t ask you to actually sell it to discover the price of it.

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Ahh, I misunderstood, my apologies.

Do you have any input on my second point?

Counterargument to this:

Until recently, I worked for a consumer lender which obtains funding for loan origination by issuing tranched securitizations (structurally very similar to DROP and TIN tokens). The securities are traded over the counter, so they have some liquidity but not really a fully liquid asset like government bonds, stocks, or mid/large-cap cryptos.

During the market selloff in March, the class C notes (first to experience losses from defaults - similar to TIN) were selling for 20% of face value or less, and even the class A notes (last to experience losses) were selling at only 80% of face value. New issuance became impossible in these conditions , and a lot of existing holders who had levered up their exposure were facing margin calls which further impacted pricing.

Illiquidity makes it much more difficult to value assets even in stable markets. During times of market stress, there’s likely to be more pricing volatility for illiquid assets.

Also worth noting all of the securitizations were rated by credit rating agencies (Kroll, Moodys, etc).

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I guess interesting would be at what price the A-shares are selling at now? While the market crashed everything went down but if you held these notes to maturity you would likely get more than 80% of face value.

Your example focuses on consumer lending. With unemployment going up the way it is right now of these loans are heavily affected. Paperchain’s counterparty risk is Spotify and Apple. @pcdan just shared their earnings report:

Using structured products doesn’t remove all risks and any this does not negate the need for the risk team to assess these parameters. That is something that the domain team still needs to do.

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The second type are the tokens that have yet to gain any significant market, or have yet to be launched, but where Maker have been involved on a bizdev level to test concepts. DROP being one such example I remember off the top of my head , but there could be more. In these cases the token in question could, if approved, be launched as a collateral-ready token. While potentially being more risky, the payoff in form of new markets, bridging to non-crypto industries or public perception could make the effort well worth it. The downside is that the applications could be let’s say vague.

These are good thoughts, and I agree with you. There is a payoff for pushing edges, no doubt.

You keep asking Paperchain to add color (adding information) to their applications. This additional information might simply not exist yet. Paperchain are for example not able to answer where, how or to whom DROP will be sold so it it safe to say the product still slightly conceptual.

Also, you keep asking questions regarding the legal and regulatory aspects of the DROP token. This is all very well but keep in mind that the legal aspects of crypto in general are still unchartered. Paperchain could spent 10 USD or 10 million USD on legal advice but the answer would still be “We don’t know”.

I agree that a lot of Defi/crypto happens in an ambiguous or vague regulatory space. No argument there. But DROPs are debt securities, as Lucas acknowledged in responding to my comments in the Consulfreight channel. From reading the public docs, MCD does not have whitelisting in auctions, and the DAO is not a registered broker-dealer. Auctions involving securities, like DROP, require whitelisting and a regulated broker-dealer. If the system does not have those components yet, doesn’t the potential introduction of DROPs as collateral seem premature? And shouldn’t the technology provider and backer of this proposal, Centrifuge, come to the DAO with some framework on how to make DROPs legally palatable?

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h/t for focusing on the “lack of recourse/ability” to collect if there are problems with the underlying assets backing DROPs. That problem is ubiquitous with all these (Consulfreight/Paperchain, etc.) applications to date.

@Planet X, very creative thinking on the staking model. Perhaps that is a new avenue to explore for the DROP auctions? Beyond me to say one way or the other, yet it’s something to analyze.

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Is there any fundamental reason why there couldn’t be a liquid secondary market for these tokens? I think this is absolutely necessary for us to use these token types as collateral. We need some way for price discovery.

This is my interpretation of the MIPS process: MIPS6 is not the final decision whether to add some collateral to MCD or not. This is the first step and a starting point for the domain teams to work on integrating them. There are assets that are simpler to integrate into MCD and one could make the case for integrating them first but the downside is that a lot of these assets (LEND, KNC, MANA, and really any other top 20 ERC20s) are so correlated with ETH and see so little usage (cf BAT’s DAI 580k debt) that these assets will hardly add the diversity in collateral and borrow demand necessary to scale Maker.

Bringing real world assets into Maker will require adapting the process the DAO goes through to onboard new assets. We’re happy to support in any way we can.

I’ve outlined how the DAO could decide to treat these tokens in the ConsolFreight thread:

Our current assumption is the following: DROP is considered a security but only if held by a legal entity. A DAO or smart contract is not a legal entity and therefore as long as theser tokens are held in a Vault controlled by the SPV, the SPV is not actually issuing a security. Only when the Vault goes into liquidation and keepers want to bid on it will the SPV issue the security to the highest bidder. Therefore while keepers need to get KYCed, not every single DAI holder or entity interacting with MCD has to.

This is the basis that we propose for MakerDAO to pursue and investigate.

We plan to elaborate further on that and develop guidelines for how to safely onboard securities into MCD with the legal domain team. Procuring a legal opinion as to how exactly this will work for MCD at this point in time would be premature and something that would likely be a significant expense. This is something we should tackle after the first set of polls that merely determines the ranking of different asset types.

The security status of these tokens means that while they are transferable (and redeemable with the SPV at any time) they are restricted: you can’t sell them to anyone on the public market. This means that the market for these tokens while available will be a lot less liquid than likely required for an efficient price discovery.

This is not something that is new to the credit world however: Credit funds frequently securitize and sell credit portfolios without there ever being a liquid market for them but instead by agreeing on price model that looks at the underlying loans and calculates a NAV (net asset value) based on a risk model agreed upon by the buyer and seller. The Tinlake contracts calculate the NAV based on the underlying loan data on chain to determine at what price to issue & redeem DROP tokens when investors join or leave a pool.

Not unlike other risk parameters the risk team needs to propose for MCD, we imagine that they would review the NAV model chosen by the asset originator, perhaps contribute to setting some of the parameters and use that as a basis for pricing the collateral in MCD. We’ve published a first article in a series on pricing here: Tinlake: Pricing and Valuation Series Part 1

We are hosting another collateral onboarding call tomorrow (Wednesday) at 19:30 CET // 10:30am PST // 17:30 UTC (Collateral Onboarding Call (MIPs #6-12): Discussion and Review of Collateral Onboarding Process). Feel free to join and discuss these topics!

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Following yesterday’s call - will Centrifuge provide the community with a write up of the scenarios presented?

Also has anyone at Maker @cyrus given any thought about if it is at all possible for Maker to interact with the Paperchain SPV? I am not a laywer myself but I do not understand how Maker can make any use of the SPV. As far as I know Maker can’t sue them or even legally interact with such an entity. Am I wrong?

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Yes, I’ll provide some more materials on what we discussed in the call in a few days.

It is not necessary that the DAO interact with the SPV via a legal contract. From MCDs perspective the system will work if there are keepers that are willing to buy the DROP tokens. Because keepers unlike MCD are generally not DAOs, they have no problem to enter into a legal agreement with the SPV. This gives the keeper legal recourse on the underlying collateral no matter where the DROP tokens are coming from including if the DROP tokens they were acquired in an auction from MCD. Thus a keeper will have the necessary legal recourse to be incentivized to bid on DROP.

Does this answer your question, @Planet_X ?

@spin how will Keepers participate in auctions if the current system does not allow for white listing? DROPs are securities and without a registered broker/dealer administering the sale, the DAO will have to ensure that certain persons from certain jurisdictions cannot participate. How does your team suggest we are able to do that?

Also, how did your team come to this conclusion:

DAO or smart contract is not a legal entity and therefore as long as theser tokens are held in a Vault controlled by the SPV, the SPV is not actually issuing a security. Only when the Vault goes into liquidation and keepers want to bid on it will the SPV issue the security to the highest bidder. Therefore while keepers need to get KYCed, not every single DAI holder or entity interacting with MCD has to.

What informed this assumption?

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How does your team suggest we are able to do that?

DROP tokens will have a global whitelist that can be read on chain. Maker’s auction mechanism is flexible and a custom Flipper contract can be deployed that can check against this list to only allow bids by whitelisted addresses. This is goes a bit beyond a standard adapter but is definitely in the realm of the possible. The whole reason for making the Flipper contracts modular per collateral type is to allow precisely this kind of customization.

Only when the Vault goes into liquidation and keepers want to bid on it will the SPV issue the security to the highest bidder. Therefore while keepers need to get KYCed, not every single DAI holder or entity interacting with MCD has to.

This is based on our own research and conversations with legal experts in the field. But as I mentioned, we can not offer any legal opinion on this and I would propose the domain team or an external paid contributor does for the community.

I’ve created a forum thread discussing general topics regarding Centrifuge’ asset class that we can use to discuss topics that concern both PC-DROP and CF-DROP as well as others in the future:

DROP tokens will have a global whitelist that can be read on chain. Maker’s auction mechanism is flexible and a custom Flipper contract can be deployed that can check against this list to only allow bids by whitelisted addresses. This is goes a bit beyond a standard adapter but is definitely in the realm of the possible. The whole reason for making the Flipper contracts modular per collateral type is to allow precisely this kind of customization.

How will a broker-dealer (in the US) or its equivalent in Europe administer the sale (or multiple sales on a potentially regular basis) of these securities? Do you suggest that MakerDAO purchase a broker-dealer? Or do you suggest that that the DAO work with a broker-dealer to perform this function (required in several jurisdictions where the auction participants likely operate)?

And how do you suggest these securities be distributed in case of Emergency Shutdown?

Pricing and valuation. Full disclosure, I co-wrote a blog on pricing invoices with Centrifuge (which is almost verbatim in the Fundamentals link in section 12,above), and in general, am positively biased towards leveraging the DeFI community for asset-backed funding. I am concerned about the community’s ability to price risk.

In all credit classes, there are sophisticated borrowers and unsophisticated borrowers. Likewise, there are sophisticated lenders and unsophisticated lenders.

On the assumption that unsophisticated borrowers would not be able to obtain the real-world financing required to be in the factoring business, that means this ecosystem will consist of:

  • Sophisticated borrowers
  • Sophisticated lenders
  • Unsophisticated lenders

Sophisticated borrowers have policies and procedures in place (or in the works) to optimize (read: lower) their cost of debt. They do this by laying out their sources of capital, their own advance requirements, terms and conditions of each of their lenders. Sophisticated borrowers adjust their “mix” of funding to maximize the spread between what it costs them to borrow and the rates they charge their customers.

A sophisticated lender knows market rates and its own return requirements, and can fashion a loan to an asset aggregator customized for the risk.

An unsophisticated lender will make loans at rates so low, that they will get cherry-picked (read: lose money) for losses, or make loans at rates so high that you would not want the borrower who’d accept those terms (read: adverse selection/moral hazard.)

Transparency, removal of asymmetric information related to pricing and risk (i.e. underlying collateral performance dashboards?) and (perhaps) pre-qualifying would-be DROP purchasers for their credit knowledge might mitigate the risk associated with the sophistication mis-match.

Mismatches have a slew of unintended consequences. Overall, great concept, but would recommend limiting participation at launch to friendly borrowers and lenders while the kinks get worked out.

-howard

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Hi William @williamr what is the status of Paperchain? I’m seeing a lot of action via NFTs and Music integrations–it felt like Maker was first, now it feels like Maker is last. As an example–I’ve watch AAVE founder Stani hanging out in every single Clubhouse Music Room that was happening–and now:

“We have been working with marshmellomusic to create a unique experience to have NFT built on top of AAVE, for the first time NFT will generate ongoing yield to the artist coming from the edge of DeFi” -Stani

I mean. It’s gotten to the point were even BLOCKSTACK is beating us to the punch–they’re releasing Music based NFTs with DEADMAU5.

image

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Hi @ElProgreso , let me take that one.

We like the idea, but the market size of the asset type remains smaller than other stuff (trade finance, revenue-based financing, real estate) so the priority is below. It’s also the smallest Tinalake pool under study.

Now if you feel good vibes about this collateral, you can start a petition to prioritize it (a forum pool might be enough). Per our MIP39, you can prioritize the RWF CU work.

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COool. Thank you for the input. I will look into your suggestion via MIP39 and see what the community thinks about such. Thanks again Seb!

quick update on our side on with Paperchain (MIP6 ):

  • we’ve successfully deployed/borrowed $930K via Tinlake
  • end of this month we’re launching the first wallet and card product that allows creators to access their digital revenues as they earn them
  • First vendor partner is United Masters (recently raised $50M series B from Apple and Google). Rolling out to top 25 users first end of May and then focused on the 1M creators on their platform
  • initially deploying ~$400K/month but can very quickly scale to $1M-$5M
  • the mechanism will be the same (stream data from spotify apis, converted into digital asset and collateralized into loan) and repayment still comes from the vendor or the streaming platform
  • not publicly announced yet, we’ve just partnered with Stripe for back-end wallet support, making us 1 of 10 companies in the world launching the first products on Stripe Treasury

We’ve been successfully raising capital via Tinlake and are part of the pipeline for MCD.

I think we’ve found a unique distribution model for a consumer finance product.
What we want to get to is daily payments for creators (via programmatic daily loans on MCD).
Daily we take data, create the CDP, borrow the DAI and send to the creator wallet, repay in 45-60 days when payment from Spotify is received. Gas prices make this impossible right now but would love to invest in scaling solutions.
Allows us to 10x the number of customers and revenues faster, while onboarding millions of creators into crypto wallets.

Happy to answer any questions.

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