Risk Concentration of RWA LendCOs

As Real World Assets are brought on as collateral, each LendCo will be lending capital to would-be Borrowers on agreed upon terms within the constraints approved by the community.

Provided LendCo originates a solid secured loan, all parties win (Maker / LendCo / BorrowCo / and all of the parts in the middle). The maximum amount of newly minted DAI is controlled and constrained by MKR Governance via the Debt Ceiling that is established for each Vault (on or off-chain).

During the middle of 2020, the community faced a concerning situation. Unprecedented demand for DAI and not enough supply to keep the peg at 1:1. As a result, the community voted to rely heavily on stablecoins as a primary source of stabilized collateral to help maintain the peg as much as possible.

In doing the above, the community relied initially quite heavily on Circle’s USDC. As the issuer of the USDC token, Circle outlines that each token is in-effect an “IOU” of one USDs in the bank that is setup using the Circle infrastructure.

When evaluating the risk premium to utilize the USDC token as collateral, the community attributed basically zero risk premium to both ethereum (as the transfer “agent”) and the bank held USDs (as it too is also an IOU) and focused on the issuer of the USDC token, Circle (as it rightly should).

During October 2020, some in the community began to get concerned about the concentration risk and depth of USDC usage as collateral and looking for a diversification of issuers. [Signal Request]Increase Risk Premium for USDC as risk increased due to over collateralization

When we start to evaluate the same scenario for Real World Assets, a similar pattern should emerge provided that all loans are secured with first priority senior lien and legal enforceability opinions have been issued confirming the perfected lien.

With this, an RWA LendCo is not the issuer of the credit. Rather, it is the loan-originator holding the liens that secures the credit worthiness of the loan. Specific to credit tenant leasing, the end tenant is the “issuer” in this scenario per the long-term lease with each tenant having its own “credit quality”.

Further, when the security interest is perfected between BorrowCo and LendCo AND when the Security Agreement is perfected between LendCo and the Trust, MakerDAO “has its hand” by means of these perfected agreements in the credit quality. This means we address the “LendCo gets hit by a bus” scenario as the community can rely on perfected liens, enforceability opinions, and legal precedent, in general.

Therefore a portfolio of credit issuers is essential to LendCo and by derivative, to MakerDAO. While it is encouraged for MakerDAO to bring on a portfolio of LendCOs (each with its own portfolio of credit quality), the most important parts are that

  • the loans are secured, AND
  • those security interests (liens) are perfected and enforceability opinions have been issued (thus LendCo knows it can foreclose and stays in compliance with the credit agreement and the community has a capital sink with a known credit quality that is measurable).

The main takeaway here is that a LendCo when viewed in isolation is only as diverse as the collateral it holds. Even if there is only one LendCo ever approved, (which is unlikely and not advisable), the concentration is by and large, defined by the portfolio that LendCo holds, not LendCo itself.

As LendCo diversifies its collateral pool, the community is less exposed to the “black swan” of one credit issuer. This benefits the community and the investors in any given LendCo.

As currently designed, while the actual portfolio is held by each LendCo, indirect portfolio “control” (not management) is done by proxy using the two most common tools in the DAO toolbox:

  • Interest Rates
    • This controls the profitability of an RWA LendCo
  • Debt Ceiling
    • This controls the capability of an RWA LendCo

While LendCOs are expected to actively engage with the community, should the DAO start to be uncomfortable with the portfolio mix of a given LendCo, either cost of capital can go up to encourage a more diverse portfolio (followed by a decrease in the cost of capital as a incentive for compliance) or the Debt Ceiling would be lowered to inhibit the ability of the RWA LendCo to continue to issue new loans (enforced by a Trustee). Either way, the DAO always retains that power.

As an example only, if a LendCo has $100MM outstanding in loans and the DAO sets its debt ceiling to $0, the LendCo is powerless to issue new loans using the Maker credit facility. Even as loans are repaid, the Trustee is required to verify if the Debt Ceiling is lower than the debt outstanding to be able utilize those funds for lending purposes. If the Debt ceiling is lower, the Trustee will cause the repaid funds to be returned to Maker thus organically reducing the portfolio as each loan payment is received. (Note: This was designed to mimic how the on-chain Debt Ceiling works)

Today, DAI is ~1.01 is backed with ~400MM of stablecoins. Per the Terms of Use of many stablecoins, they are allowed to block end addresses (in some cases at their “sole and absolute discretion”). This means that approximately 40% of value backing DAI, “could” be blocked via a collateral adapter. Because of the situation, Maker is unable to change the rate it charges for these loans without materially affecting the DAI price, the end-result is that Maker takes virtually all the risk without being compensated.

Unlike the stablecoin adapter blocklist risk described above, that cannot happen for Real World Assets without causing a real world credit default event. When a perfected first position security interest is obtained, there is no singular point of failure (other than the credit rated party on the other end). This is a crucial difference that cannot be overstated enough times.

Real World Assets de-risk the MakerDAO project as a whole as the community can rely on perfected liens, enforceability opinions, and legal precedent in general to cause exposure to sustainable credit demand. The job of managing the risk efficiently is then shared by each LendCo and MakerDAO, each collaborating with the other.


With this statement in mind–do you believe that USDC SF should remain at 4%+?

Do you believe Maker should start competing in the Commercial RE Market versus traditional lenders, such as CBRE, JPM, Meridian, Newmark, etc.? Or, are we too early? If so, why not recruit commercial RE brokers to bring loans to Maker via a local LendCo in the top markets?

Arguments both ways on this one… No, the risk of USDC is not 4%… Yes, the concentration risk pushes it that high… No, it doesnt matter soon as we are seeing diminishing returns as we are over the peg.

We are early… But not crazy early… The one thing we must always remember is that while the blockchain is code, Lenders deal with Borrowers that have people behind them. If LendCo fails to perform, Borrowers will go somewhere else.

Point being is that we have to be able to perform when the time comes. Part of the reason I wanted to start out with CTL projects for Maker is that they are small bite sized projects. In aggregate, it can represent a decent book. I do not think Maker is ready for single transactions that are greater than $100MM+ Not yet… that is coming… we have to crawl first…