RWA Strategy Update - Being more strategic

Got it! Thx

I also suggest that we need to really understand our liabilities and structure our investments to manage our liability structure. I believe that all of Maker liabilities are an on demand structure? In a nasty stressed market, what will be Maker’s liquidity needs over say over 1 day, 1 week, 1 month, 3 months…?

At this point Maker has far more down side from not being able to meet a liquidity run compared to the upside of getting a few more percent in yield from a outperforming investment portfolio. So lets manage it accordingly at least in the short run

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I have been saying this for almost the past 1.5 years. That you can’t get to 1B 10M at a time (adding various tokens vs. being focused and improving ETH and wBTC deposits - which still has not been a focus), nor can you get to 1T easily at even 1B at a time.

  1. Primary goal I think for the protocol is to get as much DAI out there as possible. This along with PEG management is priority #1 (at least from the CUs I talk to).

  2. Earning a decent return for the risk taken on is probably priority (#2). This isn’t to burn MKR but really to build up a war chest reserve to deal with any issues trying to grow, and to back expenditures (this also really has not gotten much attention).

To do this requires a laser like focus which as far as I can tell still has not happened.

Right now I think a reasonable projection for RWA is .5B at end of year (even that is aggressive). 5B at end of 2022 also probably aggressive.

I am of the mind Maker needs a better plan to expand deposit TVL and DAI borrow in key asset classes.

If I had to pick on the RWA strategy I would pick.

  1. Scale - pick the things that are going to grow us as fast as possible, that are easy to scale.
  2. Reasonable diversification across RWF assets, and in geography
  3. Risk/Yield

PR should come on it’s own and ESG should be given some priority in the above 1-3 if possible.
Honestly should develop a project ranking system and have the DAO rank order the following:

The rank order should not be a 1-8 btw but we should be allowed to have 100 or 1000 points to allocate so we can get a signal as to strength (if possible) on these.

Key points to take away from my posts and views.

There is only so much productivity each DAI can buy, we need to use it in the most effective manner. This means focus should be on doing work that brings in scale, and yield. Why? Because we can use yield to expand manpower, and if scale is considered in every one of these projects (as the #1 component) we will be able to scale when needed. The last strong component should be a geographic spread. We don’t want to put all eggs in a single geographical or regulative/legislative region.

Everything else at this point comes in as lower priorities for me. Get to scale, get income and people and then we can easily broaden horizontally the structure to incorporate all the items above and expand more along the lines of the vision presented by @rune without growth and massive DAI expansion what Maker does won’t do much when trying to address real problems of systemic human endeavor sustainability.

Which really should be another key component of the above strategy. How sustainable are these RWF projects going to be. We should try to avoid any flash in the pan stuff and focus on the brick and mortar type building of the DAI financial superstructure.

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I have been talking about things like this since I came to Maker now over 2 years ago. You can work for when times are good, but you better plan for when times will be bad. Maker today doesn’t even have 1% SB against outstanding. Lets just hope if the markets decide to dump that we find the keepers and liquidation system as well as the tx network itself can keep up. BT caused a 4% protocol loss. That was 6M, today the same loss would be 240M.

MKR was actually better capitalized then at 600M vs. now at 2.4B relative to outstanding at the time (150M vs. 6B now) and it still had to pause MKR flops to get 6M in capital ready to bid.

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Great post, @MakerMan. Not sure if you’re aware, but @SES-Core-Unit is incubating a Core Unit to take care of everything liquidations related.

Here’s the video from last week: 🚀 Core Unit Launch Pod Sessions ||| Session #20: Sidestream Auction Services

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100% agreed on this one. No amount of PR can really save Maker from loss rates, if they come (and they will). We need to be way more Risk Management focused. Leave the PR for Growth. Focus on quality, only that from here. When you have institutional grade credit quality and attract solid collateral the PR will be done by itself. No need to be a focus. Well, not from a RISK team.

Maker should be extremely happy with a 1-2% yield (on avg). But be absolutely intolerant against having PD exceeding 0.5-1% (tops) in the most stressful of markets.

The core mandate is the stability of a world currency. We lose the trust on this mandate, we lose everything.

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I think this message has been lost in a lot of the recent discussions around yield farming, going out on the risk curve, and legal structuring.

I really think this needs to be the number one — and perhaps only — mission if we actually do decide to revisit core ideals.

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I couldn’t agree more with you and @williamr on this.

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@Eumenes speak about liquidity risk not about solvency risk.

The best way to avoid a liquidity run is to hoard a lot of regulated stablecoins (USDC, USDP, GUSD). We are quite safe on that front currently but it will change going forward. You can read more on the second part of my article on liquidity.

There is a tension between the wish to get rid of stablecoin exposure and the liquidity risk. Investing in short-term ETF is a part of the solution but that doesn’t change the problem completely, it’s just a different mix of regulatory risk and liquidity risk.

If the Maker community wants to be seriously risk-averse, then let’s only invest in money-markets type of products and get rid of the rest. You should vote against anything that promises more than 2% and is not managed by an institutional asset manager.

I recognize the problem of the Surplus Buffer as well. But governance voted against an increase. Not speaking that you should focus on profit-making to fill it (assuming issuing MKR to fill the SB is out of the discussion).

The strategy laid out in this thread is based on feedbacks from the governance (through what they voted, discussions, and comments on the forum). Therefore, I encourage governance (through delegates, MKR holders and the whole community) to have discussions.

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Thanks for formulating this strategy. It’s going to be a helpful document for community members & partners to use as a starting point for onboarding more RWA. Of course though the part I am most excited about is your 10 year view:

For DeFi to become the financial system and not just stay on the fringes we need to find a way to bring the real world into this system. Just passively buying assets and holding them in some legal entity is not going to replace the financial system in the long run. It’s 10x harder and 10x slower. I voted yes on onboarding ETFs and bonds (with a focus on ESG & gren tech) as a stop gap measure for that reason and putting this in a framework with target allocations for different asset classes I think is a good way to make sure we work on both.

My personal opinion on aside, Centrifuge of course is focusing on pioneering on chain securitization.

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I was not precise is referring only liquidity risk as opposed to solvency risk as they are closely linked. Typically when the market believes a bank has involvency risk, there is a bank run which causes liquidity issues and potentially insolvency.

My question is what percentage of assets does Maker put into ‘risky’ assets versus low risk/high liquidity assets. And how does Maker construct its asset portfolio given its liabilities risks (liquidity and solvency related)? Said differently what percentage of assets need to be very low risk and liquid to provide liquidity when needed? What level of risk can Maker take in its asset portfolio and maintain actual solvency (& perceived solvency by the market)? These are difficult questions but are essential to managing the Maker balance sheet.

Its also difficult to size the liquidity/solvency risk of Maker and the overall crypto-bank space (though more research can help here), so lets see how US banks managed their liquidity/solvency risk over the last decade (per Sebastien’s article on liquidity). The banks had the following liquid assets and other protections:

  1. Averaged around 10% cash reserves though they averaged about 15% since the COVID era
  2. Averaged around 17% US Treasuries though they increased to about 22% since the COVID era
  3. The FDIC provides deposit insurance up to $250K
  4. The Banks are regulated and required to maintain a certain quality of assets
  5. The Central Bank provides liquidity to banks in emergency situations (Lender of Last Resort)
  6. Banks typically have a sticky retail deposit base

So the typical US bank had around 30% of its balance sheet in (arguably) riskless assets in addition to providing FDIC deposit insurance and having regulators oversee its asset portfolio quality. Does this provide any guidance ?

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Interesting @Eumenes,

I agree with most of your points. Having worked in banks my whole career, I can testify that solvency and liquidity are two correlated issues, although different philosophically and managed by different departments - liquidity under CFO/ Treasury and solvency under Risk Management.

I also agree that the commercial banking model is instructive and one to be looked at.

There are, however, a few fundamental differences I would like to highlight:

  • Commercial banks benefit from a very strong base of (retail) customer deposits; those are extremely sticky in nature and offer a fantastic fallback of cheap and stable funding - there is not even a shadow of such stickiness in DeFi and the underlying dynamics of each asset should be assessed carefully
  • Commercial banks benefit from the lender of last resort window with the central bank - when things go bad, and a bank has complied to solvency requirements, there is always a central bank ready to step in - that is why the bible of banking analyst is the Pillar III report of a bank, where liquidity risk is almost overlooked
  • Commercial banks have a cost of equity of c. 10-12% and average cost-to-income ratios in the >50% range - this means that their pressure to generate returns from climbing the risk ladder is very high (and that is why most successful banks are moving away from the lending model and going more and more into the advisory one - look at MS and JP as examples in the US), this is not the same for Maker where the cost of capital is negligible and the operating leverage very high
  • Commercial banks are highly regulated and centralised, this is bad in some way but also good in the sense that a lot of behaviours are enforced centrally - when interacting with TradFi, Maker naturally needs to stretch a bit and give a bit more trust than ideal to some individuals without the enforcement power of traditional institutions

The point I am trying to make is that there is, on the one hand, no need not to be ultra-conservative for Maker given its incredibly high operating leverage - growth has more benefits than risk, and on the other that the risks of making a mistake are much higher as highlighted by @williamr and @PaperImperium - because DeFi has a much more liquid nature than TradFi and there is no central pillar backing everything up.

We could even push ourselves to imagine that it could actually be Maker that central back-up pillar for the whole DeFi ecosystem.

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Thanks Luca.

I added your two other key differences between traditional banks and Maker in terms of liquidity/insolvency risk.

I definitely agree with you that Maker shouldnt take much of liquidity/solvency risk as Maker has ‘incredibly high oeprating leverage’!

In terms of top risks for Maker to manage I think the following are essential:

  1. Liquidity/Solvency Risk - if Maker loses market confidence is the value of DAI, Maker is likely done. DAI value and liquidity must be preserved at all costs.

  2. Cautious/Moderate Growth Risk - I believe that the stable coin market has definite economies of scale and economic network effects. Thus at scale there will likely only be a handful of huge stable coin players and we all want DAI to be one such super player, or perhaps only one such player. In Highlander terms:

image

Thus fast growth is essential so Maker can achieve the economies of scale and network effects early. Slow/moderate growth is a high risk in this type of market structure as other stable coins can reach scale first and outcompete Maker.

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Agree in full @Eumenes,

I think that the key will be choosing the risks ‘worth taking’ and those that are not. Profit optimisation might not be the best risk-reward path.

I think decentralisation helps naturally in this direction.

P.s. loved the quote

Regarding the growth strategy, I discussed that a stablecoin proposition is mainly a solvency/liquidity risk vs deposit interest rate (the risk-free, or no risk-added version, like DSR). You can have any point in this space to satisfy the need/want of different classes of customers.

This was also my conclusion:

How do you manage your balance sheet to meet the constraint of solvency and liquidity while optimizing the spread between funding and investment rate?

The winner will be a trillion-dollar company.

For low solvency/liquidity risk, the market is already full of “soon to be regulated” stablecoins. Only in crypto we can have insolvent stablecoins issuers and/or illiquid ones which provide rewards in governance token issuance. Therefore, I would say the sweet spot is somewhere in between as the ability to provide a deposit interest rate (assuming regulation cleans up) will be key to boosting growth and moving beyond the fiat-backed stablecoins competition. Growth has some great partnerships that will kick in only if DSR goes above 2% (I don’t see how we can achieve that in the current context).

I believe this discussion has some merits @SebVentures, although I see it decoupled from the RWA front (even if there are obviously connection points).

I believe that the treasury and liquidity management should be managed by a CFO-like actor within the protocol, not one that is at the same time engaged in improving yield on (a subset of) the asset base, and in mitigating specific (not institutional) credit risk in the meanwhile.

I think this is a natural part of the maturing process of Maker, but not one to be mismanaged.

This is exactly in the spirit of this thread. In a few months, we will have onboarded RWA (loans, project finance, structured products, bonds). We (the whole ecosystem) have moved the space forward from having small asset originators to big institutions coming to us. The work might continue likely as separated and more focused RWA Core Units (spin-off from the RWF team or externally). Those CUs will have the job to create alpha if that’s the wish of MakerDAO (I’m not a big fan of that but I understand the arguments).

Limiting ourselves is a good way to create space for more RWA CU to be created and enhance decentralization (which is why I spoke to about 4 of such possible CUs). Assuming off-chain investments are more of liquidity/treasury management than RWA, we are keeping only 8 slots. I can’t forecast the future and we will continue to do whatever it takes to move MKR forward. But the message is clear.

Thanks to those building blocks and less intensity in RWA, the RWF CU will be able to move towards ALM management which is why there is an ALM analyst slot in the next budget. It’s all part of this RWA Strategy.

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I believe this is the defining issue for Maker - what product(s) does the market want and how can Maker best meet this need???

I also believe Maker should research/test what product(s) the market needs, if it isnt already. How do market participants think about the liquidity/solvency risk versus yield? Also how will institutions think about this, assuming they enter the space. (I admit the current success of the Tether model is a bit discouraging)

I was going to say that I was getting off topic here, but the ALM strategy and implementation have a large impact on the DAI product: much of a stable coin product is defined by its ALM approach.

This is a great thread, very useful to see how the strategy is evolving. A great example of building in public.

A tension I’ve observed and a possible solution to remedy it.

The tension: RWA is still in early stages and is trying to figure out a product/market fit. This requires working on projects that offer max learning so the team can understand the risks inherent in collateral types. Off the back of these building blocks, a clear strategy can for growth can then be set. However, the team are also struggling with the inflow of onboarding opportunities and the obvious way to address this is to prioritise the opportunities that can deliver serious scale (1bn+ in first year). But these opportunities offer the team less learning as they’re likely more established organisations doing something at scale already. So the scale means it’s harder for the RWA team to figure out the true product/market fit for the longer term RWA strategy. And these groups are unlikely to want to try out different structures and experiment with different strategies that will ultimately provide the Maker community with the learning it needs.

Possible solution: Following on from @SebVentures thoughts on a Asset Managers becoming a Core Unit

  • A Decentralised Internal Asset Manager (DIAM) is set up solely as a dedicated vehicle / team entirely to being part of the Maker ecosystem. They are a commercial entity that function as a business in their own right, but somehow tied in but in a decentralised manner (eg Maker purchase 25% of the company for x number of MKR tokens) and their governance is linked to a Maker voting mechanism.
  • The Maker community and RWA team now have full visibility over the DIAM’s operations (both legally and on-chain if the DIAM documents everything in public for the Maker community to follow). Maybe a decentralised CFO style actor is also involved and provides audit, to add another level of transparency and ensures that EVERYTHING is being recorded on-chain. They in effect work on behalf of the Maker community so the community know that the risk being taken is fully understood across all aspects of the capital stack.
  • Assuming the Asset Manger has the right credentials to deploy capital at scale, then this solves both the problem of getting to scale with minimum RWA team interaction (beyond initial onboarding which will never be passive) while also allowing the RWA team and the whole Maker community to have full visibility over the Asset Manager’s workings, the risks they take on at every level of the capital stack and hence know EXACTLY what Maker’s exposure is when they deploy capital. This is part is very important.
  • If the Asset Manager is decentralised but related to the Maker ecosystem, then it can continue to be adapted and shaped for the changing needs of Maker as the RWA strategy evolves. Eg we could test two different structures / strategies in parallel, both undertaken by the same Asset Manager, and see which one offers better outcomes to the Maker community. This then enables the RWA team to spend more time working on creating good structures and strategies, and less time on the onboarding pipeline because the RWA team can run x number of strategies / tests with just one Asset Manager, rather than having to onboard x new asset managers to get the same amount of learning!

Would love to hear the community’s thoughts on this.

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Under the Off-chain investments section for ideas:

You’ve got short-terms ETFs and asset managers - just as an alternative, perhaps AAA-rated and money-market rated ABS bonds may be a worthwhile alternative.

Here’s what I see in terms of the benefits of Maker investing directly to the senior and super senior money market tranches of various ABS securitizations:

  • Highly rated (either AAA or A-1/F-1 money market) bonds collateralized by pools of loans. These bonds are very short duration, so holding to maturity isn’t a big commitment (short duration also helps minimize credit exposure and liquidity risks).
  • Participating in broadly syndicated securitizations would put Maker’s name on the radars of the issuers of these term securitizations, most of which also implement warehouse facilities and flow purchase programs to fund their originations (i.e. strong potential to cross over onto on-chain capital markets).
  • Broadly rated securitizations oftentimes have several redundancies (i.e. performance triggers, servicers/back-up servicers, trustees, agents, etc) that would minimize Maker’s need to be involved in the management/servicing/decisioning of the securitization structure or collateral pool management.
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