Real World Assets are one of the biggest opportunities and challenges for Maker, and the thing that sets the Dai stablecoin apart from any other DeFi project.
Just as it has incredible potential, the field of RWA is also extremely complex and difficult. For this reason it is extremely important that MKR holders structure the entire framework to make it as easy as possible for them to manage its risks, especially at scale.
This post is intended as a simplified overview of the Arranger Model. It has been written with input from some of the RWA experts in the community, but it is just a starting point that will need to be further discussed and refined publicly by the community. Luca Prosperi is currently working on a very detailed report that gives a more formal and professional opinion on how to structure highly scalable RWA capital allocation, which will help us to further refine the frameworks.
The biggest risk of all is the inability for MKR holders to understand the risks of the RWA collateral that is onboarded at large scale. Traditionally, the model Maker has followed with collateral, including real world assets, is a passive system where the community waits for projects to come with proposals of any kind, and then considers each of the proposals individually.
This is bad for two reasons, first of all it means that Maker is supposed to be able to price the risk of literally any type of deal that could possibly exist, which is not realistic and leads to Maker doing business with a lack of knowledge.
The second problem is that because the process is so broad, and as a result extremely slow and uncertain, we are self-selecting to only engage with counterparties that have no option to go anywhere else, and as a result we end up with generally bad deals on top of the fact that we are badly equipped to analyze them.
There’s a saying that if a borrower is willing to sit around and wait for the deal to go through, then it’s never a deal you want - because you are literally the only person on the planet that’s willing to accept those terms (or they would have gone somewhere else).
The solution to this problem is to adopt a model based on Eligibility Criteria, where Maker proactively specifies what types of proposals it’s looking for, and creates an expectation that there is a high likelihood of acceptance if proposals fulfill the requirements.
Instead of waiting for people to come to us with completely new things in structures we are not familiar with, we should standardize and specify what we are interested in as much as possible, and then create a high likelihood of a quick and successful process for the collateral that meet our requirements both technically and in spirit.
Standardization of the content of the deals are crucial, but standardization of the structure and enforcement is just as crucial. There is no reason why we should deviate from anything other than the strongest possible legal setup that provides us the strongest possible recourse, and there’s no reason why we should spread our attention across many different idiosyncratic models instead of focusing and specializing in one specific structure for each jurisdiction.
The other major risk of RWA scaling comes from the extremely complex relationships and interactions that it takes to set up a fully functional RWA pipeline with legal structures, deal flow, high value counterparties etc.
A big part of the process of performing due diligence on an RWA counterparty involves reviewing confidential information.
Without proper separation of powers, this could create a risk of private entanglement where the DAO is effectively unable to maintain relationships without the mandated actors that control them.
Examples of failure modes include:
- Not being able to monitor the risk of a deal without the consent and involvement of a privately entangled mandated actor.
- Not being able to liquidate or restructure a deal without the consent and involvement of a privately entangled mandated actor.
- Not being able to access legal information of structures that are supposed to benefit the DAO if a privately entangled mandated actor controls the relationship with the lawfirm
Because it’s hidden as it builds up and only emerges after the damage has already been done, private entanglement can cause tremendous buildup of hidden risk in the long run if it is not properly controlled.
The way to control private entanglement of mandated actors involved in RWA deals is to strictly enforce separation of powers and decentralization across the entire RWA pipeline. There needs to be strict requirements around how mandated actors can engage directly in deals, and generally their personal involvement needs to be minimized. Mandated actors must facilitate interactions between counterparties and the DAO, rather than act on behalf of the DAO and personally interact with counterparties, to the extent this is feasible.
There also needs to be internal controls specific to RWA, including auditing, standardization of best practices and enforcement of transparency standards. There also must eventually be multiple redundant RWA Core Units, to prevent a single point of failure from emerging, even at large scale.
My proposal is to create a standardized framework based around the concept of “Arrangers” - professional and highly experienced financiers with extensive networks that get pre-approved by Maker Governance based on recommendations by RWA Risk Core Units to source, arrange and propose RWA deals with Maker that fit the Eligibility Criteria Maker Governance has proactively adopted based on committee discussions and recommendations from the RWA Risk Core Units.
Specifically Arrangers have the autonomy to onboard deals based on Boxes that represent a pre-approval for a particular Elibility Criteria, and that each have unique terms. The terms of the Boxes are then continuously changed over time based on the performance of the Arranger, mostly by increasing the debt ceiling over time.
Examples of Boxes would be:
Renewable energy projects in the US
credit tenant leases in the US and Canada
Short term institutional debt in x region
Each of these boxes have their own terms, including equity requirements, maximum and current debt ceiling and interest rates. Technical DC control could be implemented as a single vault with a very slow version of a DC-IAM, while the Boxes and their individuals terms aren’t implemented on the protocol side but instead through the legal structure.
Around the arrangers is a self-regulating system that supports massive scaling, and implements a strict separation of powers with many distinct categories of actors that work together to implement the scalable and secure RWA funnel.
The RWA Audit Core Unit is a secondary (meta-governance) Core Unit consisting of a relatively small team of Highly experienced credit professionals. e.g. credit risk management experience in all stages of the credit process (origination, modelling, underwriting, performance monitoring, collections and recoveries)
The RWA Audit Core Unit continuously works to create and evolve a ruleset for best practices in terms of legal structuring, transparency, decentralization in how the RWA Risk Core Units conduct themselves. The RWA Audit Core Unit then continuously monitors and reports to Maker Governance about the performance of the core units, and if it detects potentially problematic behaviour it will attempt direct remediation efforts and ultimately recommend action by governance if it is unsuccessful.
RWA Risk Core Units are primary (doing-the-work) Core Units that do risk analysis and make governance recommendations related to the onboarding of Arrangers and specification of their Boxes, modification of Box terms for Arrangers, and in exceptional circumstances, the liquidation/unwinding of Arrangers. At scale the RWA Risk Core Units themselves are meant to be internally separated, meaning rather than building up large internal teams in black boxes, they have lean mandated actor teams that administer the Core Unit and its privileges such as budget an executive vote privileges, while managing a decentralized ecosystem of private actors doing professional risk services to perform risk analysis on the Arrangers.
Onboarding of Arrangers
RWA Risk Core Units in practice engage in discussions with prospective Arrangers, and based on these discussions and the analysis of their risk microservices resources, they recommend one or more boxes with appropriate terms.
Modification of Box terms for Arrangers
There are different conditions that can trigger an analysis that may lead to a recommendation to modify terms of an Arranger Box. If an arranger has hit the maximum debt ceiling of a Box, then it can be considered to increase it even further if the conditions and the performance allows for it. It may also be that an arranger wishes to specialize in other areas, or that they have performed inadequately and need to have their debt ceilings or terms made more strict.
The RWA Risk Core Unit makes the analysis, potentially relying on appropriate risk microservices, and then if they think it is necessary, makes a recommendation to Maker Governance.
Liquidation of Arrangers
In some special circumstances conditions may occur that make the RWA Risk Core Unit analyze whether it is appropriate to recommend a liquidation of an arranger.
The Arrangers are the key actor in the RWA pipeline, as they are the hubs of all the different commercial and legal relationships that it takes to set up a solid, scalable RWA structure. They typically specialize in a few specific areas, such as specific regions or type of credit, and then focus on scaling it up as much as possible within the autonomy they are given by Maker Governance, based on the recommendations of RWA Risk Core Units.
Arrangers are highly scalable business models that focus on charging small margins on quantity, and there is an economic limit, as well as a “political limit” to the amount of Arrangers that can practically exist, since their business models have to reach enough scale to be viable, and they need to be politically present in the community so they can build up enough trust to get the necessary scale.
Arrangers can set up various pipelines and structures below them, but in all cases they have to fit into the Boxes that have been approved by Governance. This gives them a lot of flexibility, and most importantly gives them the ability to proactively seek out deals and execute them without having to wait around for the bureaucracy of the Maker Governance process to sign off on them.
In practice however, they always need to consider the will of Maker Governance, since even if individual deals don’t need direct governance signoff, if they deviate from the spirit of the deal, e.g. by stretching the definition of sustainability or getting around sustainability metrics based on a technicality, then it may result in them getting their Boxes modified to prevent them from expanding any further. This mean the best interest of Arrangers is to operate as much as possible in alignment with the will of Maker Governance, but with the benefit of having no red tape or bureaucratic roadblocks on a day to day basis, and with the autonomy to make decisions on individuals deals so that they can be closed in a way similar to what the traditional financial world is used to, making Maker competitive as a lender.
To minimize overhead and complexity of the RWA Risk Core Units, the leg-work of analyzing data and continuously monitoring the Arrangers is done by Attestors, private actors that work with multiple Arrangers simultaneously. Arrangers are pre-approved and by Maker Governance in the same way as Arrangers, and Maker can put limits in place to ensure that there are multiple Attestors across the different Arrangers, minimizing single point of failure risk.
Attestors, as private actors, also have the ability to enter into NDAs and analyze proprietary data, and then publicly attest to its validity.
An Arranger needs to already have an agreement in place with an existing, pre-approved Attestor before they can be onboarded and get Arranger Boxes and a debt ceiling.
A key element of the Arranger Model is to standardize the enforcement of claims against the collateral, by only working with top-tier trustees, and ensuring that no cash flows can “leak” outside the control of the trust.
Maker must pre approve the list of trustees it considers top-tier for each jurisdiction, and arrangers can only be onboarded if they already have a relationship with at least one such trustee.
The Lender is the entity that borrows money from the Trust, and then allocates it to the various Boxes that have been approved, by lending out the money to end-borrowers.
All capital allocation must always be in senior secured credit.
Some potential RWA counterparties to Maker are entities that themselves are as reputable, regulated and capitalized as top-tier trustees. Examples would be large regulated banks or other large, regulated financial institutions.
Inherently Trusted counterparties can make proposals directly to RWA Risk CUs without the need for a pre-approved Arranger Box, and RWA Risk CUs can directly recommend onboarding of their vaults, and modification of their risk parameters to Maker Governance.
An example of this would be the recent Societe Generale proposal.
In the community today there are already at least 3 groups that have potential to act as highly scalable Arrangers in this framework, and scale to significant size, potentially several billions, within a year.
Matt (6s Capital) is the first RWA provider to implement a trust based structure. They are US focused. The experience of Matt and strong structure of the RWA setup means that rapidly scaling to 100s of millions in the short run is realistic.
Christian (MD Radiance) is a veteran from the RWA Core Unit that is now potentially ready to onboard as an Arranger. MD Radiance has indicated to me privately that they are interested in taking over the live and near-live Centrifuge deals, so that they can smoothly be restructured to work under the Arranger model, without disrupting our partners access to credit our damaging our credibility. In addition MD Radiance is able to focus on Canada and other non-US markets, which make them well positioned to handle Backbone collateral at very large scale (potentially 1 billion or more within a year).
Allan (Monetalis) is a newcomer to the community but with significant industry experience and based on what I’ve learned has the interest and the necessary skillset to act as an arranger. Monetalis is UK focused, which makes it a great place to place Backbone collateral that can diversify our exposure out of the US. They will need strict analysis but if passed my estimate is that this is another potential of up to a billion of non-US RWA collateral within a 1 year time frame.
In total, we already have everything in place that allows us to diversify up to 2 billion USD worth of collateral outside the US, and do major flagship projects inside the US also potentially at the scale of billions.
Since 6s has already proven the basic pipeline is legally viable and works end to end in a live setting, it is going to be a matter of Maker Governance creating a stable enough environment to give these businesses the confidence they need to start scaling up their operations and fully engaging their networks.
Meanwhile we should also consider onboarding more Arrangers, especially outside the US in climate resilient areas such as New Zealand.
Maybe even consider increasing the DSR to preempt the situation where we have too much collateral and Dai demand becomes the constraining factor on growth.