Guest Writer: Grayson Alto
Primer on Stablecoins
Since early 2021, the movement for real world assets(RWA’s) intermingling with DeFi has grown substantially. Some of the largest uses cases being real estate equity tokenization, tokenized private credit, and tokenized securities. And while many RWA focused protocols are pioneering the way with infrastructure, original players in the DeFi space such as Aave and MakerDAO could be the ones to ultimately lead adoption on the demand side.
Stablecoins have led the way for RWA adoption amongst the blockchain ecosystem. And as Vitalik Buterin recently said, stablecoins will ultimately fall under three categories:
- Centralized stablecoins that are issued by a traditional legal entity(Circle-USDC)
- Decentralized “governance-minimized crypto-backed stablecoins(RAI)
- DAO-governed real-world-asset backed stablecoins(I.e Maker-DAI)
Centralized stablecoins such as USDC and Tether in some sense led the way of using crypto to earn yield in the real world as they run a fractional reserve banking model: taking your crypto assets and investing them into the real world capturing real interest. But for a long time algorithmic stablecoins such as DAI were unable to do so as MakerDAO is not a legal entity and can’t simply buy U.S Treasuries. With legal and operational advancements, that’s all changed.
Why are Algo Stablecoins the target of RWA’s?
Algorithmic stablecoins are presented opportunities with RWA’s in that the returns are stable/uncorrelated with the general market and essentially have an unlimited demand. Algo stablecoin protocols are faced with returns that are extremely correlated to those in the general crypto markets as low-risk rates in DeFi plummet during ‘crypto winters’. RWA’s enable returns that are not only uncorrelated to crypto, but also inversely related: high Fed interest rates → equity downturns/crypto bear markets + higher RWA debt return rates. This gives protocol players a hedge on general market volatility.
The Impact of Maker, the current state
Maker coined the term ‘Real world assets’ when they were the first to move into the space in 2021. MakerDAO is the largest protocol at nearly $6 billion in total value locked(TVL), down from nearly $20 billion a year ago. In an effort to earn stable returns in highly cyclical markets, MakerDAO has turned to the real world leveraging emerging bridges between the traditional finance and DeFi.
The latest quarterly data shows Makers revenue decreasing sharply from $46 million in Q1’22 to $4 million in Q3’22. This rapid revenue decrease is representative of the sharp demand downturn for borrowing DAI where the protocol has earned a majority of its revenue via the stability fees of borrowing money.
The chart above highlights Maker’s revenue correlation to that of the overall market. As Eth prices fall, so does the protocol’s revenue, and by exponentially more than Eth price decreases. Maker with an average of $3 million in operating expenses monthly needs consistent returns without the volatility of the general market. Maker’s strategic team was quick to begin looking elsewhere to diversify revenue streams.
In reaction to negative net income stemming from falling revenues, Maker began moving to large scale RWA asset onboarding. The chart with data up till November shows the strategic onboarding process picking up as revenues begin to bottom.
RWA’s now make up more than 50% of all protocol revenues bringing in $21 million of annualized revenue as of December 18th. This is a major milestone as MakerDAO continues to prove the validity on taking RWAs as collateral.
Above is a breakdown of the current RWA collateral held. Major milestones were Huntingdon Valley Bank being activated for $100M of DAI in August, Monetalis Clydesdale(MIP65) for $500M activated in October, and as of just last week, BlockTower capital approved for $150M.
Last spring I wrote about Huntingdon Valley Bank(HV Bank shown above) which was instrumental in RWA growth from a legal and operational standpoint, so below I will briefly highlight the recent advancements in Monetalis Clydesdale(MIP65 above) and BlockTower Capital.
MIP65: Monetalis Clydesdale
MIP65 has been in the works since August of 2021 before ongoing revisions up until it’s implementation in October of this year. $500M DAI has been allocated to liquid bonds to earn yield in the real world. The $500M is allocated across two Blackrock ETFs compromised of U.S Treasuries of different durations.
- IB01: iShares $ Treasury Bond 0–1 yr UCITS ETF [$348M allocated]
- IBTA: iShares $ Treasury Bond 1–3 yr UCITS ETF [$152M allocated]
Both track US-Treasury bonds portfolios with the difference being the duration and the maturity. IB01 has a duration of 0.38 while IBTA has a duration 1.88. Duration is a proxy of the expected loss in mark-to-market value when there is a 1% unexpected increase in interest rate. Being issued by the Treasury, there is no expected possible loss if the bonds are held to maturity.
As of writing, the weighted average yield to maturity at around 3.5% and 4.3%.
BlockTower Credit
Passed on December 11th, Maker will be supplying $150M of senior capital to BlockTower who is supplying $70M in junior capital for a fund. Maker will launch four vaults to fund investments in RWA’s, originated by BlockTower and issued on-chain via Centrifuge. The DAI is minted with the senior debt as collateral at a 4% stability fee yielding a promising investment for MakerDAO with BlockTower earning the spread.
The firm manages well over half a billion dollars and draws on decades of combined experience across professional investing and trading, early-stage venture capital, and credit.
The Next Big Player: GHO
Of all tailwinds in the expanding RWA space, Aave’s upcoming ‘GHO’ algorithmic stablecoin is the most exciting to me. Aave is the fourth largest DeFi protocol currently and the second in lending with over $3 billion in TVL. The proposal was introduced in July of this year with a development update this October including the project’s official ‘technical paper’. GHO was initially thought to launch very early on in the new year of 2023, but this likely will ultimately be delayed several months. The stablecoin model is similar to Maker’s DAI in many ways with some small differences. I mostly want to highlight what this upcoming launch means for the RWA ecosystem.
Aave in it’s first proposal introduced the idea of facilitators, seemingly in place of vaults for RWA purposes for Maker.
A Facilitator (e.g., a protocol or entity) can trustlessly mint and burn GHO tokens. Various Facilitators will be able to apply different strategies to their generation of GHO. At launch, there will be one Facilitator for GHO; however, a framework with guidance on how to apply to become a Facilitator will be published on the Aave Governance forum.
For each Facilitator, Governance will also have to approve something that we call a bucket. A bucket represents the upward limit of GHO a specific facilitator can generate.
Makers success and ramping up of RWA expansion likely is why Aave is immediately bringing it’s attention to RWA’s upon launch. The graphic above depicts a RWA facilitator as its first facilitator outside of Aave itself. Rather than by chance, I believe that this is intentional by the GHO team to emphasize the importance of integrating the real world into the stablecoin.
Unlike Maker, Aave will allow users to mint GHO against multiple types of collateral rather than creating a separate vault for each asset, making minting GHO often cheaper than DAI.
As of recently, several of the top private credit focused RWA protocols such as Goldfinch and Centrifuge have been very active in pursuing opportunities with Aave. Examples include posts from Goldfinch and Centrifuge. Both Goldfinch and Centrifuge are offering mainly private credit, meaning there is great opportunity for alternative fixed-income products. Cytus for example is a young protocol that’s begun bringing U.S Treasuries on-chain which is useful in bridging the gap between risk free rates in the real world and those in DeFi. With high interest rates in the real world at well above 4% for 1 year t-bills, the off-chain risk free rate is significantly higher than that in DeFi causing great inefficiency. Cytus’ solution plans to negate the previous inefficiency by allowing capital to flow more freely between worlds.
Aave has the power to make waves in the RWA space as the implementation of GHO is expected to scale to be one of the largest algorithmic stablecoins if not the largest in time. With Aave already having ties to RWAs with previous partnerships, and clear intent to leverage RWAs with GHO, Aave is expected to move fast into the space.
Looking Forward
There is no shortage of optimism for a DeFi space that is searching for maturity. As Maker paves the path for algo stablecoins, I believe many protocols beyond simply Aave will follow suit. Maker is beginning to build a protocol that thrives outside of typical bull market parameters, soon turning profits in a winter when other protocols simply can’t. I expect Maker to continue to expand RWA collateral on the balance sheet above the billion mark by mid 2023. As Aave’s stablecoin launches, I expect RWA collateral to be one of the first things on the roadmap making it one of the early facilitators. Many Trade-Fi institutions on the flip side are starting to understand the benefits of working with algo stablecoins as you can potentially unlock relatively limitless liquidity granted your risk management and business model are up to par. RWAs are beginning to close the risk-free/low-risk gap between the digital and real world, now minimizing the intense cyclicality of markets for DeFi users and protocols.
