Mint Ventures The Only Solution for Short-to-Medium-Term RWA. A Discussion on Web3 National Debt Business.
Mint Ventures The solution for short-to-medium-term RWA and a discussion on Web3 national debt business.
Author: Colin Lee; Source: Mint Ventures
The sub-category of RWA that is most likely to experience explosive growth in scale and user base in the short to medium term is government bonds. According to data from rwa.xyz, the tokenized government bond assets in the government bond RWA category (excluding US bonds in MakerDAO) have reached nearly $700 million, an increase of about 240% since the beginning of the year. In addition, government bond RWA in MakerDAO has also rapidly grown to the level of several billion dollars. Government bond RWA has shown fast overall growth.
Source: https://app.rwa.xyz/treasuries
Based on the above industry background, let’s analyze the mainstream government bond RWA in the market.
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Significance of Government bond RWA
We can roughly consider the PoS yield of a public blockchain as the risk-free interest rate of the blockchain, and a bond market may gradually develop around this interest rate.
Even if there is no rapidly developing native encrypted bond market on the blockchain in the future, the emergence of the “risk-free interest rate” LSD still has significant implications for investors: investors who hold public chain tokens (such as ETH) as their accounting base can still obtain low-risk returns in a bear market. From this perspective, part of the investment strategies in the traditional market can be smoothly migrated to the native encrypted industry, such as the stock and bond balance strategy.
Just like LSD, once the risk-free interest rate of the traditional financial market can be introduced into the blockchain world, U-based investors can use traditional asset allocation strategies. There are several benefits to this:
(1) U-based investors still have a relatively safe and stable place for earning interest after the market enters a bearish phase. Taking the stablecoin market as an example, after the market gradually entered a bearish phase in mid-2021, the overall market size of stablecoins decreased from $188 billion to less than $130 billion. The decrease in the size of stablecoins also affects the overall market liquidity;
(2) It is easier to launch and be accepted by the market to introduce mixed investment products of stocks and bonds, which are also familiar to most investors in the traditional market. This will also promote innovation in the DeFi asset management field.
Source: https://defillama.com/stablecoins
The most typical example currently is MakerDAO. After the market entered a bearish phase and US bond yields increased significantly, MakerDAO included US bonds in its investment scope, and its profitability improved significantly after 2023.
Source: https://dune.com/SebVentures/maker—accounting_1
Therefore, there is reason to believe that other DeFi projects, after seeing the “demonstration” by MakerDAO, will also hope to improve project profitability through more diversified strategies such as RWA. Especially in a bear market, RWA can provide stable and sufficient sources of income for the stable operation of projects.
Business Models of National Debt RWA
Currently, there are five business models for national debt RWA: agency model, platform model, infrastructure model, self-operated model, and hybrid model.
The agency model does not directly participate in the packaging of underlying assets or provide KYC services to users. Its main focus is on business marketing, fundraising, and the expansion of the ecosystem and application scenarios through encrypted means of customer acquisition. Representative projects include TProtocol. These projects are similar to the infrastructure of daily use such as Aave and Compound. They often obtain liquidity by establishing a fund pool, aggregate users’ funds, and lend them out to a single borrower to purchase underlying assets such as US bonds.
The platform model refers to projects that only provide a series of services such as on-chain, sales, and KYC, but do not directly package assets. Representative projects include Desmo Labs. These projects generally provide three types of services: (1) asset/equity tokenization services; (2) on-chain verifiable information services; (3) user KYC services, etc. These types of projects theoretically assist in packaging any type of assets/equity from traditional markets, not limited to national debt RWA, and are more similar to the business model of internet platforms. To stand out in this field, the project needs to consider the usability of its one-stop solution and the ability to acquire customers.
The infrastructure model provides services such as on-chain RWA, asset purchasing, and asset management, but does not directly interact with users who purchase government bonds on the C-side/B-side. Representative projects include Centrifuge and Monetalis Group.
The self-operated model involves the project itself finding the corresponding assets, collaborating with external partners to establish a business structure, ensuring the risk isolation of assets, and tokenizing the assets/equity. Currently, there are many projects of this type, such as MakerDAO, Franklin OnChain U.S. Government Money Fund, and Frax Finance. This type of model has a higher degree of complexity in off-chain business compared to the first two models and requires investment in legal affairs, corporate business structure establishment, and selection of assets and partners. However, an important advantage of these projects also stems from this: the underlying assets are relatively controllable, and the project team has the ability to actively manage risks.
The hybrid model can be a combination of the four models mentioned above. Projects of this type can provide services such as on-chain, KYC, etc., and also search for assets themselves to directly provide investment opportunities to users. An example of such a project is Fortunafi. For example, Fortunafi provides four types of services: (1) Access Capital, which provides a way for financing parties to obtain funds; (2) Earn Yield, which includes pre-packaged assets that users can directly invest in after completing KYC; (3) Protocol Services, which provide governance, treasury management, and other services to other protocols; (4) whitelabeled products, which provide full-process on-chain services for RWA. Of course, the RWA services of these projects are not limited to government bonds and can also provide on-chain packaging services for other assets.
Of course, in addition to the above five models, there are also more pure trading-based infrastructures such as DEX that serve RWA, such as DigiFT. However, these projects do not participate in the selection, on-chain, sales, and other processes of underlying assets, so they will not be further elaborated here.
Asset Side: Underlying Assets and Asset Side Architecture
Underlying Assets
Currently, there are several types of underlying assets in the market:
(1) US Treasury ETFs. Projects that use this type of underlying asset include Backed Finance, Swarm, MakerDAO, and ARKS Labs, among others. The advantage of using this type of scheme is simplicity: the management of underlying assets is entrusted to the ETF issuer and manager, including liquidity and bond rollover issues, which do not need to be managed by the project team themselves. US Treasury ETFs have not encountered significant risks so far, so asset management risks for projects of this type are not a major concern. It is only necessary to include the largest and most liquid assets on the market.
(2) US Treasury Bonds. Projects that use this type of underlying asset include OpenEden, TrueFi, Matrixdock, among others. These projects often choose shorter-term US Treasury bonds, which are as liquid as cash. However, as the projects directly seek cooperating trustees, it is important for these projects to bear the asset management-related risks and select suitable partners.
(3) Combination of US Treasury Debt, US Government Agency Debt, and Cash/Repurchase Agreements. Projects that use this type of underlying asset include Franklin OnChain U.S. Government Money Fund, Superstate Trust, TProtocol, Arca Labs, Maple Finance, among others. Similarly, these projects entrust the management of underlying assets to professional managers, and the rollover and liquidity issues of underlying assets are directly related to the project team. At the operational level, if the project team fails to select a high-quality manager, problems may arise.
Fee Structure
The fee structure resulting from the three types of underlying assets discussed above also varies. Without considering the gas fee resulting from on-chain transactions, the main fee structures are as shown in the following figure:
Since the management of US Treasury ETFs is entrusted to ETF managers, the main fee issues arise from the minting and redemption processes, with fee rates usually around 0.05%-0.5%; for the latter two types, additional management and transaction fees are incurred due to the management of underlying assets, with management costs approximately 0.3%-0.5% and transaction fees such as bank transfer fees around 0.2%.
Asset Business Architecture
The difference in underlying assets also affects the overall business logic architecture. There are currently several types in the market:
(1) Trust Structure: Projects that currently adopt this scheme include MakerDAO.
Source: https://forum.makerdao.com/t/mip65-clydesdale-governance-framework-setup/16565
The trust operating mechanism involves the transfer of assets from the sponsor to an SPV to establish a trust relationship. The sponsor obtains the right to trust income and then transfers the beneficial interest of the trust to ordinary investors. Taking MakerDAO’s US Treasury RWA architecture as an example, it includes multiple roles such as managers and auditors, but part of the off-chain business architecture is built by Monetalis Group. The corresponding asset purchase, regular reporting, and on-chain operations are all completed by Monetalis Group. In this architecture, MakerDAO influences the scale and details of underlying asset purchases through governance.
(2) Limited Partnership SPV Business Architecture: Currently, projects such as Maple Finance and Matrixdock adopt this type of business architecture. The project participates in the process of asset searching and liquidity acquisition.
SPV, which stands for “Special Purpose Vehicle”, is a special purpose entity. The main function of SPV is to finance investors in the process of asset securitization or asset purchase. The original design purpose was to achieve bankruptcy risk isolation. Strictly speaking, the first trust structure mentioned above can also be considered as an SPV structure. The development of SPV has become more mature, and in addition to bankruptcy risk isolation, there are several advantages:
· Simplify financial management processes, avoiding the problem of too many departments involved in financial processes and unclear business flows in traditional corporate business architectures;
· Facilitate transparent management. In general, a single SPV corresponds to a single project/asset, which may avoid management issues. For example, in a commercial bank, it may be difficult for investors to obtain in-depth understanding of the underlying assets because the bank does not disclose too many details. Such information may only be disclosed at the management accounting level within the bank. Take individual housing loans as an example, the financial statements and annual reports disclosed externally will not reveal the characteristics of such loans, let alone the information of individual debtors. However, if individual housing loans are packaged in an SPV, more detailed loan information, such as term, interest rate, collateral, and loan amount, will be disclosed. In this case, the information provided by the SPV will be much richer;
· Reduce taxes and fees. For certain underlying assets, SPVs have lower tax and fee standards.
Source: https://downloads.eth.maple.finance/docs/legal/abe08ded-5d07-42c f-b 435-a 0 d 8 d 8156 ca 5/Cash_Mngt_T&C.pdf
In this business architecture, there are two layers:
The first layer, Users and SPVs: Users actually obtain the debt rights of the SPV, and the guarantee for users’ income is that the SPV can fulfill its obligations on time;
The second layer, SPVs and commercial banks: SPVs participate in the national bond market and also participate in the interbank market for reverse repurchase operations. In this process, if there is a default in the reverse repurchase between banks, there may be greater risks than holding US Treasury bonds directly.
In addition, in this architecture, users face an additional layer of risk: the SPV itself may have some risks.
ARKS Labs has expanded the above business architecture by embedding small SPVs into a large business architecture. This can achieve scalability of the business scale and facilitate future operations when adding new underlying assets. This is very similar to the architecture of MakerDAO mentioned in the previous article “RWA Discussion: Underlying Assets, Business Structures, and Development Paths”.
Source: ARKS Labs
(3) Lending platform + SPV architecture: Currently, TProtocol adopts this type of business architecture. The difference between this type of SPV business architecture and the second type mentioned above is that in the second type of SPV business architecture, one of the relevant parties of SPV is the project party, and the project party will participate in the process of finding and packaging assets. In TProtocol, however, SPV is not related to TProtocol, but rather the initiator of RWA assets.
Using the following diagram as an example, the initiator of SPV can be different institutions, and subsequent on-chain service providers and asset brokers can also be different. TProtocol’s business structure is more flexible, but this does not come without costs: as the number of partners increases, the subsequent control of SPV, including the ability to inspect and manage service providers, may be somewhat reduced.
(4) On-chain tokenization of fund shares: Similar to traditional fund purchases, detailed information about the purchasers, such as their addresses, is required. Currently, Franklin OnChain U.S. Government Money Fund adopts this type of business architecture. This type of project is more like what was commonly referred to as “chain reform” in the past, where the project party puts the off-chain assets and purchaser information on the chain, and future transfer information will also be recorded in a bookkeeping manner and recorded again on the blockchain.
Although the RWA track is still in its early stages, the requirements for business architecture are not high in terms of user base and fund size. However, as the value of national debt RWA gradually gains recognition from investors, the “scalability” of the architecture becomes very important. The ability to timely package new assets and access more off-chain service providers may be the decisive factor in the rapid development stage of the track.
User End: KYC and Other Requirements
Due to the differences in underlying assets and business architecture, there are also differences in the requirements of project parties for the user end. Currently, the main differences exist in three aspects:
(1) Minimum investment threshold: Projects led by MakerDAO, ARKS Labs, and TProtocol do not set a minimum investment amount for users, but projects such as Maple Finance, TrueFi, Arca Labs, and Backed Finance have set explicit minimum investment amount limits. “No minimum investment amount limit” is more in line with the habits of current DeFi users, while projects with a minimum investment amount of over $100,000 mainly target high net worth users.
(2) KYC requirements: Based on the difficulty of KYC, it can be divided into three categories: projects without KYC requirements, such as Flux Finance, ARKS Labs, and TProtocol; lightweight KYC, such as Desmo Labs, which only requires the submission of passport and other information; and heavy KYC, such as OpenEden, Ondo Finance, Maple Finance, and Matrixdock, which require the submission of KYC information comparable to the traditional financial industry. A higher KYC threshold not only means a threshold in the traditional financial industry but is also difficult for DeFi users to accept at this stage.
(3) Other requirements: Some projects also restrict their investors to certain regions, such as only serving non-U.S. users or only serving users outside of the United States, Singapore, and Hong Kong. This type of restriction is generally implemented by limiting IP addresses.
Some projects often use third-party KYC service providers to verify user requirements, such as KYC and regional restrictions, and the project team does not directly participate in the KYC verification process.
Earnings Distribution Strategy and Composability
Earnings Distribution Strategy
Currently, there are mainly two types of earnings distribution strategies in the market:
The first and most common strategy is direct distribution through debt relationships. Whether users hold SPV debt or obtain national debt ETFs and national debt through other architectures, users can receive the majority of the earnings generated by national debt. Excluding earnings from minting and destruction, as well as earnings earned by intermediaries, users can expect a net return of approximately 4 percentage points.
This earnings distribution method is very similar to LSD: most of the staking earnings are returned to users, with only a portion of the fees deducted.
The second strategy currently only appears in the MakerDAO project, which is through deposit interest rates. Since users’ funds do not directly correspond to underlying assets, MakerDAO uses a similar model to commercial banks: on the asset side, assets are invested in currently relatively high-yield assets such as RWA; on the liability side, user earnings are adjusted through the DSR. Up to now, the DSR has been adjusted 4 times, namely: (1) adjusted from 1% to 3.49%; (2) adjusted from 3.49% to 3.19%; (3) adjusted from 3.19% to 8%; (4) adjusted from 8% to 5%.
This strategy gives the project team more flexibility, but the disadvantages may also be obvious: users lack a clearer analytical framework for future yields. Originally, it was national debt RWA, and users directly understood that they should receive returns similar to the national debt yield. However, through monetary policy, such as MakerDAO recently giving excess returns to deposit users, the yield soared to 8%. If the number of deposit users increases to a sufficient amount, the yield will again drop to a level near the U.S. Treasury yield. This kind of fluctuation is not friendly to investors who hope for a stable yield level.
For the yield of national debt-type RWA, clear and explicit “predictability” is very important, so the first earnings distribution strategy may be better than the second strategy. However, once a project that adopts the second strategy clearly anchors the national debt yield, there is no difference between the two in terms of yield.
Composability
Due to KYC requirements, tokenized national debt RWA has also been differentiated in terms of composability:
For some projects with strict KYC qualifications, such as Ondo Finance, Matrixdock, Franklin OnChain U.S. Government Money Fund, etc., because there are whitelist restrictions on addresses, even if there is a corresponding token trading pool on the chain, it is not possible for users to trade freely without admission. For these types of projects, unless the scale of the underlying assets is large enough, it is difficult to obtain support from many DeFi projects and achieve more extensive composability.
There are currently no difficulties in the composability of projects that do not require KYC. The only limitation on the composability of such projects is the project’s own business resources, BD capabilities, and the scale of the project.
Summary
By reviewing the above national debt RWA projects, we can vaguely see the potential business models that may succeed in the short to medium term:
Underlying assets: Using national debt ETFs may be a relatively clever way to delegate liquidity management and other issues to giants in the traditional financial sector. If direct purchase of US bonds or hybrid assets is involved, it will test the project’s ability to select and cooperate with partners;
Business architecture: There are already relatively mature models that can be applied, preferably with strong scalability, facilitating faster expansion and future inclusion of new asset classes;
End-users: In the short to medium term, projects that do not require KYC and have no capital threshold requirements tend to have a wider user base. If KYC becomes mandatory in the future, lightweight KYC projects may become more mainstream solutions;
Profit distribution: To make the expected rate of return for investors in national debt RWA more stable and reliable, the best solution is to align the returns offered by the project with the yields of national debt;
Composability: Before regulations restrict access to on-chain RWA assets, it is important for project teams to expand the use cases of national debt RWA tokens for users in order to achieve greater business volume in the medium to long term.
In the medium to long term competition, projects with lightweight KYC may have greater opportunities due to deeper regulatory involvement.
