Collateralized Debt Obligations for Issuer-Backed Tokens

The collateral does not put a lower bound on the stable coin but it is a put option that users can use when the total market-cap of shares and coins is lower than the value of the collateral.
If the coin is a success, the total market cap will rise in the first year and the put option will be far out of the money. Options that are “far out of the money”, have their price go to zero when they are about to expire, because the chance that the option can be used is low. In this case, the collateral can be removed easily.
If the total market cap of the shares and coins is close the value of the collateral, when the option is about to expire, the project probably has failed. But at least the investors will get their money back.

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Hi everyone, I liked this discussion so much that I signed up to participate in it (and hopefully many more). A stable world-wide cryptocurrency is one of the main unfulfilled promises of blockchain, and would probably benefit a lot from a trusted institution such as the Ethereum Foundation to provide the initial push.

Coming back to CDOs: I don’t understand how the incentives for issuers are controlled in this model. Say I am an issuer whose strategy is to put half of the collected assets into dividend-paying stocks. I will have a much higher default risk than an issuer who just locks the assets in a safe, but likely make profits from this risk. How do I pay for the risk that I impose on the entire CDO? Or are risky issuers just leeching off of the security provided by reliable issuers? What are the incentives for an issuer to be reliable?

I have always asked this myself in the case of Tether who claimed it will store its dollars in a bank account—thus, collecting interest thanks to the risk imposed by fractional reserve—but doesn’t seem to propose to give any part of their profits from this back to Tether holders.

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Doesn’t this depend on having price feeds for the various ERC20s so that you know when to trigger liquidation calls for CDPs? My scheme does not depend at all on price feeds; it instead gets the same effect through incentivized preference revelation (ie. people participate in the “implied price feed” by choosing which asset they withdraw).

Great point, the feeds can be manipulated, and will be a target for hackers as the makerdao/DAI system grows in the crypto space.

Your suggestion around tranches makes sense, as the data provided is from an alternative “data source” that cannot be easily hacked as it is people or algorithms making decisions with their own internal data as a starting point, effectively distributing the attack surface.

I am more of a proponent of seignorage shares:

I am familiar with basecoin and looked into seignorage shares, and those models to approach stablecoins are interesting, but I have a hard time thinking they would be successful in the long-term unless backed by real-world assets (collateral).

If I take a few steps back, the value of money is connected to multiple attributes (not exhaustive): fungability, stability, availability, portability, acceptability, etc. In the perspective of monetary policy, the money supply is adjusted to influence interest rates, ie: the cost of money. Basecoin and seignorage shares from what I understand provide a similar function to a central bank in the adjusting of the money supply.

An additional attribute is faith in the currency, ie resilience to withstand economic contractions and provide a stable value. During the 2007 financial meltdown, only a few assets provided positive returns (not exhaustive): USD, US Bonds, Gold, and Japanese assets (Yen, bonds, etc.). The reason why those assets had positive returns is because they are viewed as assets that hold value and can withstand economic contractions.

The faith element does not exist from what I can see in the crypto world, the faith that the system can re-stabilize itself without pouring additional capital from outside resources into it. The faith attribute may occur in time, but people will need to build faith in the system that when there are economic contractions, the stable coin can hold its value. This idea has not been tested, as there has been a good degree of economic growth since 2009, with the community not really knowing how crypto assets will perform during large economic contractions.

I believe the faith aspect is needed for the long-term success of a crypto stablecoin, and a reason why I question basecoin and seignorage shares long-term sustainability. A bridge to effectively create a synthetic “faith” would be to leverage collateral, not just crypto collateral (ETH, BTC, LTC), but crypto collateral that is connected to real-world assets, such as a government currency (USD/Euro/Yen), physical assets such as Gold and Silver, or even securitized assets such as mortgage backed securities wrapped in a crypto shell.

An additional thought I had is there could be a mechanism that incentivizes lower correlated assets to be included as collateral backing the stablecoin through reducing interest rate costs to withdraw the stablecoin from the collateral. For example, if it would cost 0.5% to withdraw makerdao DAI using ETH from a CDP, vs. .4% using TrueUSD.

Curious as to your thoughts.

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It is the other way around, in monetary policy short term interest rates are adjusted to influence the money supply.

In basecoin and seigniorage shares, the coin supply is actively adjusted to influence the price of the coin. So it is more similar to currency manipulation than to monetary policy. When countries want to peg to another currency they can buy or sell assets/currencies/gold etc to keep the peg. Assets are always limited, so sometimes pegs brake (Swiss franc 2015).
In basecoin they offer high returns, so there will always be someone to buy the bonds. In seigniorage shares the value of the share can always drop more to sell more shares.
Unless the markets for the bonds/seigniorage shares collapses to 0, the stable coin will stay relatively stable.

But of course, the proof of the pudding is in the eating.

Incorrect, the money supply is adjusted to influence the interest rate, see the following link:

The central bank controls the money supply, mainly via the discount rate:
“The discount rate allows the federal reserve to control the supply of money and is used to assure stability in the financial markets.”

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A paper you may be interested in has been published and is now public.

I’d love to hear your feedback.

Today, CB’s target the short-term interest rate and adjust the money supply to manipulate the STIR market to hit that target. It has complete control over the (base) money supply and as a result a high degree of control over the STIR market. Monetary policy today is about a committee of experts picking that STIR target and ordering the CB’s trading desk to do whatever it takes on the supply side to bang the market to the target.

It hasn’t always been like this. If you’re gonna do the discretionary monetary policy thing, you can basically target the STIR or the money supply (one or the other, can’t do both). So the alternative monetary policy is to target a rate of money supply growth and let the market determine the STIR. This regime has also been followed but fell out of favour in the mid 1980s.

Of course, we can and should do away with the discretionary aspect of policy and adopt rules instead. But still gotta decide on the target. Seigniorage Shares is basically a cryptocurrency implementation of Irving Fisher’s dollar stabilisation theory (with the added twist that it’s implemented against the NPV of all future seigniorage rather than a stock of government bonds or gold on a CB’s balance sheet). As such, in monetary policy terms it’s money supply targetting (by rules rather than discretion).

What do you think of Rune’s response?

the holders of slices closer to N would be paid interest rates, which would come out of the pockets of the holders of slices closer to 1.

I think this kills the Idea. Charging a user on slice 1 some non-negligible ‘fee’ (estimating anything >5% APR as ‘non-negligible’) to use that slice’s Stablecoin is a non-starter.

Since the ‘friction’ to exit one Stablecoin Ecosystem and ‘enter’ another is 0 (it’s just one click on a DEX) users would be happy to ‘exit’ the 1-of-N Stablecoin Ecosystem and just use Bank-Issued Digital Fiat for 0 fees and 0 risk. The Bank-Issued Digital Fiat Stablecoin would have more ‘Trust’ with users because they would always be able to walk into a Bank Branch and redeem that $1 of Digital Fiat for $1 of Physical Fiat.

Late to the conversation :wink: A big difference between changing the collateralisation ratio and the price feed is that the former is auditable, and the latter is not. The (fairly) recent scandals in IR & FX settings show that it is possible to manipulate price feeds subtly and get away with it for a long time in a highly regulated environment. If this allowed MKR holders any advantage (for small changes to the rate), and was fairly undetectable it would def. be a big trust leak IMO.

It’s not a coincidence (I guess) that Maker uses a similar scheme to that seen for IR, FX and commodity daily rate setting - i.e. a median or other average of a number of inputs - and it is susceptible to the same types of subtle manipulation.

Trying to understand to what degree liquidity is necessary for Maker CDP holders not to lose value (their collateral).

In a simple setup, with a single CDP, there seems to be a vulnerability:

  1. Suppose that Alice deposits 4 ETH ($1000) and withdraws 600 DAI.
  2. She sends the 600 DAI to Bob (to buy an iPad).
  3. At this point, in order to release her collateral she needs 600 DAI. Her collateral is actually worth ~1000 USD.

What stops Bob refusing to sell her DAI back to her for less that ~999 USD?

In a multi-CDP setting this could be done by locking all DAI in a DAO that ensures extracted DAI must be used to pay off a CDP with 95% of the collateral being sent to the entity that deposited the DAI into the DAO.

At this point CDP holders would have no ability to do anything other than pay the high price for DAI to recoup a small amount of their collateral.

In practice it is probably too hard to coordinate and a global settlement could be triggered (via a centralised process or MKR vote - not sure) which may bypass this - and the threat of this option means that there is no incentive to try and exploit this. If the process is via an MKR vote, then DAI holders could incentivise MKR holders through offering them a portion of the collateral to bribe them.

This is really a consequence of the law “if token holders (i.e. DAI holders) have control over collateral greater than the future discounted expected earnings of their token, they should exit scam”

Not sure why interest rates are needed. Wouldn’t the different tranches be sold off at different prices (i.e. tranche 1 (least risky) might require 0.35 each of DAI, USDC and GUSD, whereas tranche 3 might require 0.32 of each coin) - and these prices account for the risk profile of the issued tranche?

EDIT - I guess the idea is that the fair value of each tranche is $1, and since the principal repayment of tranche 3 is worth less than tranche 1 this needs to be balanced by interest payments from lower tranches to higher tranches. It’s not clear to me how you’d set this up to correctly adjust to changing credit ratings for the underlying issuers and without this the value of each tranche would fluctuate (i.e. suppose USDC goes to 0, the value of tranche 3 would go to zero in the above example). If the tranches don’t maintain a stable value then I don’t really see a need for interest payments?

(i.e. suppose USDC goes to 0, the value of tranche 3 would go to zero in the above example)


If the tranches don’t maintain a stable value then I don’t really see a need for interest payments?

The need for interest payments is to compensate holders of higher tranches for the greater risk that those tranches will go to zero.

The need for interest payments is to compensate holders of higher tranches for the greater risk that those tranches will go to zero.

But they have already been compensated by paying less per unit than those who bought lower tranches (through the initial auction of tranches). This is a market driven approach to determining the amount of “compensation” buyers of higher tranches need, vs. some form of interest rate which would hard to set based on market conditions.

So if I buy tranche 1, the price may be 1.00 USD per unit, if I buy tranche 3 the price may be 0.97 USD (USD prices derived from the amount of issuer stable coins I am paying), so I am effectively valuing the likelihood of any of the issuers going bust before time T + D as 3%.

Between time T and time T + D the price of each tranche will vary on the 2ndary market to reflect any changes in the counterparty risk of issuers.

You could force everyone to pay the same amount for each tranche, and instead bid on what interest rate they would be willing to receive, but I can’t see any advantage to this (and it seems equivalent in any case, but more complex).

We are building something somewhat similar to this called Decentral Bank but including much more in this basket than simple issuer-backed tokens since even decentralized products like Dai have their own risk profile. The idea is almost identical but we want to include a large plethora of good stablecoin projects in the basket so that this is truly a huge basket of different stability mechanisms, then issue a 1:1 privacy wrapped cash token against the basket for truly private stable currency. You can apply basis style bonds to this system at the endgame when you want to float it off the dollar peg and issue bonds when/if one of the pieces of the basket fails, so that you can retract cash supply until the system recovers again. What do you think of this @vbuterin

EDIT: Is this proposal only viable if N slices are identical in size? How would it work if there were weighted portions of the basket with varying proportions? You could never do the “can redeem if one issuer fails” rule if they aren’t exactly the same size?