IIPXX : Launch the $REAL Index

IIP Number: [to be assigned]
Title: Launch the $REAL Index
Status: [WIP, Proposed]
Author(s): @sidhemraj, @photonscapital (https://www.photons.capital/)
Reviewed by: @afromac @allan.g @overanalyser
Discussions-to: N/A
Created: Jan 19, 2022

Simple Summary :

The aim of $REAL is to allow crypto assets to be lent to real-world businesses in return for an income stream using specialized DeFi protocols gathered within a single managed INDEX fund.

Abstract :

The $REAL Index will function as a structured product that will capture yield generated from Real World Assets (or RWA). Initially, it would be composed of loans provided to RWA pools on protocols like Centrifuge, Goldfinch, Maple Finance, and more.

Investors of the $REAL Index can expect a weighted average return of 10-15% from a diversified portfolio of assets. Rebalances will occur according to protocol-specific epochs and maturation in the respective pools.

Motivation :

A RWA (Real World Asset), in context of this proposal, is any yield generating / value accruing asset that supplies credit to activity in the real economy, but which is represented on-chain through various protocols. These protocols lend to real-world, largely non-crypto-related businesses. The most prominent protocols in this space are Centrifuge(Tinlake), Maple, and Goldfinch. More recently, MakerDAO and AAVE have also partnered with Centrifuge to add liquidity to RWA debt pools. More information about how these protocols work can be found here.

Many global credit markets are failing spectacularly, driving investors towards more and more risky assets. The total volume of negative yielding debt in the world is greater than the total volume of US fixed income instruments - Treasury Securities, MBS etc. This is a large and inefficient market that is primed for disruption. DeFi can solve this problem by democratizing access to positive yield assets for all investors of all sizes.

Similarly, the traditional financial system fabricates credit instruments that are opaque and potentially dangerous. During the 2007-2008 financial crisis, shadow banking intermediaries created billions of dollars in bad credit assets and re-packaged them into AAA-rated CDOs, and subsequently CDO-squared & CDO-cubed instruments. These assets appeared to be diversified in terms of risk, but they were actually composed of high-risk, recycled debt. However, rating agencies considered these instruments safe for the most conservative investors. Sunlight is the best disinfectant, and moving these markets on-chain can provide a safer and more transparent option to all investors.

Size of opportunity in traditional lending markets :

Unmet financing needs for SMEs globally - basically zero or limited access to credit - total of about $6 trillion+. Businesses with basic access to informal finance (individual/community of money lenders, loan sharks, gold & other pawn lending) pay significantly higher interest rates than well-funded corporations. Larger corporations and more established businesses have access to formal credit channels and they borrow at the most efficient rates, while small and medium businesses suffer from limited access. The cost of borrowing can be as high as 30%, leaving them with no viable options to better their business circumstances.

Some of the market inefficiencies which we believe DeFi can disrupt:

  1. Banks have limited motivation or strategy to lend to this segment. Even if they are interested in this space, their lending processes and requirements make it extremely challenging for these businesses to access those funds. Furthermore, banks lack the technological capabilities to access alternative data to underwrite these loan proposals.

  2. While Fintechs solve some technological problems for banks by relying on alternate data and AI/ML engines, Fintechs still rely on banks for liquidity to lend to this segment, and the credit available is extremely expensive. In developing markets, middlemen (private lending institutions) in the ecosystem exploit these gaps by charging exorbitant rates for credit. These rates can range from 16-30%, while traditional bank loans can range from 5-12% for established corporations.

  3. Corporations have the resources and support required to raise capital through public issuance of bonds, while smaller businesses are excluded from this market.

  4. Many investors in this debt market today are effectively earning a negative yield.

DeFi can solve this liquidity problem in the most efficient way and provide a fairer cost of credit for these customers. Additionally, DeFi can provide investors in these markets with an opportunity to invest in real world assets and earn institutional-grade yield.

The growth prospects for this product category are extremely high. The creditors that could avail of this credit are companies and businesses situated in regions and market segments that are growing at double digit CAGR, and that contribute significantly to their national GDP. Their sector focus is varied and can range from Manufacturing, Import and Export, Retail, E-Commerce, Solar and Renewables, Property & Real Estate, and Information Technology/Software Development.

With DeFi paving the way for a fairer and more transparent financial ecosystem, $REAL will act as the premier decentralized liquidity provider to RWA-backed loans.

Value Proposition :

$REAL aims to be the first decentralized index of real world, stable-yielding assets, which includes debt assets, tokenized leases, renewable energy assets and more. As DeFi matures, retail investors, DAO treasuries, and institutional investors will seek to diversify their portfolio into sustainable non-crypto/digital asset yield to insulate themselves from crypto volatility.

The Index solves a few pain points for investors of RWA represented on-chain.

  • Investment Cycle Management: Monitoring timelines for each pool, withdrawing, re-investing needs active management. An example of deposit/withdrawal timelines on Maple Finance is highlighted below.

  • Due Diligence: Apart from the above, due diligence of underlying assets, keeping track of repayment risks, working closely with asset originators, etc requires the expertise of a team of professionals.

  • Gas Fees: Investors would be able to diversify their portfolio across multiple RWA for minimum gas cost.

In the long term, $REAL aims to become the gold standard for Real World Assets represented on-chain.

Opportunity Size :

Real World Assets TVL on DeFi has grown to $500M + at the time of writing, with 90% of that value added in the last 6 months. Needless to say, this is a nascent but rapidly growing sector.

This number could grow to trillions of dollars as major asset classes in the real world economy are tokenized and represented on-chain in the coming decades. Crucially, the potential upside for a dominant product in this class is almost limitless, while the stability created by connecting these debt markets to DeFi creates a long-term opportunity that will outlive the gold rush environment that exists today.

In 2019-20 the global fintech lending market size was about $450B. Were the $REAL index able to access even 0.5-1% of that market, we are targeting a $2.5B - $5B market size. Furthermore, the fintech lending space is projected to reach $5,000B by 2030. If we can continue to capture the same 0.5-1% market share, we could grow the product to $25bn - $50bn by 2030.

At $5B AUM and a 1.45% streaming fee, this index would generate ~$70 million USD in annual revenue for the Index.

Some background on RWA financing in DeFi :

Real World Asset financing protocols are similar, but behave differently to the fully permissionless lending platforms like Compound and Aave in some crucial ways. They are not fully permissionless protocols, and various stakeholders in the value chain work in tandem to make these protocols safe for large scale borrowing and lending. More information about how these uncollateralized lending protocols work is summarized here.

Brief overview of some pool originators and their borrowers:

  1. Fortunafi

Fortunafi Asset Management is a technology-enabled, revenue-based finance provider, providing capital to small or growing businesses in return for a fixed percentage of ongoing gross revenues. Fortunafi funds through CORL technologies, a Fintech lending company.

  1. Maven11

Maven 11 is an Amsterdam-founded blockchain and crypto asset investment firm that invests in and supports its ventures globally, focused exclusively on the blockchain, distributed ledgers and disruptive emerging technologies. Their borrowers include NAOS finance that allows for collateralization of loans through off-chain assets.

  1. Almavest

Almavest provides debt capital globally to high-performing companies in a variety of sectors, including small business and consumer credit, climate finance, sustainable/regenerative agriculture and more. They work with institutions like SKS Microfinance, Fast Cash etc to create a large-scale impact.

Methodology :

$REAL index would initially provide capital in pools across Centrifuge, Goldfinch and Maple. You can mint $REAL using USDC or any other stablecoin.
The initial composition could look like (subject to change based on pools state at launch):

Pool Platform Asset Maturity Pool Description Portfolio Allocation Expected Annual Return
Databased.FINANCE 1 Tinlake by CFG 30-90 days Branded Inventory Financing 10% 10-11%
1754 Factory Tinlake by CFG 30-90 days Payment Advances 5% 10-11%
Harbor Trade Credit Series 2 Tinlake by CFG 60-120 days Trade Receivables 5% 11-12%
Fortunafi 1 Tinlake by CFG 24 months Revenue Based Financing 15% 10-11%
Almavest GoldFinch Various Global Multi sector loans 25% 10-11%
Orthogonal Trading Maple Various 10% ~12%
Maven11 Capital Maple Various Capital Intensive Businesses 10% ~12%
BlockTower Capital Maple Various 10% ~12%
Alameda Research Maple Various Market Maker 10% ~12%

Rebalancing would be manually approved transactions to claim expired positions and deploy fresh allocations in agreement with the methodologist.

Issue and redemption flow is to be agreed with the simplest option being to hold a USDC reserve.

As the product AUM grows, more sophisticated / automated strategies (e.g. white listed withdraw from positions) would be developed.

Costs :

Costs to Customer :

Index Coop will charge a 1.45% streaming Fee.

0.10% of mint and redeem fee would be charged.

Rebalance frequency : Weekly.

Partner protocols retain few basis points on the interest earned as protocol reserve and the indicative APY given above is net of any such deductions.

Liquidity :

The suggested pair for liquidity is REAL:USDC, as the pools REAL deposits into are denominated in USD pegged stablecoins. We request the Liquidity Pod to seed this pool with $400,000 USDC in total.

Author Background :

This is a methodology proposed by the Automated Indices Pod and Photons Capital. The AI pod is a multidisciplinary team that works to support automated products for Index Coop. The AI Pod has partnered with Photons Capital to support the Pod and Index Coop as asset manager for this index. Photons Capital will focus on growing the product in a number of ways:

  • Product Design: as experts in this field, Photons will play a central role in assessing opportunities and borrower pools for inclusion in the methodology.
  • Risk Management: evaluating the risks behind Real World Assets as the nature of these is expected to become more complex as the product grows.
  • Borrower Due Diligence & Relations: Build direct relationships with Pool originators to assess borrower agreements and stay abreast with pool life cycles.
  • Asset Originator: By working with our partner protocols - would allow the Pod to take a more outbound approach in sourcing Real World Yield Generating assets for the $REAL Index.
  • Institutional Sales: Actively work with Crypto Funds, DAO Treasuries and other institutions to diversify their portfolio into sustainable, real world yield assets.
11 Likes

Very interesting! I haven’t really looked into any of the underlying investment platforms - how are they doing? Is there any risk of being oversubscribed, i.e. we have more capital than requested borrowers?

1 Like

Hey @jackiepoo! Yes, there have been instances of Centrifuge pools being oversubscribed, though this hasn’t been the case recently. In my opinion, this is an operational challenge that @photonscapital will need to tackle by staying informed about upcoming pools. In case of the Index itself being oversubscribed, we will need to keep a check on that by keeping an eye on the supply cap.

2 Likes

Few questions:

  1. Are the protocol APYs actuals or advertised?
  2. Is the yield in USDC or native tokens? If the latter what’s the approximate net volatility?
  3. I couldn’t tie these expected return figures to the advertised APYs on the protocol sites, eg, for the Databased.FINANCE 1 pool. Can you show by an example?
  4. Do you think the on-chain argument is strong enough to attract away customers currently earning 10-11% on their USDC off chain?
  5. As far as I can see the only costs are pooling and minting and there are no swaps. If so, that’s great.
  6. What do you roughly estimate as $REAL’s net yield factoring in cash drag, streaming fee, price impact on the way in and out, etc?
2 Likes

Intriguing proposal. I am familiar with Maple Finance by name only so I will need to research their protocol. Forgive my ignorance but does this relate to synthetics or through the tokenization of RWA?

1 Like

First time I’ve heard of this. Reminds me of corporate and even sovereign bond ETFs whereas I suppose this makes PAY and PINT seem more like … Generalized lending in a sense.

Interesting.

2 Likes

Hi Joseph,

Great questions. Hope we are able to clarify for the benefit of the community

APYs are actuals accrued by Junior tranche depositors, as they also receive the spread between the average financing fee and the senior tranche rate. However, junior tranche APYs on Centrifuge are advertised as 30%, 16% etc. For the purpose of this proposal, we have indicated a lower number considering pool oversubscription risks. Please also note that the composition presented above is indicative and we will update the final composition and produce accrued APY via backtest data as this product moves further in the governance pipeline.

The actual financing fee portion of the yield is earned on the stable coin. Additional rewards are earned in the native tokens with net volatility in the range of 4-6% (with the limited historical data)

The average financing fee of the databased.FINANCE 1 pool as given in the tinlake portal is 9.09%. $REAL will hold TIN, ie a junior tranche position in this pool. 73% of the pool is fulfilled by senior tranche, while 27% is composed of Junior tranche investors, which brings the junior tranche APY to ~30%. As mentioned above, we have added conservative and tentative numbers to the table.

**Corporate Bond rates in the US are at ~2-4%. Bank FD rates vary between 0.5-6% (mostly in the lower end) across the world. think we have a strong argument for the on-chain rationale there. Further any return premium over and above this requires some level of active management. We also think that this product is also for the DeFi users who want to insulate their yield from crypto volatility as crypto lending rates fluctuate based on market cycles. Apart from returns, such products would also enable DeFi to make a positive impact in real world projects.

30-40% of the portfolio is denominated in DAI, so there would be a USDC->DAI swap @ 0.04% Curve trading fee. No other direct cost involved.

Roughly, we estimate net yield to be 9-10% at the minimum. However we will share a yield calculations sheet here in the coming week which lays out all the factors influencing the returns.

1 Like

Hey @epyon! I understand, real world/institutional lending is just getting started in Defi, we want to front run the market on this one :slight_smile:
The $REAL portfolio would consist of debt assets - loans given out to real world businesses. You can read about how these protocols work in brief here

1 Like

Hey @IGdood yes, this is very different from other productive assets we are building. Please hit me up with questions if any.

I think you’re benchmarking against USD rates, whereas crypto USDC yields are routinely between 6-11%.

Thanks. I’ll look forward to the final yield calculation.

Hey y’all, I’m the cofounder of Goldfinch. I think this is great, but wanted to add some thoughts, and I also had some questions.

To start, if you were to participate in the junior portion of Goldfinch pools (ie. as a Backer, in Goldfinch terminology), then your yield would actually be substantially higher than what you have listed. For example, in Almavest Basket #4, the “headline” rate is 12.5%, but Backers get a 6.25% boost (as seen in the app), meaning an actual rate of 18.75%. This boost comes from the design of the protocol, where the Senior Pool adds additional capital to pools that receive sufficient consensus from Backers, and 20% of the Senior Pool interest is re-allocated to the Backers as compensation for doing the hard work of assessment. So @sidhemraj had written that the return would be 10-11% for Almavest, but it would actually be more like 18-19.

Second, I’m curious if the intention of the index would be to allocate capital as a Backer to any of Goldfinch’s borrower pools, or only specifically ones from Almavest? There are lots of great Borrowers on Goldfinch besides just Almavest. Related, all of the Borrower pools now are over subscribed (more will open soon). So the $REAL index could either A.) potentially buy portions from existing Backers (each Backer has an NFT representing their portion). or B.) Just get in on new pools as they open up. Both would be great!

Third, there is another option here which is for the $REAL Index to go into the Goldfinch Senior Pool, instead of the individual Borrower Pools. The advantage of the Senior Pool is that it can always take more capital, and it’s much safer as it’s automatically diversified and is protected by Backer capital (which is always first-loss). The downside is it’s much lower return (7-10% after protocol fees), and fluctuates with the amount of capital coming in, so could in theory get heavily diluted. So all in all, maybe that’s not the right goal for the $REAL index, but it is an option. You could even mix and match I suppose.

My two cents is that simply participating as a Backer in all of the pools (and especially acting as a potential liquidity provider for existing Backers) could be the right move. If the $REAL index also acted as a liquidity provider to existing Backers, you could probably take a liquidity fee (eg. 2% discount on the NAV)

Love the idea! Down to help how I can.

2 Likes

Hey @blakewest! Welcome to the Index Coop community, and thanks for the supportive comments above.
Firstly, the composition above is indicative, we will change it right before the launch based on pool availability at the point.
Secondly, we have indicated a conservative yield because we might establish a composite senior/junior position and there could be instances of oversubscribed pools leading to some cash drag. Hence the APY indicated is in the average range of Senior and Junior pool.

I think this is ideally the strategy we will adapt, to diversify as well as to maximize returns. Would love you support in this respect.
We will share a final yield calculations sheet with the community which will show actuals based on a detailed composition that we will use if we were to launch this tomorrow.

Thanks for posting!

Do we have any market research on who the primary buyer is and whether they’re looking for this type of product in DeFi yet?

It’s a bit concerning that the whole Real World Assets TVL on DeFi is just slightly larger than the Index Coop. Wouldn’t we want to target markets that are multiples our size?

Are we convinced that people are coming to DeFi to buy products based on real world assets? It also seems counterintuitive of the early adopters of crypto that currently dominate the market.

Thank you @DocHabanero for your questions.

$REAL is primarily a yield diversification product.
Most protocols today have served the DeFi degens who chase short-term yields, but there is a need for a non-crypto volatility related returns in Defi. The primary buyers would be DAO treasuries, Institutional Funds, and market makers who are looking at an all-weather sustainable yield for their capital.

Additionally, we solve an existing problem for the investors in this space - 1 click diversification into pools across protocols in the space. Investors don’t need to keep a track of asset maturity and maximizing returns by choosing the right pools, we do it for them. Something that debt mutual funds in TradFi already solve.

Further with AAVE and MakerDAO doubling down on these markets, RWA DeFi is expected to grow multfold in the coming years. While consolidated TVL on uncollateralized lending markets today is $1.5-2B(counting Truefi)the number is growing fast. Maple recently shared a road map of 2022 to reach $5bn in TVL. Centrifuge has set a target to originate about $148bn loan every year by 2026.

With this product, we will essentially place ourselves alongside AAVE and MakerDAO as the largest providers of liquidity to real world/institutional borrowers in Defi.

1 Like

Hello!
Currently working with one of the issuers on Tinlake (not one that were selected for this index).

Just curious - is this RWA index specific to just loans to SMEs (the write up seemed to focus heavily on SMEs)? Or will it eventually cover tokenized securitizations of other assets as well? (i.e. unsecured personal loans, mortgages, auto loans, solar/PACE loans, etc). Given Photons Capital’s involvement, it seems that Photons Capital (at least according to its website today) specializes in SME lending - are there plans on onboarding an external co-manager with a broader exposure to collateralized assets? Also, would these investments be limited to only senior tranches?

Also, the initial selection are technically a mix of tokenized loans to loan originators, tokenized loans to funds providing lender finance, and tokenized loans to crypto hedge funds.

Also curious to know - what kind of credit analysis has been done to determine the initial composition (and to determine rebalances)? There is mention of risk management, but no clear indication of what metrics are monitored (is it overall collateral CNL? will Photons run collateral cash flows to calculate on-going breakevens?), or how underlying loan covenants are monitored. Lastly, will there be specific rules on allocation concentrations? Would be helpful to get more clarity.

Otherwise, this is quite interesting - essentially very similar to the Aave RWA Markets pool, but not limited to Tinlake tokens.

Hi Jeremy, Great questions!

Firstly, we want to clarify again that the composition given above is only indicative. The final composition may be different based on pools active at the launch of the index. $REAL index is intended to be for all fund-able yield generating assets and not just for SMEs - anything from a trading invoice to a piece of real-estate, given that it’s represented on-chain through one of our partner protocols. We intend for the index to support all real-world and institutional opportunities including exposure to tokenized securitisation suggested in your comment.

Additionally, we are looking to establish a composite of senior/junior positions and in discussions with these protocols to establish the framework.

We are working closely with these protocols to establish integrated risk management strategies. There are two level risk management and due-diligence processes already in place (a) by the protocols and (b) by the originators operating in these protocols. $REAL Indexes risk management and due-diligence process include (but not limited):

  1. Continuous monitoring of delinquencies in these pools
  2. Pools focus areas and macro outlook
  3. Monitoring of underlying covenants
  4. Quality of assets class these pools are funding

Rules for allocation for concentration of a single pool would be a minimum of 8% to keep costs of rebalancing low, while a maximum of 20% to ensure healthy diversification. @sidhemraj will update this into the forum post.

We would be very happy in taking any further inputs from you to devise more robust risk management strategies for the Index, as well as any advice on a specific asset class you think we haven’t covered. Please reach us on [email protected] for conversations in this regard.

This would be a great addition to the product line. I’ve led the Centrifuge integration from MakerDAO-side so I’m excited to see new RWA players. The space is growing fast!

2 points:

  • How will the KYC/AML be handled? All those pools need a KYC counterparty. Moreover, those are all securities so the index will be a security as well. Was it researched and who pay the legal fees?
  • The risk profile is quite aggressive. Junior tranches of Centrifuge are … junior. Maple loans are not without risk. I understand the need to go high on the risk curve, there are fees to cover and all of that is innovation so there is any way an innovation risk. We should just be upfront I guess.
2 Likes

Mike from Centrifuge here. Firstly, wanted to say that we think this is an awesome initiative and we are happy to collaborate on making this happen!

We think the product you outlined has huge potential, both for the RWA ecosystem and the IndexCoop community. The proposed $REAL index would give users exposure to a diversified basket of RWAs, allowing them to generate yield that is uncorrelated to the broader crypto market, a benefit that is all too apparent at times like these. Furthermore, the opportunities within the exemplary composition are also relatively uncorrelated to each other. Meaning that even if one sector, such as real estate, were to experience some highly negative event, it should not impact the returns across the various pools. This could give users a product that offers a stable and sustainable yield, which isn’t generated from token rewards, and performs through market cycles. A big win our view.

To @Sebastien’s point above, he is correct (at least in the Centrifuge case) that the junior tranche is inherently riskier than the senior, as it takes the first losses in any pool. However, the junior tranche is only a small portion of the overall Centrifuge pools (~15%). If for example, $REAL held a proportional senior/junior ratio as represented in the pools (~85/15%), it would disperse risk and help mitigate any potential losses from a specific junior tranche. Moreover, if $REAL is diversified across numerous RWA classes and only holds a reasonable proportion of the risker tranches in any one of the individual constituents, then we believe the overall risk could be well managed and the benefit of junior investing to deliver higher yield could be warranted.

As the RWA ecosystems grows in depth and liquidity, there could be some cool iterations of this product as well. Splitting indexes by yield is an example. There could be one product that focuses on senior lending, less risky with a lower return, and one that focuses on junior lending, the opposite profile. This could give users more choice based on their risk appetite and mimic some of the traditional debt products that are available today ie. investment grade vs high yield funds. We won’t get ahead of ourselves though, just wanted to highlight what the future could hold!

We are happy to contribute to the thinking here and help @photonscapital and the community get fully up to speed on what we are doing and the broader RWA space. Great to see @photonscapital mention working on risk management strategies, we believe that using on-chain data can greatly improve on existing capabilities today to monitor and manage lending portfolios and look forward to exploring those integrations

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Hi Sebastien, Thanks for your comments. We are big fans of your work with RWA at MakerDAO.

We are in discussions with the protocols and evaluating some solutions to the KYC challenges along with the Index Coop team. We will update the way forward soon.

Considering the risks in the junior tranches, a composite strategy of senior and junior tranche positions which optimizes for risk and rewards seems to be the way forward.

As always, we are very happy to take any inputs and suggestions to de-risk the portfolio further for the investors.

Hey @thepacecatjr Mike- Thanks for your support and feedback.

You’ve summarised a key differentiator of this product very well. $REAL would be insulated from crypto activity, and we think there’s a place for such a product in each Defi users’ portfolio.

The opportunities available for users to earn a relatively stable yield on their stable-coins, through market cycles, are few. We’ve also seen that returns diminish as supply on lending platforms far exceeds demand, or borrow demand reduces as top assets like BTC, ETH which are used as collateral loose value temporarily based on sentiment.

For ex - below is the chart for USDC returns on Compound for the last year. The APR for this pool has varied from 2%-20%(inc interest + COMP rewards), and has stayed below 5% for majority of the year.

Looking forward to working with the Centrifuge team to bring this to life.