This is the second part of an article that explores the concept of collateralized multi-asset digital securities(CMADS). The first part explored some of the general principles behind CMADS and how they relate to other forms of security tokens. Today, I would like to deep dive into some of those ideas to explore a protocol for the creation of CMADSs.
The idea behind CMADS is to create security tokens that are collateralized by multiple assets. While single-asset security tokens are a great digital representation of assets such as shares in private companies, many other asset classes such as government or corporate bonds or real estate leases are traded in groups. For instance, take the example of a real estate fund that would like a tokenize a pool of property leases. Issuing a token per lease, although technically possible, it seems impractical as most investors would like exposure to the larger group of underlying leases. A single security token collateralized by the entire group of real estate leases seems like a much more attractive idea. However, the implementation of this type of CMADS is far from being trivial.
Principles & Challenges
I believe that collateralized multi-asset digital securities(CMADS) are an inevitable step in the evolution of security tokens. While conceptually trivial, the implementation of CMADS vehicles present some very tangible challenges from both the technical and financial perspectives. Among those challenges, there are three that I consider foundational to the dynamics of CMADS:
· Dynamic Asset Registration and Redemption: A CMADS should be able to add and remove assets dynamically based on the requests of the token holders.
· Valuation Adjustments: In order to maintain a stable correlation with the underlying assets, a CMADS would need to be able to adjust its valuation dynamically based on specific market conditions.
· Market Maker Dependencies: Valuation adjustments in CMADS require the ability of buying or selling assets at a decent scale. To achieve that, a CMADS protocol depends on entities with purchasing ability to maintain the correlation between the crypto-security and the underlying assets.
The Cypto and Non-Crypto Inspirations
Implementing collateralized multi-asset digital securities(CMADS) is far from being an easy endeavor. While the challenges are many, the good news is that we can borrow different solutions and inspirations from established products in both the crypto and financial markets. Specifically, there are two models that I believe provide a lot of relevant ideas for the implementation of CMADS:
· Maker Protocol: Maker, is the blockchain protocol that powers the popular cryptocurrency Dai. Maker uses programmable mechanisms to maintain the price of Dai close to a 1-to-1 correlation with the US dollar. Differently from other stablecoins, Dai is able to maintain a stable price while relying on unstable collaterals such as Ether. Maker accomplishes that by providing a programmable mechanism to adjust the valuation of Dai depending on fluctuations in the market.
· ETF Creation/Redemption Processes: Exchanged-Traded-Funds(ETFs) is a marketable security that tracks an underlying pool of assets such as stocks, bonds or commodities. The foundation of ETFs is based on a process known as creation/redemption in which a market maker (known as the authorized participant(AP)) can buy or sell the assets in the ETF to maintain the price correlated to the underlying collateral. For instance, if the price of the ETFs surpass the value of the underlying assets, the AP will intervene and increase their position in the underlying assets that make up the ETF in order to stabilize the price.
Combining ideas from both the Maker protocol and the ETF creation/redemption model, we can outline the basics of a protocol for CMADS.
A CMADS Protocol
The complete mechanics of a protocol for collateralized multi-asset digital securities(CMADS) are beyond the scope of this post but hopefully I would be able to outline some of the fundamental concepts to enable this new form of security tokens. At a high level, CMADS protocol will have the following actors:
· Issuers: Entities responsible for collateralizing a specific asset and receiving the corresponding CMADS.
· Token Holders: Entities holding CMADS at any given time. The token holders and the issuers might be the same persona at different times during the lifecycle of a CMADS.
· Validators: Validators are actors that assert the valuation of a specific asset. This process can be completely off-chain.
· Authorized Participants(AP): The APs are independent actors incentivized to maintain the price stability of the CMADS.
· Oracles: Oracles are external sources of information that are used to ensure fair pricing of the CMADS.
· Collateralized Multi-Asset Position: A smart contract that maintains the correlation between the underlying asset and the CMADS. It is important to notice that for CMADS to work effectively, they need to be over-collateralized by the underlying asset.
In a very simplistic form, a CMADS protocol can be summarized in the following interactions:
1) The Issuer register a specific set of assets with a given Validator.
2) Upon receiving confirmation from the validators, the Authorized Participant(AP) will create a collateralized multi-asset position(CMAP) and uses that to add extra-funds to the CMADS smart contract.
3) The CMADS smart contract will issue the corresponding CMADS to the Issuer.
4) At any given point, the Issuer can trade the CMADS with a specific Token Holder.
5) When the Issuer or Token Holder wants to redeem their CMADS, they will send an amount to the CMADS smart contract to pay down the CMAP and redeem the underlying assets.
6) The AP will unlock the target assets and burn some of the received CMADS to maintain the price stability.
7) During this process, the Validator will leverage Oracles to ensure the correct prices correlation of the CMADS. If any variation occurs, the AP will intervene to maintain the price stability.
Collateralized multi-asset digital securities seem like an inevitable step in the evolution of security tokens. The idea that security tokens are going to stay as a representation of a single underlying asset is simply not sustainable in the long-term. Hopefully, some of the ideas outlined in this two-part article can help to spark the conversation about this new form of security tokens.