Evolving beyond RWAs
Digitally-native asset (DNA) cash flows are as "real" as it gets
The “current thing” in crypto is bringing “RWAs” on-chain. This trend encompasses on-chain representations of US Treasuries (Ondo), S&P 500 ETFs (Backed), bank loans (MakerDAO), and asset-backed securities (BlockTower / Centrifuge), among other traditional finance products.
Bringing “RWA” / TradFi assets on-chain is a large opportunity, but shouldn’t we aim to do better? RWAs introduce centralized parties and limited composability, while digitally-native assets (“DNAs”) bring the best of what crypto has to offer – trustlessness, transparency, and composability – in addition to real cash flows.
In this post, I’ll argue that digitally-native assets (“DNAs”) are superior to RWAs and that the tech needed to create DNAs already exists.
We’ll start by covering the benefits and pitfalls associated with today’s “RWA” tokenizations, and then put forward a picture of what “high-fidelity” digitally-native assets might look like.
“RWAs” bring new asset classes to DeFi (...but with clunky implementation)
What are the benefits of bringing “RWAs” on chain? We see three key benefits:
Tokenized “RWAs” can reach new audiences and increase access. For example, users in typically underserved geographies might better access US Treasury yields via DeFi than they could via the existing banking system. KYC requirements and high minimum deposit sizes (sometimes >$100k USD) may limit this access in today’s RWA instances.
DeFi composability can enable new functionality and greater returns for lenders. For example, Flux enables US Treasury lenders to lever their returns. However, the limited transferability of permissioned tokens like OUSG limits composability and liquidity for RWAs.
DeFi infrastructure can enable lower costs, instant settlement, and improved transparency. These benefits explain in part why stablecoins have been adopted and become the “premier RWA” in crypto.
But there are also pitfalls with tokenized RWAs. One could argue that tokenizing TradFi assets today via a wrapped / tokenized version of off-chain paper agreements is actually the worst of both worlds. How?
Tokenization stacks (i) counterparty risk in relying upon centralized parties necessary to uphold off-chain agreements on top of (ii) technical risk in smart contracts and DeFi protocols, and
Does tokenization of RWAs actually improve transparency?
The point here is that today’s “RWAs” are clunky to construct on-chain and, by definition, they’re limited in what they can achieve. To use the analogy from this recent thread, a lot of fidelity is lost today in moving “RWAs” on-chain.
We can do a lot better. What we really want is *attractive* assets, regardless of whether they originate as “real-world” assets or “digitally-native” assets.
Quality RWAs fill a void in the current DeFi ecosystem because they present decent low-volatility returns in a DeFi landscape mostly made up of highly correlated tokens and equity-like instruments.
As the ZIRP era and the glory days of yield farming have generally come to a close, DeFi capital has begun to seek “real yield” — lower risk, steady cash flow opportunities. RWAs such as corporate and sovereign debt can deliver these lower risk, steady return profiles, and so they make for an easy, attractive plug to fill the gaps in DeFi investment strategies.
While tokenized RWAs are easy-to-see examples of "real yield", a wave of digitally-native assets that turn significant real cash flows is quietly emerging.
“High fidelity” digitally-native assets (“DNAs”) can bring the best of what crypto has to offer – trust minimization, transparency, and composability – in addition to real cash flows.
What might the first attractive “DNAs” look like? They could be debt instruments built upon powerhouse protocols like Lido and NounsDAO, and securitizations built upon cash flow streams from many projects or NFT creators.
Lido debt: a potential high-quality fixed income DNA?
We’ll start this conversation with Lido Finance. Why? Because it’s the steadiest cash flow machine in crypto today. Lido is the dominant Ethereum liquid staking derivative (LSD) with over 5mm staked ETH in the protocol.
Lido stakers earn 5.2% APR on their staked ETH (stETH), of which 10% goes to LDO as a protocol fee. Doing some napkin math, that means LDO is generating ~250,000 ETH in revenue and ~25,000 ETH in protocol fees annually (= 5mm ETH * ~5% yield * 10% margin). At $1600 ETH, this translates to ~$40mm USD in protocol fees annually, or ~$3.5mm USD per month. Not bad, right?
Lido spends ~$20mm USD each year to pay contributors, marketing, audits, and other opex (note: this excludes token emissions and token-based comp, which is worth another post), and to date, has sold off LDO and ETH/stETH to pay its expenses. Just last week, the Lido community discussed selling 10-20k ETH to fund the next 1-2 years of its runway (1,2). But is selling ETH really the best option for Lido governance?
In traditional finance, growth-stage businesses often tap debt to cover funding needs. While Lido has key differences from SaaS businesses (income in ETH, 90% of GMV paid to stakers), the cash flow model for Lido does look similar to a SaaS business. Looking at public SaaS comps, we see PagerDuty (PD), Blackline (BL), and Fastly (FSLY) have comparable growth and cash flow profiles to Lido, while also carrying hundreds of millions in debt on their balance sheets. The debt on these companies is often made up mostly of convertible notes, term loans, and revolving credit facilities.
Shouldn’t protocols like Lido adopt a similar capital structure? Lido is a levered bet on ETH with significant upside in the cases of ETH price and/or staking adoption increasing. If the protocol can fund its expenses by raising USD-denominated debt, tokenholders should prefer this type of debt funding over selling ETH or selling LDO today.
Lido could structure this as some form of convertible debt, or perhaps even revenue-based financing. Convertible debt could let Lido take a bet on ETH price appreciation, letting Lido sell in the future to pay its interest and principal, while also capping downside risk by setting caps on the amount of ETH or LDO the protocol might repay to lenders in a downside case.
In summary, Lido could raise attractive digitally-native debt that offers predictable income to lenders, is recorded fully on-chain, and is backed by on-chain cash flows (and perhaps convertible to ETH or LDO held within the protocol’s treasury). Such an instrument could be attractive to both institutional and DAO lenders alike, as it could offer fixed yields secured by steady cash flows from one of DeFi’s blue-chip protocols.
Lido debt could be constructed by using existing infrastructure to collateralize revenue streams and/or tokens. 0xSplits, bonds from Arbor Finance (formerly Porter), and DebtDAO’s spigot are pieces of infrastructure we are excited about in this space.
NounsDAO: another ETH-printing machine
NounsDAO brings its own sunglass-wearing version of steady cash flows to the table. Over the past 617 days (at the time of writing), Nouns DAO has generated >27,000 ETH ($47mm USD) from sales of its namesake Nouns NFTs.
The way NounsDAO works is simple:
One Noun is trustlessly auctioned every 24 hours, forever.
100% of Noun auction proceeds are trustlessly sent to the treasury.
All Nouns are members of Nouns DAO.
One Noun is equal to one vote.
The treasury is controlled exclusively by Nouns via governance.
Nounders (founders) receive rewards in the form of Nouns (10% of supply for the first 5 years).
NounsDAO has plenty of ETH in its treasury to fund its current operations, but if a need for funding were to arise, NounsDAO’s future cash flows could make a compelling case for lending to the project.
DABS: Digital Asset-Backed Securities?
Composability is one of the key elements of magic made possible within DeFi. In another example of crypto “speedrunning” TradFi’s evolution, we should expect to see securitizations of DNAs emerge soon.
Today in crypto there are many irregular, hard-to-model assets. Back in the 1970s and 80s, Salomon Brothers figured out how to package bundles of residential mortgages into multiple tranches that could help investors more comfortably underwrite the prepayment and credit risks involved in each individual mortgage. The introduction of RMBS (Residential Mortgage-Backed Securities) kicked off a wave of innovation on Wall Street, leading to other structured products like CDOs.
Most importantly for crypto, structured products like RMBS enabled more conservative investors to participate in an asset class that they previously found too risky. More conservative lenders can play in senior secured tranches while risk-on investors can bet on the equity in these securitizations.
It stands to reason that as on-chain activity evolves, we might package many revenue streams together into securitizations to make asset classes easier to underwrite. Similar to how securitizations became common for funding movies, we might see music NFTs funded by on-chain structured financings. Each time revenue is earned on a transaction, it would be split out and distributed by predefined rules. We can look at how Airswap is using 0xSplits today to see an example of this in action today, where 14% of the fee on every swap transaction on Airswap is routed to contributor tips and 86% to voters.
TrueFi has also built infrastructure for structured credit vaults, making it easy for portfolio managers to create and operate multi-tranche credit funds / undercollateralized lending pools on-chain.
The revolution will not be televised (but it might be tokenized)
I could keep going on about the Cambrian explosion of innovation to come with a new wave of DNAs, but I’ll stop here.
I encourage readers to explore some of the cool things that I didn’t even mention in this piece, like Alkimiya, a protocol that enables miners/validators to sell future mining rewards via non-custodial swaps, and the entire spaces of decentralized wireless (“DeWi”) and decentralized science (DeSci).
Note: Finally, I recognize that the ideas discussed in this piece carry legal considerations that make building some of these things complicated. If you’re inspired to go out and build any of these instruments, please consult your lawyer.
Great points Tyler!
One thought - Credit rating agency (S&P, Moody's etc.) issued ratings of digitally-native debt/assets def would help the growth/adaptation of DNAs.
Great read Tyler!