Why we chose Listed Shares as our first real world collateral on the OTL
When choosing which real world asset to tokenize and put up as collateral on the OTL, one of the heaviest things that weighed on our mind was how we would handle enforcement.
It is all fine and well to say that you have tokenized a property or gold or some other real world asset and it is now being used as collateral, but the real key question to address is what happens if the party who was borrowing does not repay.
The problem now becomes:
- Who will handle the enforcement and how
- How fast can the liquidation be done to recover the position of the lender
Platforms like realt.co and DMM and even Centrifuge have started some work around tokenizing real world assets and using the DEFI ecosystem as a way to source funding. However if you are dependent on the good will of the platform operators to enforce and there is no clear liquid market where the liquidation can be done or it can only be done in an adhoc manner then that becomes a problem.
When you are going via DEFI platform the understanding is that this is a decentralized play and you are deploying your funds based on the quality of the code and not the party behind the code. This is an important distinction as that means there is no formal “issuer” as defined from a securities regulatory standpoint.
In a CEFI platform you are trusting the people behind the platform, the platform code is a means to an end. You have additional legal recourse when it comes to a securities offering. But in a DEFI platform there is in reality no meaningful recourse.
Realt.co does not make any pretensions of being DEFI, they have AML KYC and those who deploy the funds are doing so on the back of an investment offer document. How enforceable that is and whether or not those who invest actually read and understand the risks is a separate question, but realt.co has a legitimate argument that investors are relying on them to generate the return and that is perfectly fine.
Centrifuge tokenizes invoices and has a partnership with Maker DAO where their tokenized assets have been approved as part of a basket of future real world assets. Multi Collateral DAI is now supposed to be backed in part by these tokenized invoices.
DAI is at the heart of all DEFI (or atleast was). When Centrifuge claims that they are tokenizing real world assets, starting with invoices then the question needs to be asked.
- What happens when the invoice is not paid?
The assumption here is someone from the Centrifuge team (or partners) engages in manual enforcement. That creates a fallible manual dependency off chain, and secondly if these invoices are not paid are they worth anything?
Suppose these unpaid debts can be flogged to a debt collector, who buys them for a discount, then the subsequent question is how deep the discount is and whether or not a liquid market exists where these unpaid debts can be flogged without leading to a loss of principal.
If these invoices were secured by a guarantee against some real world assets such as real estate then the question becomes again, who is going to enforce, where can the underlying property be sold, and how fast can cash be recovered?
Real estate transactions can be slow moving and take months to process.
DMM claims to do liens against cars. Cars are a depreciating asset. Used cars are probably one of the worst collateral there is. Worse if the loan is not paid who is going to take possession of the cars, and where and how fast can these cars be sold. Used car salesmen are notorious to take advantage of the lack of price transparency and flog them for whatever they can get away with. Used car secondary markets exist, but they are hardly liquid or transparent like listed stocks.
If we are to tokenize real world assets, the asset needs to have:
- A highly liquid secondary market
- with transparent price discovery, so you know exactly what that asset is worth at any point in time
- Enforcement should not be dependent on human actors i.e programmable liquidation should be possible
Listed stocks or commodities tick all of the above boxes. They have deep and transparent liquid secondary markets with transparent price discovery and buy and sell can be done via scripts which can be used to trigger automatic liquidation when price drops below a certain threshold.
Our team actually comes from a real estate background, however after considered analysis we came to the conclusion that the first real world asset class we had to put on the OTL was listed blue chip shares such as Apple, Facebook, Google etc.
In future articles we will talk at a high level about the technology bridge we are building between the scripts to trigger buy and sell and smart contracts.