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MakerDAO Chases ‘Real World’ Deals and Assets in Major Test for DeFi

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Société Générale’s request for a $20M loan from MakerDAO is just one of several real-world deals that the DeFi protocol has coming soon.

The O.G. decentralized finance protocol is on the move to fund projects that will make tangible differences in the world. That potentially includes MakerDAO founder Rune Christensen’s push for the organization to help combat climate change

The organization has seven deals involving traditional assets in the works, including SocGen’s, according to Sébastien Derivaux, an economist in Maker’s decentralized autonomous organization (DAO) focused on real world assets. In an interview he said other transactions would contribute to financing farmland in Iowa, a film, and a solar array in New York state.

Real World Assets

MakerDAO has already closed five deals for loans collateralized with real world assets, starting with those backed by real estate for New Silver. Three of the deals aren’t live yet.

The fact that an upstart DAO is getting deal flow with Europe’s seventh biggest bank is an important moment in the development of DeFi. Unpacking how MakerDAO is using real world assets shows the rest of DeFi the pitfalls and opportunities on the road ahead.

From its first governance vote, MakerDAO has pursued a vision to use DeFi to change the world with scientific governance, serving the underserved and making finance sustainable. But to do so, the DAO needs to reach global scale. Since its beginning, this has always meant aiming to incorporate real world collateral into the system in order to mint its stablecoin, DAI, against those assets. The idea is that if MakerDAO  can do that, it can grow so dramatically that it will have enough clout in the market to use its capital to address global challenges at a scale that would make it a significant force.

Scale could make that possible, or it could also entice MakerDAO and similar projects to recreate the very world of high finance that DeFi was founded to disrupt. 

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MakerDAO has already invented a new type of financial business model. Institutions, investors, and other DAOs deposit assets into MakerDAO (for now, almost entirely crypto assets), and it allows them to borrow  a certain amount of DAI against those deposits. Here’s the surprising part: the DAI doesn’t come from a pool the DAO minted long ago. The DAI is created at that moment the loan is made. And when loans get repaid, DAI gets destroyed.

Every DAI reflects a debt, and every loan MakerDAO makes puts new money into the world. By collateralizing real world assets, MakerDAO can issue a lot more money. This is why it’s called the Central Bank of DeFi.

Enter Société Générale, a Paris-based institution known for specializing in financial engineering and taking risks. 

The token is the bond. It’s not a representation of some legal document on Ethereum. The token is the thing.

Last week, SocGen submitted a proposal to borrow $20M worth of DAI from MakerDAO using its OFH token as collateral. “This first experimentation of a refinancing structure of security tokens through a DeFi protocol will allow us to shape the future for bond refinancing business activity,” the proposal states.

In other words, this is how bonds representing things like mortgage refinancing, commercial office leases, and auto loans would find their way on-chain, and that in turn makes them usable as collateral in blockchain-enabled loans and derivatives. DAOs could start holding both assets that reflect the value of real estate as well as those that capture the value of decentralized exchanges and yield aggregators. 

Legal Issues

This is not SocGen’s first blockchain move. The bank previously created $100M of these tokens on the Ethereum blockchain in 2019. Subsequently, it issued another $40M in such tokens in 2020, which are based on mortgage refinancing deals, according to Derivaux. That second lot, or part of it, is the one that would be at stake in this $20M loan that the bank has sought.

Derivaux emphasized what’s important about these bonds: the token is the bond. It’s not a representation of some legal document on Ethereum. The token is the thing.

The deal is pending and may take some time to finalize, if it ever does, Derivaux said.

There are any number of legal and, perhaps, technical issues to sort out as the deal moves forward. It remains to be seen if all of them can be solved. Directly addressing these problems appears to be the true purpose behind this deal, because it is not a meaningful amount of money either for MakerDAO (which has created $6.6B in outstanding debt, according to DaiStats) or SocGen, which had operating income of €2B in the second quarter.  “It’s really to make the first steps to the new system and having all the bonds on Ethereum,” Derivaux said. “It can then be used with the rest of DeFi.” In other words, real world bonds could then take advantage of the composability and transparency of distributed ledgers. 

“We see it as only the beginning,” Derivaux said.

Ever since financial institutions started experimenting with blockchain technology several years ago, they’ve been keen on harnessing its innovations without running afoul of regulators. In this way, MakerDAO appears to be directionally aligned with SocGen. To create the OFH tokens, the bank used something called the Compliant Architecture for Security Tokens (CAST) framework.In the CAST whitepaper, the authors describe the importance of putting new structures in front of regulators rather than waiting idly for a regulatory framework to present itself.

Moving Parts

“DLT promoters barely consider the highly regulated environment of financial markets and the complexity of operations within existing market infrastructures, which are real barriers to adoption,” the paper says. “We believe DLT promises make sense and offer opportunities to challenge existing legal, regulatory, operational and technical frameworks (and their underlying legacy systems).” (DLT stands for distributed ledger technology.)

The blockchain isn’t simple, of course, but the real world is a mess. Just look at all the moving parts and entities in the SocGen deal to see how complicated the analog world makes finance. Oracles can just query a database in DeFi to check the facts a contract needs to verify, but, in the real world, humans are needed everywhere.

The deal with Société Générale – Forge, a subsidiary that specializes in digital financial products, fits into MakerDAO’s larger plan to scale by creating DAI backed by assets in the real world. That will help manage risk and execute MakerDAO’s mission of advancing sustainable finance.

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Société Générale – Forge is a unit of the Paris-based investment bank.

Société Générale – Forge has not answered questions from The Defiant about the deal.

MakerDAO’s founder Rune Christensen (who now has no formal role) poured urgency onto that mission this week when he proposed a plan for MakerDAO to make its stablecoin, DAI, into “clean money” that isn’t just carbon neutral but funds energy sources that don’t contribute to climate change.

It’s important to note that Christensen’s plan is only a proposal, and no one person speaks for the DAO, even its founder. 

As it stands, new DAI issued is made using cryptocurrency as the collateral, and that’s primarily done so the borrower can engage in speculation. “Obviously you can’t build a world ecosystem on speculation. If you want to replace or complement traditional finance, you need to achieve significant scale,” Derivaux said. “The supply of real world assets is almost unlimited.”

MakerDAO does not exist as a legal entity that can submit to know-your-customer/anti-money laundering requirements needed to do business with TradFi firms.

By starting with using home refinancing loans as its collateral, MakerDAO may change its image as an entity disconnected from real life. In the immediate terms, it is providing liquidity to a major bank for assets it has from refinancing real property.

Later, once MakerDAO has strong deal flow in real world assets, then it can deploy its capital in line with the DAO’s values. Broadly speaking, MKR holders seem to agree that they want to go beyond the blockchain and finance real world projects and help the world create wealth. If Christensen has his way, it will become even more focused and use some portion of that capital to take on climate change.

Still, real world deals raise complicated issues for MakerDAO. The most obvious one: MakerDAO does not exist as a legal entity that can submit to know-your-customer/anti-money laundering requirements needed to do business with TradFi firms. It will have to create legal entities to do so, a process Derivaux said is underway.

But this question of MakerDAO’s legal status, particularly in the U.S., has recently become a much larger conversation within the organization. 

Further, the OFH tokens cannot be delivered to MakerDAO. Instead they will be custodied by a partner, the DIIS Group, an investor services firm. “[SocGen] can’t just send $20M in bonds to a smart contract. That’s not going to happen,” Derivaux said.

Liquidate the Collateral

This means that MakerDAO will have to use oracles to communicate the status of the bonds to its own smart contracts. The oracles won’t have much to do beyond confirm they are still there, though, as there’s no market to discover OFH prices.

Which raises the other issue for MakerDAO: Should SocGen default on the loan, MakerDAO would not be able to liquidate the collateral to recoup losses.

“If they cannot repay the loan, the custodian will keep the bond until maturity, which is in four years,” Derivaux said, and MakerDAO would take the funds. But of course that’s extremely unlikely. As Derivaux pointed out, if SocGen can’t repay a $20M loan, the world has much larger problems.

But of course if MakerDAO is to do more of these deals, it needs a way to liquidate bad loans and there is no marketplace for these kinds of securities today, according to SocGen’s proposal. 

“With time, and after these payments, there will be an ecosystem to handle these bonds,” Derivaux said.

Until that happens, creating DAI as loans against real world assets at massive scale won’t be feasible. Once it is, though, it’s impossible to hazard a guess about how big DeFi could ultimately get.

[ CORRECTION on Oct. 7 @ 2:43pm EST to clarify in the first paragraph SocGen is requesting the loan from MakerDAO]

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