September 17, 2020
Blair Bingham
Thought Leadership

The Melding of CeFi and DeFi: ArCoin’s Path to Becoming MKR Collateral

I’m always astounded by the myriad of use cases our team envisions for ArCoin, Arca’s digital security backed by a portfolio of short-duration U.S. Treasuries. It seems even more incredible when our team takes an idea and begins to create new use cases for ArCoin that have the potential to reframe and strengthen the digital asset ecosystem.

The Fund, and ArCoin, the digital security linked to a share of the Fund, is the first closed end interval fund registered under the 40 act. We believe that the Fund’s registration under the ‘40 Act is one of the greatest benefits it offers. This regulatory standing means ArCoin holders receive the following digital security attributes:

  • Benefits associated with ‘40 act products
  • Mandated daily reporting of the Fund’s Net Asset Value (NAV)

Upon the creation of the Fund and ArCoin, we knew that applying to be a collateral option for MakerDAO was one of the first use cases we wanted to pursue.

For those not familiar with MakerDAO, it is a decentralized organization built on the Ethereum blockchain. Just recently, Arca Labs submitted a Collateral Onboarding Application (MIP6) with the aim of receiving approval for ArCoin to be used as collateral when creating DAI in the MakerDAO ecosystem. DAI, issued by MakerDAO, is a decentralized, crypto-collateralized stablecoin that aims to maintain a dollar peg to USD. Maker’s smart contract manages the borrowing and lending of DAI. A user of Maker will deposit an approved digital asset to borrow DAI, which aims to keep a peg of approximately one dollar. A user can then use this DAI as a medium of exchange within the larger digital asset ecosystem. Under our proposal, a user would deposit ArCoin to borrow DAI, which would be held by MKR’s smart contract until the borrowed DAI was repaid and ArCoin returned to its holder.

Given the relatively historical low volatility of U.S. Treasuries, we believe that ArCoin could be a lending tool offering less volatility when compared to most digital assets.  The potential for yield from the Fund means that using ArCoin as collateral for DAI could be more attractive than using stablecoins, which have no potential for yield when locked in the Maker system. Further, the benefits outlined above differentiate ArCoin from stablecoins and other DAI collateral types.


MKR APPLICATION PROCESS

With our application submitted, the Arca team prepared for Maker’s Collateral Onboarding Meeting, where we would present our proposal to the community and respond to any questions. While preparing for the call, we soon found ourselves exploring uncharted territory for our digital security: what is the value of adding a relatively centralized digital asset into a decentralized protocol?

ArCoin’s underlying assets, U.S. Treasuries, are referred to as “real-world assets,” making ArCoin a more familiar financial instrument. However, in creating ArCoin through the use of blockchain technology, our digital security has capabilities that traditional securities do not. ArCoin can be transferred peer-to-peer, offering the potential of reduced costs due to the removal of intermediaries. Through our Fund structure, the underlying U.S. Treasuries remain much the same, but ArCoin (digital securities) and their wrapper (the ‘40 Act Fund) have changed the attributes of these securities. This structure allows for personal ownership (in a wallet of the tokenholder’s choice) and peer-to-peer transfer of an asset previously restricted by the norms of the United States’ financial system. These features, enabled by blockchain, work to expand the capabilities and ownership rights of individual investors over their assets. This transfer of power from established institutions to single investors is a key element in decentralization.

The graph below is a great way to visualize this concept. U.S. Treasuries stand as the most centralized of assets, as they are issued by the U.S. Government. Additionally, the tradable market for U.S. Treasuries is massive, recording roughly $2,600B in notional value traded during the week of August 14th. On the other end of the spectrum, we have MakerDAO and its currency, DAI. Maker, being a decentralized autonomous organization, is not controlled by a single entity, but is instead managed by its tokenholders. DAI’s value fluctuates in accordance with DAI supply, which follows the actions of tokenholders (hold, buy, sell, redeem or liquidate DAI). ArCoin straddles these two opposites. Unlike DAI, ArCoin’s value is determined by the value of the portfolio of its underlying assets, U.S. Treasuries. One ArCoin is equal to one share of the Fund. The Value of the Fund, and hence the value of ArCoin, is based on the value of the portfolio of U.S. Treasuries as well as the income payments received from the Treasuries. However, very similar to DAI, Arca does not determine the floating supply of ArCoin. Though underlying assets that make up the portfolio of investments for ArCoin are centralized, ArCoin’s structure allows for a relatively more decentralized and continuous economy for U.S. Treasuries.


We believe that decentralizing real-world assets requires a bridge, and that ArCoin acts as the bridge of real financial assets to DAI. This is why our team believes ArCoin is a good fit for a decentralized organization such as Maker. The goal of creating an alternative financial system is to innovate. Without a bridge, we believe that digital assets will never achieve mainstream status, as institutional investors will lack the confidence necessary to invest in this new asset class. If our goal is to promote healthy growth in the digital ecosystem, then assets that are deemed to have real world value must be used to encourage growth in this ecosystem.  


In my next blog post, I will further discuss the details of our proposal to be included as collateral for MCD.


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