Author(s)
The Capital Markets team at END Labs: Edward Wu, Jeremy Kim, Alex Forshaw, and Deepak Lalit, also known as END Capital.
Proposal Summary
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Create a $15M, 10% cash APY, FRAX-denominated END Capital AMO for short duration (90 days or less) real world assets.
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Advise the Frax Protocol and Community on establishing best practices pertaining to on-chain onboarding and tokenization of real world assets, credit underwriting of institutional structured credit deals, and on-going credit risk monitoring and surveillance of on-chain real world assets in Frax RWA AMOs.
How would END Capital benefit Frax?
- The asset-backed loans we would source, underwrite and monitor on behalf of Frax (primarily focused on gig economy payment advances) offer excess risk-adjusted return via short-duration, self-liquidating real-world asset mechanisms, combined with structural loan protections which we would incorporate into the loans. As these loans finance real-world demand, they offer sustainable yield with little correlation to crypto. This results in a more robust collateral base for the Frax stablecoin and ecosystem.
- As Frax pivots towards RWA lending, Frax will need to prudently manage the many new risks inherent in RWA lending. END Capital proposes to act as the Underwriting Agent on behalf of the AMO and the Frax community, and will provide on-going surveillance, reporting, and risk management for as long as this AMO exists.
- Create a regular framework for on-going education for the Frax community on how TradFi assesses credit risk on the very assets that will be brought to Frax DeFi-to-RWA AMOs.
- Work directly with the Frax community on establishing best practices around DeFi-to-RWA AMO credit risk management and operations, not only for this END-Labs proof of concept AMO, but DeFi-to-RWA AMOs in general.
Background & Motivation
For the Frax Protocol to responsibly scale FRAX adoption in a post-Terra environment, we recommend that Frax consider allocating a portion of liquidity away from the expensive, concentrated AMOs of the recent past (i.e. Curve) in favor of AMOs underwriting real-world loans (as asset collateral) which are used to finance actual real-world GDP productivity in reasonably short durations (12 months or less) and reasonably low per-borrower concentration risk.
END Labs (Early, New, Different) is a 20 person team comprised of 80% blockchain product managers & engineers (our dev team) and 20% capital markets professionals (END Capital). Our END Capital team has over 40 years of combined experience originating, underwriting, and investing in asset-backed loan portfolios in aggregate totalling in excess of $500 million of transactions. The range of assets which our team has transacted in is very broad, ranging from mainstream consumer credit (subprime auto, mortgages, unsecured lending, etc.) to merchant cash advances/SMB lending, content/IP financing (film/music receivables), Amazon merchant financing, litigation finance, short term worker financing (‘gig’ economy), real estate bridge loans, and many other types of assets. On structured deals which our team has been involved with originating, executing and closing, we have consistently achieved excess risk adjusted returns, while avoiding any loss of principal, by utilizing extensive structuring and financial modeling expertise to stress-test underlying default rates to understand at what point our loans become impaired and create structures which then mitigate that impairment if default rates increase (including early warning asset performance triggers, financial covenants, cash controls, turbo structures and other protective mechanisms).
We target asset backed loans that are high yield, short duration, and self liquidating. Our expertise is in sourcing and structuring transactions with niche specialty finance originators. Borrower selection is the most critical factor in determining success and we have had decades of experience in borrower selection. By focusing on short duration, self liquidating transactions, we have tremendous flexibility to adjust operations on the fly given changes in the macro economy. For instance, we can quickly adjust rates upwards in a rising rate environment and we can quickly exit the entire portfolio if issues arise. We believe that these types of assets are ideal for a Frax AMO.
END Capital in DeFi
Frax will be our third DeFi pool.
We launched the GIG Pool on Centrifuge’s Tinlake platform in July 2021. The GIG Pool has had no defaults and has returned a blended yield of about 9% since inception. END Capital has tokenized over $8m of loans using DeFi via the GIG Pool. Please see a Dune dashboard of the GIG Pool’s on-chain history at Dune.
We launched our second pool in December 2021, the Real World Asset Market (rwamarket.io) on Aave, which we created in partnership with Centrifuge to invest in a collection of the senior tranches on Tinlake. This pool currently has a total size of $7 million.
We believe that integrating DeFi with real-world borrowing demand is the first step towards a future of finance in which crypto and stable stablecoins serve as one of the main operational rails upon which everyday financial transactions occur. Innovative credit and stablecoin protocols have been making steady progress integrating RWAs with their own deposit bases; however, these protocols need to either a) lease capital to external asset selection teams such as ourselves, or b) operate as a centralized internal private credit fund.
We also believe the downfall of Terra proved conclusively that stablecoins are only as stable as the amount of borrower demand for that stablecoin. Capital allocated to real-world loans is not mercenary capital able to flee the protocol as Terra’s Anchor deposits did. On the contrary, when the currency peg is under extreme pressure, real-world borrowers are strongly incentivized to prepay their loans, thus redeeming their debt at a discount while defending the currency peg. In the long run, an algostable’s endogenous collateral component (the 12% of equity backed by FXS in Frax’s former formulation) is only as secure as the amount of debt backing it.
If Frax wants to scale its model to thousands of large-wallet users (or millions of everyday users), a very prudent way of doing so is by sourcing real-world institutional loans. Our AMO proposal is thus elegantly aligned with Frax’s short-term and long-term strategic needs.
Proposal
Our team is now ready to scale up DeFi operations to source, underwrite and fund institutional asset-backed loans. We propose a “proof-of-concept” AMO of $15m to prove out how an AMO directly facing an independent asset manager (as opposed to an aggregator of asset managers) with the Frax community will work. END Capital will source and underwrite loans of real-world institutional borrowers for the benefit of this AMO, focusing on companies that originate loans to small businesses and consumers, as well as monitor and manage risk on a continuous basis throughout the life of these loans. END Capital will also manage the on-chain onboarding and representation of these loans, and will facilitate the fiat on- and off-ramps facing the underlying borrower companies. If we collectively conclude that this POC works, then we will bring in our dev team to build a more robust tokenization protocol in order to scale our operations.
Secondly, we’d like to offer our asset-diligence expertise to the Frax community, for the purpose of evaluating potential real-world asset investments. Assuming the community agrees, we envision this progressing to a direct dialogue with Frax senior management. (What RWAs would Frax like to fund? At what durations? What other risk factors are most important? Tokenized vs. offchain? How should END Capital be compensated for due diligence? Etc.)
AMO: Structure, Protections/Risk Mitigation
- Expected Collateral Pool duration: 90 days or less (the Frax Protocol’s liquidity would effectively be tied up for 3 months or less)
- Expected Asset-Backed Loan duration: 6-12 months
- Contemplated AMO rate: 10%
- Expected Asset-Backed Loan yield range: 11%+
- Structure & protections
- Structural alignment of interests with the ultimate company borrower
- Collections performance triggers and covenants based on the performance of the Collateral Pool backing each Asset-Backed Loan
- On-going surveillance of the performance of each Asset-Backed Loan, both at asset and portfolio level, and the production and presentation of the results of surveillance to the Frax community
AMO Projected Timeline
- T + 1 months: END Capital AMO launch
- T + 3 months: END Capital to implement a monthly reporting cadence, and a quarterly AMA to present updates on END Capital’s lending activities for the AMO
- T + 6 months: END Capital to deploy no less than 85% of the AMO’s total capacity
- T + 9 months: Depending on the feedback from the Frax community on the success of this AMO, END Capital to propose either an expansion of the AMO, or a wind-down plan.
About END-Labs
END-Labs is focused on web3 lending infrastructure and has built a developer team as well as a capital markets team. Our capital markets team, END Capital, creates DeFi pools to connect fiat-native borrowers and institutional DeFi capital, driving greater capital efficiencies. Our developer team builds rails to provide lending infrastructure to borrowers, lenders, and those that service them. We believe that the credit industry will adopt Web3 rails resulting in more increased access to capital and lower cost of capital globally.
END Labs is backed by ConsenSys, Coinbase Ventures, Circle Ventures, Blocktower, and CRV (Charles River Ventures), among others. END Labs’ unique combination of software engineering expertise and Tradfi structured credit expertise enables us to serve as a bridge between Tradfi and DeFi due to an ability to solve problems/challenges in both arenas.
More information about END-Labs can be found at https[colon]//end-labs[dot]io/about.
Proposal
A: Create a $15M AMO for END Capital.
B: Do nothing.