Background
In corporate finance, any cash that won’t be touched for 90 days requires a productive home where it can be put to work. Currently most is converted to T-bills, U.S. government bonds, where corporations receive a fixed interest rate corresponding to the duration for which they lock their funds. Current T-bill “risk free” rates:
- 1-month T-bill: 4.2970% yield
- 3-month T-bill: 4.3140% yield
- 6-month T-bill: 4.3030% yield
- 12-month T-bill: 4.22% yield
Unfortunately corporations pay substantial fees to enter and exit their T-bill positions, requiring them to allocate their funds to these positions for longer durations than they would like to accrue additional interest that offsets the fees. There’s also little diversification between corporate T-bill strategies, they all depend on the U.S. government.
Thesis
If Compound Protocol can systemize a product for Corporations who deposit capital for fixed durations to receive fixed returns, with onramp and offramp fees lower than those associated with T-Bills; There is an ocean of available capital greater than the value of the US Stock market that could be tapped to deposit onto Compound.
Hurdles
The three risks that have kept TradFi away from DeFi are:
- Fixed Rate Risk
- Smart Contract Risk
- Regulatory Risk
Roadmap
In order to remove these risks, the TradFi team will work to build a product pipeline that streamlines the process for any investor to vet these three risks with their own team, and confirm that the opportunity lies within their risk profile. From the time an investor wants to pursue Compound’s Fixed Return opportunity they require the following components:
- Fixed Rate Product Interface → Marketplace to shop current fixed rate products
- Ability to vet the smart contracts and technology → Clear documentation that simplifies the process. Plus potential smart contract insurance.
- Custodial Solution → Who will custody their funds? (Their CTO, a paid custodian) → How will they know the custodian is trustworthy and action limited (to prevent an FTX or Celsius situation)
- Onramps & Offramps → How will funds be converted from Cash to Crypto & back
- Clear understanding of the current regulatory environment.
Overcoming Fixed Rate Risk
First this team will work to remove the Fixed Rate Risk. We’ve already started through our work with a Fixed Rate Product (FRP) over the last six months; a market place where:
- Corporations will be able to purchase fixed income products on top of Compound markets.
- Market Makers will be able to purchase the interest rate volatility on the corporation’s deposits.
For example: If Compound’s USDC Market on Mainnet has historically returned 7% APR over the previous year, but the APR rate has fluctuated between 29% and 3%, the FRP will crunch the numbers and figure out a reasonable fixed rate to offer to both sides of the market. If T-bills are 4.297% for a 1 month lockup, then a corporation may try Compound if they can get 25 basis points higher (4.55%). FRP then goes to the Market Makers interested in buying the interest rate volatility. They say, The historic interest rate for the last month was 7%, we’re offering them 4.55%, therefore as long as the interest rate on the USDC vault remains above 4.55%, you earn, if it falls below 4.55% you are required to pay the difference. Therefore FRP always has the capital (either Real Yield from the Compound Market, or profits from the Market Maker to ensure the fixed rate).
Overcoming Smart Contract Risk
Investors in blockchain typically employ technologists on staff who audit smart contracts on their behalf. For example during the LTIPP campaigns on Arbitrum multiple large whales made it clear they were interested in the boosted rates on Compound through Vaultcraft’s vaults but needed one-three weeks to self audit before they would feel comfortable depositing $15M+. Audits were eventually completed and funds were deposited.
We don’t expect TradFi institutions to have extensive smart contract auditing talent. Some will, but even in those cases we’ll work to create explicit documentation to accelerate auditing and decrease the opportunity cost of evaluating Compound’s financial opportunities.
Additionally, we’re looking for an insurance fund to back the entire TVL of Compound Protocol because this is what TradFi has told us they’re looking for. If an insurance fund can take a small portion of the fixed rate return to insure the investors’ underlying principle, the fund would still receive a higher rate than T-Bills and require less auditing time as the insurance company would have performed the audits on their behalf.
Overcoming Regulatory Risk
The regulatory risk climate is now changing due to the Trump administration. This will be an ongoing conversation and one reason AlphaGrowth has multiple team members in close proximity to Washington.
Driving Adoption
We will initially pursue the tens of larger crypto investors looking for this type of strategy. We’ll then focus on family offices, sovereign wealth, and high net worth individuals who can act with more autonomy and carry less regulatory risk that could otherwise prevent them from being first movers. Finally we’ll begin conversations with corporations having created a track record of solid products & returns. That’s why this is a multi-year business unit as the timelines for new product adoption in TradFi are longer than most crypto timelines.
Steps to Operationalize
- TradFi team peaks the interest of a Wealth Fund
TradFi & Wealth Fund Teams
- Discuss Risk
- Work together to self-audit the product
- Choose a product to insure their position
Wealth Fund then:
- Onramps funds through Circle or another partner
- Deposits those funds with a Custodian
Together the Custodian & Wealth Fund manager navigate to the fixed income product dashboard where they:
- Choose the asset they’ll deposit (USDC, USDT, etc …)
- Choose a lockup period & corresponding interest rate (4.5% for 6 months)
- Deposit funds
After the selected lockup period is over either …
- The funds are deposited into another position
- Offramped back to the investors original bank account
Team Construction
The TradFi Business Unit is a business development, operations and product team dedicated to building out the aforementioned strategies. The initial team lead will be Patrick Hudgins who will hire additional BD & Operations support with TradFi backgrounds.
Cross Collaboration
The TradFi team will be one of the more independent teams. While it will benefit from the infrastructure created by other teams, the pipeline of clients it supports are largely disconnected from the primarily blockchain strategies that govern the remaining teams.
Questions?
This document is intended to educate community members on the value generated by and general activities of a Road to TradFi business unit. If there are additional questions you’d like to know please ask them below, we’re happy to answer, though some answers may be during office hours to protect strategies that are more valuable if they cannot be easily copied by our competitors.