On-chain securitization
Last updated
Last updated
By nature, real-world assets are often illiquid and can have maturities of up to several years. This makes investing in individual assets extremely difficult. One way to solve this problem is to pool multiple assets together and allow investors to finance the pool of assets rather than financing each asset individually. This is called securitization and is a recognized concept in traditional financial markets.
Therefore, after the asset is tokenized and the NFT is minted on the chain, the NFT is used as a representation of the off-chain collateral for the assets associated with the investment pool, as shown in the figure below. Assets are priced and issuers borrow liquidity from the pool. Over time, issuers repay the accrued debt on each asset, including interest payments and principal repayments.
In short, this creates transparency at the asset level on the chain: investors can see at a glance what assets the pool contains (NFTs), what assets have been borrowed and repaid, what assets are overdue, and so on. This creates an immutable, transparent track record of financial transactions that can be publicly verified. In contrast, the status quo of traditional finance is that historical financial data is often hidden and locked in private, isolated databases that are not accessible to the public, and financial analysis is based on spreadsheets.
In traditional finance, many securitizations are static: a group of investors provide funds to the issuer, the issuer finances the debt, and then repays the interest and principal when the asset matures. In the end, investors can get their capital and yield back. This situation is not a good deal for investors, but creates unnecessary overhead because they must reinvest after the pool matures. This also makes it more difficult for other DeFi protocols to integrate with the NPC protocol because they will have to continuously invest in new pools.
To solve this problem, mining pools using the NPC protocol are constantly evolving: investment and redemption (withdrawal of investment capital) orders can appear at any time, and assets can be continuously financed and repaid. This has multiple benefits for both issuers and investors:
Issuers can finance assets at any time, provided there is liquidity in the pool;
Investors, including DeFi protocols, can make flexible portfolio allocation decisions without having to constantly reinvest;
The overhead of setting up and operating the underlying legal structure multiple times is eliminated.
To do this, two basic components are required: the epoch mechanism and the on-chain NAV (net asset value) calculation.
Epoch mechanism
A decentralized pool where investors from different parts can invest and redeem at any time requires a decentralized mechanism to coordinate the inflow of investments and the outflow of redemptions. To solve this problem, each pool is managed using "epochs": sessions with a fixed minimum time (e.g. 24 hours) during which investment and redemption orders can be submitted. At the end of the epoch, the decentralized solver mechanism considers the pool state and executes orders based on the seniority of the installments (e.g., senior installment redemptions take precedence over junior installment redemptions) and available liquidity.
On-chain NAV
The second component to enabling a revolving pool is an on-chain NAV (net asset value) calculation: to support ongoing investments and redemptions, the pool tokens need to be accurately priced. In traditional finance, pricing of such illiquid assets is typically done using a discounted cash flow model: expected cash flows (e.g., principal payments on assets in the pool at maturity) are discounted at their present value. The protocol brings these calculations on-chain and continuously calculates new NAVs.
NAVs should also take into account different types of loans to ensure accurate pricing: financing of real-world assets can range from simple bullet loans (borrow now and repay principal plus interest at maturity) to complex amortization schedules (repay principal plus interest at specific intervals).
NAVs also need to take into account asset defaults: if an asset fails to repay, the NAV should represent this. The protocol supports this through an on-chain representation of asset write-offs. The protocol will display written-off assets according to a pre-determined write-off schedule (e.g., when an asset is 30 days past due, 25% of the asset value should be written off and a 3% penalty interest rate should apply). This allows for fairer pricing of overdue assets. Assets can also be written off manually by a third party.
Instalments
Investors often want different types of risk exposure and yield on the same asset class. In the traditional financial world, one way to achieve this is to introduce a tiered investment structure, in other words, to introduce different tranches. This means that investors can invest in the same set of assets through different classes of debt with different risk/return profiles. A standard example is shown below.
In its most common form, a pool can have junior and senior tranches, with the junior tranche tracking the first-losing position and earning excess returns, while the senior position earns a lower fixed rate of return but is protected from losses by the junior. A key advantage of this structure is that it allows the issuer of the pool to invest in the junior tranche and thereby be in a first-loss position in the pool.
