USDM: A Real-Word Asset Backed Synthetic Coin

One of the most significant use cases in the blockchain space that has emerged in recent months is its role as an ideal platform for the digital management of Real-World Assets. This is important for RWAs that lack technological market infrastructure providing liquidity access (e.g., IP in many sectors like music, receivables, etc.).

The current approach to RWA management is still immature, as this is a very young industry. RWA applications typically simply “tokenise” specific assets to allow the onchain circulation of tokens representing ownership of those assets.

This is certainly an innovation but does not entirely solve the liquidity problem.

Eliminating friction in circulation is the conditio-sine-qua-non for an asset to be liquid. Still, then it is necessary to ensure that investors can access and allocate their capital efficiently, thus creating a deep and liquid market.

Here lies the main problem: RWAs that do not have access to the financial market and, therefore, benefit from using blockchain as a market infrastructure are assets with a risk profile that is often difficult to assess. How can we create the conditions for a sufficient amount of capital to be allocated to such a market?

In traditional markets, this gap is often filled by asset managers who manage the tactical allocation of assets by creating portfolio allocations that are then packaged by banks into financial products that most investors use to allocate their savings.

We propose an innovative financial structure that addresses the challenges of accessing capital in real world asset (RWA) markets. This structure leverages tokenized credits, which are essentially illiquid. Specifically, we focus on credits derived from the sale of cash flows generated by music catalog royalties. This tailored use case highlights the potential of our financial structure to enhance liquidity and facilitate efficient capital allocation in the music industry.

Mechanics

This mechanism allows liquidity to be invested in the music market through the issuance of tokens denominated USDM, each representing one dollar of liquidity. The incoming liquidity is invested in Music Bond Contracts (“MBC”), which are specific Future Royalty Cash Flow Assignment Agreements generating cash flows over a predetermined period. USDM can be staked, opening positions rewarded with the yields generated by the Music Bond Contracts.

At a macro level, the financial metrics around which the equilibrium revolves are as follows:

  • Liquidity inflow: the amount of liquidity in USDC entering the system, against which new USDM are minted.

  • Liquidity outflow: the amount of USDM burned in exchange for an equivalent amount of USDC exiting the system.

  • Underlying MBC value: the amount paid by the system to enter in the MBC.

  • Music Cash Flow: incoming cash flows from the Music Bond Contracts. These cash flows include both a capital component and a yield component.

  • Reserve: the accumulation of the capital components of the Music Cash Flows. These flows are reinvested over time as new Music Bonds become available, but in the meantime, they accumulate, forming the Reserve. When the Reserve is high relative to the underlying MBC value, it can be financially efficient to have liquidity outflows that reduce the system's size. Otherwise, if the Reserve is low, it means that there is capability to inflow new liquidity into the system. The Reserve also has new liquidity inflows not yet invested.

The system regulating the issuance and investment of USDM consists of a series of flows:

  • Liquidity creation

  • Liquidity circulation

  • Music Bond Contract (MBC) creation

  • MBC execution

  • Staking, yield, and redemption

Liquidity creation

Liquidity is introduced into the system by sending USDC to the Minting Smart Contract and receiving an equivalent USDM in return. Only accredited (whitelisted) Liquidity Providers can access this mechanism. In the initial phase, the Web3 Music Association manages the accreditation process. Liquidity Providers must be regulated financial entities.

Liquidity Inflow is permitted only when the system's Reserve is less than 10% relative to the MBC Underlying Value. The maximum Liquidity Inflow is such that it restores the aforementioned ratio to 10%.

Liquidity Circulation

After minting USDM, liquidity providers must sell it on the secondary market. USDM will then be purchased by entities that can use it as a short-term store of value or earn yields through the Music Yield Smart Contract.

Music Bond Contract (MBC) creation

A Music Bond Contract is a Future Royalty Cash Flow Assignment Agreement between a Music Rights Owner (e.g., a record label) and an accredited Music Underwriter on Music Protocol. The Music Underwriter is an entity with specific expertise in selecting and evaluating music catalogues. Its role is to establish MBCs whose cash flows are directed to the Music Yield Smart Contract owned by the Music Underwriter.

In exchange for its services, the Music Underwriter receives a fee established in the MBC.

All MBCs have standard features, including:

  • Payment to the assignor of an upfront amount by the assignee, who acquires the right to collect future cash flows related to the streaming rights of a specific music catalogue up to a predetermined amount (e.g., $1 million upfront in exchange for $1.5 million in the future) for a period defined at the protocol level (e.g., two years).

  • The right to collect cash flows is exercised directly with the distributor generating these flows. To avoid counterparty risks, the assignor is never included in the payment flow.

  • If the random cash flows are lower than expected, the duration of the operation will extend until the full expected amount is paid. The contract compensates for the possible extension period with an additional interest rate. This means the issuer only has a time risk, although this extension is compensated.

  • The assignee's right to collect must take precedence over any other possible creditor in any situation (e.g., the assignor's bankruptcy, distributor's bankruptcy, etc.).

  • The Music Underwriter's fee amount.

This standardisation process transforms the risk profile by removing counterparty risks, leaving only the "music" risks related to cash flow consistency. However, since the guarantee can be extended over time and the extension is compensated with additional interest, the music risk is also standardised to a comparable scale. The only non-eliminable risk is the permanent loss risk if the catalogue ceases to generate returns. The magnitude of this permanent loss is the sole non-eliminable risk component, justifying the different implicit yield rates among RBs.

MBC Execution

The Reserve is a liquidity component in the protocol awaiting investment. These investments occur as MBCs are established. The order in which MBCs are served is first come, first served, with the condition that MBCs with the best risk-reward ratio are prioritised. The reward is the IRR, while the risk profile is a parameter defined by the Music Underwriter (that is a regulated entity)

When an MBC is invested, the Music Underwriter acquires the cash flows, which are then directed to the Music Yield Smart Contract to be distributed as yields.

Staking, yield, and redeem

These operations are managed by the Music Yield Smart Contract. The system can have various Music Yield Smart Contracts, each distributing yields from deals made by different Music Underwriters. These Smart Contracts offer different yields, reflecting the average IRR of the various MBCs linked to them.

The cash flow of a Music Yield Smart Contract is divided among all USDM staked in the contract. Specifically, when a user creates a staking position, they can choose one of the following modes:

  • Yield only”: The position will generate yield indefinitely as long as it remains active. The user can close the staking position at any time.

  • Yield and redeem”: The position will generate yield for two years. Simultaneously, the capital component of the cash flows entering the Music Yield Smart Contract is used to repay the staked USDC, burning the corresponding USDM. At the end of the two years, all USDM in the position will have been burned.

  • Redeem Only”: This option is available only to accredited Liquidity Providers and allows immediate burning of all USDM in exchange for an equivalent amount of USDT. It is possible only if there is sufficient Reserve.

When the Music Yield Smart Contract receives the cash flow, it is divided into the following components:

  • Distribution Yield: The distribution yield is a certain percentage of the total cash flow calculated at the protocol level as an “alpha” percentage of the implicit yield in the established RBs. “Alpha is a protocol-level parameter inversely related to the USDM collateralisation rate. The smaller the alpha, the faster the USDM transitions from being collateralised by future receivables in RBs to being collateralised by USDT.

d = f(IRRs) * 𝜶

Where:

  • d: distribution yield

  • f(IRRs): a specific function of the IRRs of the MBCs that generate the cash flows

  • a: over-collateralisation factor

  • Underwriter fee: the fee that remunerates the Music Underwriter who manages the flow.

  • Stability fee: a protocol fee used to buy and burn $RECORD (Music Protocol native token) on the market. Its function is to counteract inflation, ensuring more stable and secure governance balances of the protocol.

  • Liquidity provider fee: a protocol fee that remunerates the liquidity providers.

  • Accrued Value Flow: the liquidity flow that feeds the Value Accrued Fund and, if not redeemed, is reinvested in MBCs.

Collateralisation logic

The system is designed so that the number of USDM in circulation always equals the underlying capital of RB plus the accumulated Underlying Value in the U_sc. Redemption can be performed by opening a yield position in “earn and redeem” mode. If all RBs are exhausted, resulting in no incoming flows, the yield position will have a zero return. Still, at the same pace, it will continue to burn USDM in exchange for USD by drawing from the accumulated Underlying Value, which will eventually deplete. According to this logic, there are no more USDM in circulation or active RBs when it depletes.

Arbitrage

Let's assume that the system is paying an annual yield of 20% to USDM stakers. If more retail investors want to participate in this yield, they will need to buy USDM tokens on the market and stake them. This buying pressure will cause an increase in the price of USDM above 1 USDC. At that point, the Authorised Liquidity Provider will be able to inject new liquidity into the system to mint new USDM at a 1:1 ratio and immediately sell those USDM on the market at the market price, earning an arbitrage profit.

Conversely, if the yield offered by the system is too low, prompting retail users to redeem their USDM for USDC, the selling pressure will cause a decrease in the USDM price. In this scenario, the Authorised Liquidity Providers will have the incentive to buy USDM tokens on the market and redeem them for USDC at a 1:1 ratio, again earning an arbitrage profit.

This mechanism will ensure that the USDM price remains around 1 USDC. However, it is important to note that parity with USDC is not guaranteed, nor is it a goal of the system. The price will be allowed to vary within a tolerance band that does not impede the system's functionality. For example, if a retail user buys USDM at 1.05 USDC, they are effectively forgoing a portion of the yield from the staking contract. However, this could still be economically acceptable for the user if the staking yield is sufficiently high.

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