Inter-protocol Underwriting Middleware

Incentive Compatible and Decentralized Moody's (+ insurance)

Any entity can delegate the underwriting process for any yield source to a set of managers from the RAMM protocol.

These entities we call (liquidity)suppliers can be, but not limited to,

  1. other DAOs that want risk assessment/structuring for their treasuries by a non-centralized party,

  2. protocols looking for assessment and insurance in complex yield sources they want to invest in,

  3. protocols that want to lend to a counterparty but are in need of an underwriting and structuring system.

  4. lending protocols who want assessment + insurance of the borrower's creditworthiness or collateral.

For a given yield source a supplier(i.e DAOs, protocols) is considering investing in, the following procedure will be undertaken by the protocol.

0. Propose

A yield source needs to be proposed to the protocol by a utilizer(anyone associated with the supplier DAO and the yield source such as strategists, loan originators, borrowers, etc)

1. Assessment

During this phase, the managers will buy longZCB from the prediction market if they deem the yield source to have high-risk adjusted returns. Hedgers(investors in the supplier protocol) will buy shortZCB tokens if they want to hedge the risk in the new yield source. The (capital used to buy longZCB - capital used to buy shortZCB) = X amount will be directed to the Middleware contract.

2. Approval

When approvalCriterion is met, the protocol participants have essentially decided the yield source is worth investing in. The supplier can then supply Y amount of capital to the yield source, executed through the following atomic transaction.

  1. Supply Y amount of capital to the Middleware, which triggers the investToYieldSource function.

  2. The Middleware then invests the supplier's Y amount and the assessors' X amount of capital to the yield source.

  3. The Middleware escrows the IOU token to itself and gives the supplier a promissory note for its senior tranche portion of the investment.

Note: At no point does the supplier's capital is escrowed to the Middleware, they are invested directly to the yield source contract within a tx, minimizing smart contract risk.

Also, note that the supplier may opt out from the yield source even if approvalCriterion is met, by simply not supplying to the Middleware

3. Post Approval

During the post-approval phase after the yield source has been supplied, anyone can still participate in the AMM as a tool to hedge or gain more exposure to the yield source. It's a zero-sum prediction market.

4a. Supplier Withdraw

When the supplier decides to withdraw, it will send a message to the Middleware, which will invoke its withdrawFromYieldSource function. This will withdraw the invested X+Y amount * whatever returns the yield source has generated. As in 2), the supplier will receive its investment and its senior portion of the returns within a single tx.

The remaining capital would be escrowed back to the AMM from the Middleware for the assessors to redeem.

4b. Managers and Hedgers Withdraw

Managers and hedgers can redeem their longZCB and shortZCB tokens from the AMM, where their redemption price is going to be computed from the returns the yield source has generated.

Parameters that the Suppliers can control are

  1. The degree of tranching; more tranching means the managers incur higher risk and higher returns. No tranching means the managers and the suppliers share the same payoff.

  2. How much leverageFactor managers will incur; a higher leverageFactor entails managers are more incentivized to participate in assessment, but results in a lower insurance buffer for the suppliers. It also means less returns allocated for the supplier's senior tranche.

  3. How much should the managers have to put up as collateral as a collective for approvalCondition to hold, determined by the parameter alpha.

  4. How much reputationScore is required for a manager to participate in the assessment.

Benefit for Suppliers

  1. The underwriting module can be applied to any investable asset including those that are non-trivial to gauge risk in a non-centralized and incentive-compatible manner, expanding the universe of possible investments for the suppliers.

  2. Offers a bidirectional insurance market even after the investment has been supplied.

  3. First loss protection from manager's collateral.

  4. Higher risk-adjusted yields

    1. More skilled(higher reputation) managers are weighted heavier during the decision aggregation

    2. Decentralization entails the inclusion of more private information, increasing the accuracy of predictions.

  5. No extra smart contract risk is introduced from the underwriting module.

Benefit for Managers

  1. Earn higher yields with their financial knowledge, which is further amplified by gaining a good track record.

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