RWA CDS Protocol
Last updated
Last updated
The RWA CDS provides credit default swaps based on the individual real-world asset (RWA) loan data tracked by the dashboard. The protocol pulls the loan status and data to create unique smart contracts for each individual loan. Whilst the loan is active, users can deposit collateral to sell a CDS. CDS buyers can pay the premium to buy coverage over an amount of collateral, which is then locked until the loan matures (seller can withdraw collateral) or defaults (buyer can claim collateral).
Not exactly. The technical term for the CDS offered here is reverse zero-coupon swap. In RWA CDS the buyer pays the premium upfront and the collateral is locked until the loan either matures or defaults. The seller of the CDS can claim the premium earned once the contract is sold. This structure guarantees the CDS is active for the duration of the loan and that the collateral is available as well as provides a clear upfront price to buyers, with the sellers being able to earn their yield upfront.
Selling a CDS can be advantageous for several reasons.
When you sell a CDS, you receive a premium payment from the buyer of the CDS. This premium payment serves as compensation for taking on the risk of the borrower defaulting on their loan. Selling an RWA CDS contract can be a way to generate upfront income on collateral.
Selling CDS contracts allows you to diversify your risk exposure. Instead of solely relying on the performance of specific loans or bonds, you can spread the risk across a portfolio of CDS contracts. This diversification helps reduce concentration risk and can potentially provide more stable returns.
Another use case would be to create a synthetic loan position. If an RWA loan pool is closed and can no longer be accessed, an investor could provide a yield-generating asset as collateral to then sell a CDS. The combined yield of the underlying collateral and the premium earned by selling the CDS will provide cash flows and risk similar to lending funds in the underlying pool.
Buying a CDS can serve several purposes and provide various benefits.
One of the main reasons to buy a CDS is to hedge credit risk. If you hold an investment (such as a Goldfinch loan) and want protection against the risk of the borrower defaulting, buying a CDS can provide that protection. In the event of a default, the CDS seller will compensate you for the loss, reducing the impact on your investment portfolio.
Buying CDS contracts allows you to diversify your investment portfolio by adding an additional layer of risk management. By acquiring CDS on different underlying loans, you can spread your risk across various issuers, sectors, or geographic regions. This diversification can help mitigate the impact of potential credit defaults on your overall portfolio.
Some investors purchase CDS contracts with the intention of speculating on credit events. If you believe a particular company or sector is at risk of default, buying a CDS allows you to profit from that scenario. If a credit event occurs and the underlying issuer defaults, the CDS value can increase, allowing you to sell it at a higher price and realize a profit.
CDS provides liquidity when markets collapse and debt defaults. This is an important primitive for markets where the collateral is volatile. CDS can offset liquidity shortfalls in times of volatility, and provide stable yields otherwise. These derivatives will allow larger institutions to effectively manage their risk positions across crypto products, whilst providing an additional source of yield in the market, in exchange for taking on a ring-fenced risk.
In future iterations of the RWA CDS protocol, we will be looking to provide credit risk-based premium prices, opportunities for secondary markets with robust free market pricing, greater capital efficiency, and the ability to provide more advanced forms of collateral to create advanced structured products.