A Stable Reserve Asset for a Decentralized Economy

Institutional investors need a large-scale, inflation-hedged, and digitally native asset class like Homium to use as a secure alternative to fiat-pegged stablecoins for use in automated market-making in compliant DeFi applications.

Decentralized financial (DeFi) networks and protocols have experienced rapid growth in adoption and seen over $200B in total value locked since their emergence just a few years ago. This surge builds on software development, investment, and speculation on the rapid appreciation in the value of cryptocurrencies, and the projects, companies, and distributed autonomous organizations (DAOs) currently building and using DeFi applications. These projects still represent the early phase of blockchain and DeFi development. But sentiment among heavy users of these applications is euphoric, and with deflationary token issuance models deployed on backward compatible distributed software architecture many advancements have emerged in the course of months which threaten to disrupt how all securities are traded and valued.

Most tools and enterprises in DeFi enable the trade of tokens representing protocol governance and software utility, often applying bootstrapped liquidity incentivized by token printing to liquidity providers (LPs). Some applications augment digital scarcity and speculation by tying non fungible tokens (NFTs) to a social metaverse of unique and limited release art and collectibles, crowdfunding, and social capital events. The integration of Web3 features into many websites and applications promises that crypto’s influence and functionality will leave the boundaries of the blockchain and extend into the fashion, sports, entertainment, and traditional finance worlds as well.

The inclusion of digital assets within traditional financial brokerage and banking applications has driven growth in the trading volume of dozens of cryptocurrencies and protocol governance tokens. Much of this new volume is driven by small-dollar trades by retail investors speculating on general sentiment and the recommendations of public figures, many with undisclosed financial interest in these tokens. Such interests and potential for manipulation pose a threat to investors who may not understand the relationship between those giving the advice and the assets under discussion. Any investment in cryptocurrency bears these known and unknown risks, and as such remains a relatively tiny part of global industrial and financial investment portfolios.

DeFi trading activity necessarily takes place outside of centralized brokerages and exchanges, with many users choosing to transact with non-custodial smart contracts which hold and disburse liquidity through automated market making protocols, or peer-to-peer lending protocols which administer programmatic liquidation of collateral assets when their market value falls too far in relation to principal. These liquidations then rebalance asset values through automated treasury functions to support a stable price relative to the US dollar. In addition to their clever engineering, game theory, and regulatory arbitrage, these systems benefit from two concurrent trends.

The first is that cryptocurrencies are currently accumulating value relative to fiat assets at a rapid, sometimes exponential rate. This undergirds stablecoin reserve systems across the space, enabling the issuance of more and more stablecoins as enthusiasm in crypto grows. This dynamic is unstable and risky.

The second is that volatility and rapid settlement, both inherent in crypto, drives high transaction volumes and fees which support strong cash flows. This further accelerates speculation on protocol or LP tokens, asset appreciation feeds the first trend and compounds.

The distinction between an investment contract and a massively cooperative game are blurred within many of these projects. While Ethereum and Bitcoin have concrete and likely long-term value as instruments in the traditional financial world, DeFi’s most invested users see a return to fiat and establishment markets as undesirable and anathema. This independence and optimism drives adoption of new projects by insiders, which promise to grow rapidly as more and more investors seek to participate.

For investors who remain firmly in the world of fiat and traditional assets, an entry into Bitcoin and Ethereum remains mysterious and risky. The proliferation of DeFi and its alternatives to centralized custody and governance are not compatible with the investment mandates of most institutions. Funds and institutional investors want to see that this technology can deliver on its promise to automate existing securities and treasury functions through instant settlement and programmability, within secure computing environments and behind KYC walls where compliance can be assured. In order for institutional investors to take advantage of the rapid early growth of this space, they need an interface between a stable real world asset classes they understand and hold at scale, and the cryptocurrencies and applications that present the greatest opportunities for growth.

How will DeFi protocols overcome resistance from legacy managers and regulators to add them to the league of real estate, public equities, precious metals, and private securities? What will it take for pension funds and insurance companies to commit billions of dollars to digitally native assets, where their capital can interact with other digital assets inside decentralized applications?

The answer is through a digitally native reserve asset that can scale into the trillions while maintaining fungibility, price stability, recourse to real world value stored in a distributed pool of well-maintained and secured assets.

Stablecoins, Volatility, and Risk

The uncertainty and enormous potential of digital assets has generated famously high volatility in crypto markets, with asset prices gaining or losing as much as 20% on an almost weekly basis. Volatility begets speculation, which generates transaction fees, and interest from leverage. These revenues feed the system via liquidity providers who benefit from trades, asset appreciation, and early adopter bond curves. Since the DeFi Summer of 2020, the name of the game has been liquidity mining, where investors stake balances of token trading pairs to enable transactions within a price range on an asymptotic curve. Liquidity providers stake what amounts to a volatility bet between a pair of tokens within a given range, and other users access that position to get liquidity from one token to the other. A price for each transaction is set by a simple constant product formula, which keeps the token balances in a ratio that scales the price with the transaction size over the total liquidity in the pool. Because many of these assets also appreciate, unpredictable as it is, by 200% or 2,000% or more per year, the resulting pools earn large fees and asset appreciation at the same time. In summary, speculation in DeFi markets is a self-satisfying machine which continues to ingest “real world” capital from all over the world.

All of this trading depends on a means of exchange and unit of account, most often denominated in a fiat currency like USD. This is not always the case — Many active trading pairs directly price ETH to BTC or SOL to MATIC or DOGE to OHM. In the NFT space, transactions take place purely in the protocol tokens used to mint each issuance, where creators collect the proceeds on delivery. (sometimes before) But when your token or project’s value and reserve assets are calculated by market capitalization in a fiat asset, the promise of your token’s growth cannot remain holistically on-chain.

Digital asset ecosystems remain tied to fiat prices mainly through assets known as stablecoins, deposit-like instruments by which users can encumber collateral to transact in a price-stabilized asset with some recourse or balance to a protocol or bank reserve. These stablecoin systems can take the form of peer-to-peer networks, where users deposit a crypto asset like ETH and receive a balance of stablecoins which serve as bearer assets with little to no restrictions on their trade. Stablecoin issuers vary in structure. Quasi-banks like Tether and Circle (which issue USDT and USDC) issue their stable tokens via deposit windows and user interfaces which secure real world and on-chain value in exchange for their bank note. There has been considerable scrutiny in the portfolios backing these tokens, and questions about their future as unregulated entities. Others are software projects like MakerDAO, whose algorithmic stablecoin DAI maintains its value to the dollar by encumbering pools of assets which self-liquidate when collateral prices fall. Both of these models presdent significant counter-party risk for investors hoping to use DeFi applications which rely on stablecoin value working as advertised.

The flaw in these systems is that when reserve asset prices fall steeply and suddenly, automatic liquidations can cause a flight to safety which could exacerbate liquidity and reserves across the ecosystem in minutes flat. A run on a virtual bank may be algorithmically secure one moment and then hacked or bugged the next. In a programmatic environment dependent on the price of a handful of stable assets remaining constant, if such a price peg were to break for an extended time it would cause chaos and compound the problem, perhaps sending the token to zero without any real chance of recovery. And while many stablecoin systems have survived large drawdowns of crypto reserve assets are recovered from recent failures, survivorship bias must be accounted for when evaluating the successes of these systems, and that they remain relatively small compared to the fiat payment systems they seek to replace.

While DeFi investors are willing to move on from these kinds of disruptions and live and learn alongside with the evolution of their favorite market, fiduciary investment managers do not have or want this discretion, nor are they likely to attempt to understand such a system. For institutional investors and pension funds, the risk that an asset expected to behave like cash within an automated price mechanism could suddenly break is intolerable, even temporarily. Regulators likewise will not permit stablecoins to become systemically important so long as there is any threat to their viability as payment instruments, and will likely require their issuers to seek banking charters insofar as their applications operate like deposit instruments.

Missing out on the opportunities created by this emergent technology just as it comes into it’s own is also intolerable for institutional investors, who want to profit from the growth in the sector just as much as everyone else. They also know they need to plant their flag in this new financial ecosystem. Many of crypto’s marquee tools and communities reward first-movers, early adopters, and evangelists handsomely. Private firms smart enough to get involved in crypto have realized enormous benefits. But regulation impedes most institutions’ ability to directly engage, and the small scale of decentralized projects make institutional involvement impractical at best, and a custodial nightmare at worst.

Either institutions will overcome this fear and begin to rely on probabilistic settlement and game theory-based reserve liquidation algorithms, or they will seek solutions which contour with their existing mandates and regulatory orientations. While adoption of crypto-economic security models by financial institutions may be possible in the long term, here at the beginning of the story, we can expect managers and committees to fill the buckets they already have, with assets that look and behave like the ones they’re used to, but which include the features which make this space so attractive.

This could mean Bitcoin held in qualified custody in a trust or chartered bank. It could mean Ethereum tokens held in a fund at a crypto-enabled investment advisor. Both of these on-ramps to the blockchain come with their own thesis tied to their respective blockchains and user bases, and they move a great deal from month to month, causing headaches for managers seeking long-dated assets to match to their liabilities. Stablecoin assets issued by decentralized protocols will likely not satisfy their needs for even temporary exposure, and stablecoins issued by banks will carry the same opportunity cost of cash in the real world.

Institutions will need a stable asset with real world economics and recourse which operates in predictable ways within DeFi applications. This asset must itself satisfy the investment needs of institutional portfolios as well as the transfer liquidity and fungibility needed in automated market making and staked lending protocols.

The New Programmable Finance

No matter how you look at it, the consequences of instant trade settlement and its applications in decentralized banking are profound. One example is how popular lending protocols enable “flash loans,” micro-term loans extended only for the time necessary to close a multipartite transaction on chain. In a single atomically-executed trade, an investor can:

1. encumber 10 ETH to borrow $2,500 in a USD stablecoin from a decentralized protocol,
2. use it to purchase 0.05 BTC from an automated market maker (paying a liquidity pool to those who staked both sides of the USDC-BTC trade),
3. sell the BTC to another market maker for more, then,
4. use the USD to retire the original loan and recover their 10 ETH, earning arbitrage and risking nothing except time and fees.

If any part of the transaction fails, all of it fails, and no assets are moved. Only the gas software fee is paid in ETH. This would be an expensive computation, but it demonstrates how programable assets and cash don’t just make finance cheaper. Programmability moves account balances into a kind of superposition where liquidity is created and priced instantly by protocol, only as needed and as possible, with no intermediary or counter party risk. All of this is built outside the firewalls of a bank and can be executed on 24 hours per day.

This is just one among many powerful DeFi tools which could transform traditional markets and asset classes. Its application to cryptocurrency investment is interesting and has created a new global financial market.

But institutional investors are even more interested in how these new instruments can be applied to structured products, private securities, and loans. These assets have the characteristics institutional investors need to satisfy their mandates, and all of them are ripe for innovation.

Private securities alone represent $7.5 trillion in value globally which trade with lower frequency and efficiency than public securities and commodities. OTC trading systems are limited in their scale and availability, and early employees and investors in valuable companies are often dependent on financing events for liquidity and exit. Price discovery and on-chain settlement will free up a significant share of private stock to allow for a better distribution of capital among businesses that don’t currently use traditional, higher friction finance streams.

Securitize, Inc is a transfer agent and broker/dealer who helps issuers tokenize their private company cap tables and list them on the Securitize Markets proprietary ATS. Companies like Homium work with Securitize to issue shares in the form of a digital token represented on an integrated blockchain. This token can be minted and issued, transferred, and tendered for buyback, serving as an interface to a share of stock represented in the master security file for the issuer. Because the token contract and related compliance software prevents improper and unauthorized transfers according to the issuer’s rules, the blockchain ledger can be relied upon by Securitize and regulators to represent the up-to-date cap table for the company. This solidifies the control location for the shares and allows for private stock to transact in (mostly) the same way as any ERC20-compatible token.

This service is valuable for reducing the hefty liquidity discount paid by many transferers of private shares, since many offerings require legal review and approval by founders or investors. For investors, these tokens are tied to real world economic value intrinsic to the company’s shares. Tokenization accrues the utility and financial benefits of liquidity and price discovery to all shareholders, disintermediating traditional fundraising and OTC markets. Shares of private companies are made more valuable and easier to transact in this digital format and many will find enthusiastic audiences ready to hold shares in a Web3 connected wallet. On-chain settlement, distribution, and compliance are huge advantages.

Homium’s private offering goes a step further. Our security is designed to eliminate all the idiosyncrasies and scaling issues that come from varied terms in classes of shares, rights of first refusal, and other hurdles, to take best advantage of DeFi flexibility and asset securitization. Homium shares are fungible from inception and will remain so forever. Once mandated restrictions are observed, Homium’s shareholder terms are such that any token transfer permitted by the rules is also permitted by the underlying documentation. This alignment in form and function allows for Homium to act less like a share of stock in a company and more like a commodity, one tied to the largest asset class in the world: housing. And not just any housing -– every share of Homium is tied to a dollar (* ħ) of digitized California home equity, recorded to county title and bank-operated blockchain at the moment of its creation.

A Scarce but Stable Asset Made Digital

Homium is a digital asset backed by equity in California owner-occupied homes. We have written before about the key features of Homium as an asset and the home equity agreement which backs each Homium token from its inception. At its heart is the shared appreciation note, a one-to-one investment in an owner-occupied home, recorded to title with a conforming second position trust deed, with no monthly payments and a payoff due only on sale or refinance, and solely based on the home’s price appreciation. These exit values are set by third party appraisal or arms-length purchase, and the value of each note marked to its relevant Fed Reserve S&P/Case Shiller home price index and is rolled up to calculate the Homium portfolio NAV, expressed as a number on-chain we call ħ.

What makes Homium especially unique is that tokens are not simply minted and sold to raise funds to finance shared appreciation notes, like one would do with an investment fund or REIT. Instead, Homium is designed to take advantage of the settlement features, compliance and advanced custody of the blockchain from the moment it is issued. Homium tokens are issued daily and redeemed in quarterly tender offers at a price equal to ħ in US dollars. Each Homium token issuance is closed simultaneous to the closing of a shared appreciation note made to an individual homeowner, such that every HOM token on chain is a real time securitization of a dollar (* ħ) of digitized home equity. This is not to say that HOM tokens are tied to individual homes — quite the contrary — every HOM is the same except for its issuance date. HOM tokens are fungible and able to transact and mix at the same scale as home equity more broadly. This means that Homium can scale into the tens and hundreds of billions through its network of originating lenders and support a true institutional asset class.

California home equity is a globally recognized asset class and investment brand, one which attracts investors of every scale, from East Asian investors securing inflation-hedged assets overseas, to longtime residents seeking affordable housing in the US’s biggest state, to Wall Street firms commercializing entire neighborhoods. Home prices in California and beyond are a stable and reliable source of equity appreciation, and even more importantly, it is in the hands of a distributed network of custodians who care deeply about these assets: the homeowners themselves. All Homium shared appreciation notes are made with maximum 80% CLTV, leaving the homeowner in the driver’s seat (and first loss position) for their home.

Mortgage-backed securities normally rely on the borrower’s ability to repay to justify their value and are vulnerable to employment shocks and other events which threaten their cash flow to investors. But shared appreciation notes are tied to equity and have no cash flow, they demand no payments or interest from borrowers. Instead, they operate as a slice of preferred equity financing for the homeowner, who can use the funds for whatever they want.

A Different Kind of Tokenized Real Estate

There are obvious applications for tokenized real estate and transaction tools using DeFi. Blockchains represent a disruptive change for title and settlement of real estate transactions and syndication, and many applications promise to tokenize projects with vast differentiation to garner liquidity and new capital sources for mostly commercial buildings and rented homes.

Homium is designed to be much more than a tokenized mortgage product or real estate investment fund. Homium is standardized to the dollar and recorded on a blockchain at issuance, making it instantly auditable by price-sensitive protocols or prospective investors seeking deep understanding of ħ, which mediates the supply and redemption of new tokens. More importantly, it establishes a soft price floor that can provide a rational alternative to existing market pricing within DeFi protocols which are dependent on stablecoins and unregulated market pricing among unknown actors.

This feature — that Homium is a fungible and digital in its entirety and tied to a simple but verifiable basis for its issuance and eventual real-world liquidation — is what makes it the first contender for a stable reserve asset that institutions and funds can use to enter DeFi and stay on chain for a long, long time.

Institutions will do this because no asset like Homium currently exists in traditional capital markets. Homium is a breakthrough because it makes home equity investable for institutions at scale, with no commercial operating exposure and with the liquidity and utility of a native digital asset.

Homium accomplishes this by commodifying an immense but eminently fungible asset from the real world — homeowner equity — structures it in a low volatility, high security agreement with the homeowner, and ties that asset to a set of predetermined and independently validated processes that issue the stock and record the loan. Homium is designed to stand as a reliable and highly scalable store of value and unit of transfer, pricing more volatile assets like ETH and ALGO in a rate tied to its own portfolio NAV, expressed as ħ.

Once these price pairs are established, ħ can become a stand-in for the growth of owner-occupied real estate as a financial primitive within other DeFi systems which can lend, encumber, trade and synthesize exposure to Homium through authorized means. Below is an example of how a transfer-restricted asset like Homium could transact in permissionless architecture common to automated market making applications in DeFi.

Decentralized Trades of Centralized Assets

Unlike bearer crypto assets like ETH and non-custodial stablecoins like DAI and USDC, HOM is a transfer-restricted asset which requires a pre-authorization of a given investor wallet and identity before it can confirm compliance of a trade and settle to each investor’s balance in the token contract. This takes the form of special implementation of the ERC20 token standard, routing permission for trades through a rules layer and address whitelist, and in the case Homium, settles the approval on chain and crosses the trade.

Automated market making contracts and secure lending protocols using digital securities like Homium will work the same way. An authorized liquidity provider will deploy a conforming smart contract with staked HOM and register the contract with Homium and its digital transfer agent. This contract will ensure that all participants in the liquidity pool or those who trade with it are whitelisted and identified with Homium in advance or making any transactions, maintaining compliance with KYC/AML and tax reporting for the underlying share. All of this occurs through simple automation and user interfaces, making it invisible to the user and much faster than legacy securities trading systems.

Once in compliance, the user can transact with the capital pool at will, paying whatever fees are charged by the LP and the protocol, but with no further need for trading architecture or order management, beyond an interface for the market-making contract itself. The HOM token and its corresponding share of stock can function as a freely traded digital asset in an instantly responsive environment, interoperable with other digital assets that want to trade. It can be staked as stable value within liquidity pools and lending platforms, collateralized using ħ or to some market price, within protocols which support transfer-restricted assets.

Now, institutions can move their capital into California home equity in a digital format interoperable among whitelisted investors and other institutions, who can now access the growth and fees of automated market making and liquidity mining possible in DeFi.

A Stable Asset Pegged to Commodified Home Equity

Such an asset is a powerful tool to onboard institutions to the blockchain and give them direct exposure to home equity they can’t find elsewhere. Because Homium is only available in fiat at a primary issuance window, institutions can secure a direct line to the issuance of new Homium and take advantage of any arbitrage to the secondary market price. Likewise, institutions get a front seat to quarterly tender offers which provide automatic liquidity events whenever Homium shared appreciation notes mature and proceeds are realized.

This is a stark difference from nearly every other digital asset currently available. Even in an event where every blockchain shuts down, every stablecoin goes to zero, and no one will accept Bitcoin again — Homium owners will maintain direct ownership over their interests in the Homium portfolio and will enjoy automatic quarterly liquidations in the form of stock buyback from the trust’s non-profit asset manager. Homium is uniquely designed to satisfy a need for a stable reserve asset for digital markets, untapping a brand-new asset class in the process.

Automated market making applications are a next-level innovation enabled by distributed networks and smart contracts. They currently rely on stablecoins which present systemic risks and compliance problems for institutional investors. By entering the blockchain through Homium and staking with a broker/dealer-managed liquidity pool, buy-and-hold investors can benefit from the fees and growth seen in the hottest applications in DeFi. Like any new financial technology, early adopters will benefit the most from high margins early in the innovation curve.

With Homium, institutions can interact with digital assets through an instantly auditable asset secured to property titles all over California. Our digital asset is designed to bring the opportunities of decentralized finance to large scale capital pools who will define the future of finance in the coming decade. The key to unlocking this potential is the marriage of a revolutionary new home finance product with the transparency and efficiency of digital securities.

Homium is an ideal reserve asset for institutions looking for stability and interoperability at scale with a decentralized economy.

For more information, visit homium.io