OPN RWA Series: Autopsy of a bankruptcy
From Maple Finance’s entanglement with misrepresented financials on a market making loan to Orthogonal Trading, to an African motorbike financing company’s creditline default, the RWA space has had to deal with several defaults over the years. In this blog I will explain how learnings from these defaults have informed OPNs RWA module design and philosophy.
This is part 2 of our RWA series going into details on the mechanics of OPNs event financing module. The premise is that OPNs ticketing companies have the ability to lock in large deals by offering financing based on onchain tickets as collateral. If you missed part 1 be sure to check it out!
The juice should be worth the squeeze
That at times a loan isn’t completely repaid is an anticipated risk in the lending business, factored into interest rates. Following several high profile defaults some pose that the yields returned to lenders don’t sufficiently compensate for risk. This doesn’t undermine RWA’s potential but emphasizes the need for protocols allowing for proper and reliable up and downside alignment.
This isn’t solely about charging borrowers high yields. If the loan results in a high payout for the borrower, this should be reflected in the yield. However, if the business outcome is disappointing, the yield should be adjusted to not burden the borrower excessively.
For borrowers (event organizers): Finance event for a reasonable base yield that will not threaten the continuation of the business in case of disappointing event results. Also giving the organiser the tools to tokenize and sell value flows that will yield if the event is a success (like sell resale rake fees forward).
For RWA lenders: OPNs onchain tickets ensure reliable data from the business venture while OPNs onchain value flows (both from primary and the secondary market) allow for dynamic and low cost dynamic yields/returns on loans while keeping control.
Seeming risk reward mismatch
Often, defaults reveal that borrowed funds were used differently than agreed, altering the loan’s risk profile and potentially leaving the yield insufficient for the risk incurred. My thesis is not to abstain from financing such loans onchain but to accurately account for their risk in the yield.
We feel that we can protect lenders and reward them appropriately for risk taken using the following pillars of our OPNs RWA module.
Why OPN can lead in RWA
- Onchain ticketed events = onchain collateral: Every event ticket is issued and sold onchain, which enables real-time tracking and trading of these assets. This transparency allows lenders to gauge the progress of ticket sales and understand the status of their investment at any given moment.
- Onchain billing & revenue tracking: OPN doesn’t just tokenize the tickets and turn them into collateral, but also processes value flows onchain in real-time as event tickets are (re)sold. This ensures immediate repayment to lenders but also a reliable data source on the health of the business(important for follow on financing).
These two pillars work together to provide lenders with a more secure and transparent RWA proposition, ensuring they are appropriately compensated for the risk they take.
No shade, progress comes from experience
Our reference to other RWA protocols with defaults aren’t a critique, but an acknowledgment that refinement comes from real-world application. We highlight these to stress the unique challenges of the RWA business. Unlike onchain lending and borrowing, RWA borrowers finance offchain businesses handling regular FIAT, increasing complexity and potential risk for lenders.
Example 1: The default of Maple Finance and the role of Orthogonal Trading
In 2023, Orthogonal Trading defaulted on its loans from Maple Finance, totalling around $36 million, when its trading inventory got embroiled in the now-bankrupt FTX exchange. This default impacted roughly 30% of active loans in the Maple Finance protocol (at the time).
Although Orthogonal Trading had previously reported healthy trading inventory levels, they suddenly disclosed a significant loss of principal. This appears to stem from a minor misrepresentation that snowballed into a substantial default. It reveals a common mindset among borrowers to distort facts, believing it will eventually allow them to repay their lenders.
In the Orthogonal Trading case, borrowers deposited USDC with the expectation of achieving an 8% APY. The source of this APY was to provide market makers with inventory for ‘delta neutral’ trading(this means very low risk in normal english). However, following FTXs black swan event, there was speculation that the funds borrowed between December 10–12 were instead used to trade themselves out of the hole and recoup losses incurred in Novembers FTX collapse.
This ordeal revealed that Maples liquidity providers (LPs) were taking on significant directional trade risk in return for an 8% return on their stable coins. LPs would have been inadequately compensated for this risk, even if Orthogonal had managed to recoup the losses.
In conclusion, while borrowing for effective hedge funds isn’t inherently problematic. However there needs to be certainty that funds cannot be rerouted or ‘reused’ for a different purpose. The Orthogonal case highlights the risk-reward balance issues associated with this type of financing — but these types of issues will be present in all loans to businesses that incur unexpected losses. Sources: 1,2,3 & 4.
It might seem difficult to use this ‘black swan’ triggered default as an improvement framework for loans to events.
However, it’s important to note that in both cases, humans were the ones making the decisions.
Disappointing sales moving the repayment goalpost
Consider a festival organizer borrowing $50,000, expecting $500,000 in ticket sales revenue(and having good data and past performance to back that up). The agreement is made that the organizer can borrow for single digit yield on the requirement to pay the loan off after the first 10% of the tickets are sold.
Come the initial sale only and 15% of tickets are sold, far below expectation, generating $75,000, a lot less then expected. The organizer might be tempted to invest all revenue into a marketing campaign rather than using $52k(50k principal + 2k interest) of this to repay the loan as was agreed on legally. The borrower, fearing losing money themselves with such little sales, could convince themselves that this approach would even be a win/win as increased ticket sales is more ticket service fees for OPN and the ticketeer(that underwrites the loan legally).
Of course doing this would be in breach of the loan agreement and when provable grounds for a lawsuit. However bank accounts are not public record making it hard to prove — also the borrower is also your client fuzzing the line even more.
The result; insufficient compensation for risk
If the loan’s interest rate was calculated based on the case that at least 10% of tickets to be sold, not repaying the loan after reaching this target increases the lender’s risk. Now, 25% of tickets need to be sold in order for there to be enough money for repayment. That is assuming the organizer doesn’t repeat this behaviour(after all it worked before). Allowing such deviation from agreed upon terms eventually leads to lenders being under-compensated for risk.
OPNs RWA module ensures with smart contracts and PSP integrations that such deviation is not possible to begin with — how we do this will be explained in the final section of this blog.
Example 2: Goldfinch 7 million dollar motorbike default
When Goldfinch, a decentralized credit platform, lent money to Tugende, an African motorbike finance company, they expected the funds would be used to finance motorbikes — a business model they had vetted and a model the interest was calibrated on. Later it turned out that Tugende used the borrowed money to support a struggling subsidiary company. After this company failed it led to a significant default costing Goldfinch’s LPs 7 million dollars.
When people and companies fear losing money, they often make decisions aimed at avoiding that loss at all cost instead of accepting it and writing it off. Unfortunately, these choices often lead to even bigger losses down the line. Sources: 1,2 and 3.
Utopian blockchain solutions for these default cases
In a perfect world, technology could have prevented the two real-world asset defaults. The Maple market maker loan could have been avoided if smart contracts had been able to access centralized exchange trading inventory and position PNLs. No trader would allow such a feature even if it where technically possible — but lets entertain.
As for the Tugende motorbike loan default, where funds were misused, it could have been substantially reduced by issuing a revolving credit line based on the onchain proof of motorcycle financing. If onchain data of a motorbike loan and its repayments were onchain in a reliable way, additional funds would have been automatically made available to finance more motorbikes. This approach would have safeguarded the principal and prevented the funds from being diverted for other purposes.
For onchain ticketing RWA utopia is now
While these proposed technical solutions might seem ideal, the reality is that our society and technology have not yet evolved enough for such solutions to be implemented seamlessly and effectively. This means that managing these types of RWA loans currently requires substantial manual work and human involvement, a process that doesn’t really scale.
However, the scenario changes when considering onchain event financing. In this context, even though events are real-world businesses that generate value, the primary asset generating revenue, the ticket (represented by a QR code, which is sort of a private key), is actually a digital asset and is even traded as such by non-crypto people. This creates a unique situation where these ‘utopian’ solutions might not be so far-fetched after all.
How we account for human loss avoiding behaviour
In both default cases, the common thread is businesses acting in their self-interest and an unwillingness to accept or take on losses. This mindset is represented by thoughts like “we will recover all costs,” “the war will end soon,” or “the stablecoin will re-peg.” In the context of onchain financing for events, we address these issues with the following features:
- Waterfall repayment guaranteed. Because OPN integrates with the Payment Service Provider the first revenue of ticket sales will go towards repayment.
- Principal protection. Smart contract enforced revolving credit line based on onchain ticket sales targets. Only release the next tranch if early bird sales confirm consumer interest.
In the final sections of this blog, I will delve into more detail about the design of these aspects of the financing module.
OPNs waterfall payment structure
This structure means that when a consumer purchases a ticket with their credit card, the payment service provider (PSP) processes and then settles this transaction with the bank of the ticketing company, not the event organizer (which is generally the standard). Once the loan is repaid, the PSP payment settlement flow will be rerouted or automatically forwarded, depending on the capabilities of the PSP.
With this mechanism, the borrower cannot use the incoming revenue for other expenses as they will not receive this until the loan is fully repaid. This ensures repayment seniority/priority. The diagram below illustrates this mechanism.
Still frens, but just frens based on tokenization
Despite the strictness of the funding process, it’s important to understand that the lender and the borrower (event organizer) maintain a mutually beneficial relationship. The lender is not just providing a loan, they are partners in the success of an organizer. The tools OPN offers, such as real-time data on ticket sales and targets, empower this relationship by providing a foundation of trust and understanding.
For instance, if an event organizer can demonstrate that a marketing campaign will likely turn a $100 ad-buy into $1000 of ticket sales, the lender might be willing to allocate more capital towards such a venture. This creates an opportunity for the event organizer to express certain marketing campaigns as investable opportunities for the lender. The lender, in turn, can track, understand, and scale their investment based on real-time data and reliable targets. This dynamic is not about imposing strict rules, but about facilitating business growth through transparency, mutual understanding, and trust.
OPNs revolving credit line based on (onchain registered) ticket sales
In the case of the Tugende default, the borrower used the funds for a completely different purpose than what was agreed upon. This is difficult to prevent because the funding usually needs to be converted into FIAT to support the RWA opportunity. Although solid underwriting and counterparty due diligence are crucial, it is essential to design with the assumption that such incidents may occur.
Opportunity is the mother of cooking the books
The primary reason a significant portion of the loan was diverted is simply because it could be. Prior to this event, Tugende (founded in 2012 with 500+ employees) had a solid company revenue/investor record, suggesting they intended to repay the loan until the very end. They diverted the loan to a different purpose because they could do it without lenders immediately spotting it. If the loan hadn’t defaulted, we would have never known, which was precisely their plan.
OPN’s onchain ticket inventory and value flows
With OPN, tickets are issued by smart contracts, so their sales are reflected onchain in real-time. Check out our Dune dashboard, onchain ticket explorer or OPNs worldwide usage as onchain ticket fuel.
The registration and transfer of revenue-generating assets onchain make it easy for OPN’s RWA module to issue revolving credit based on ticket sales. This could be as simple as unlocking the next $50k of credit line once 5000 early bird tickets are sold. This approach is sensible because evidence of demand for an event underpins the value of the ticket inventory, helping lenders assess risk.
Therefore, the RWA collateral/assets issued by OPN provide lenders or pools with real-time, reliable data on their potential for revenue generation. Not only is the amount of tickets traded onchain visible, but OPN’s onchain economics and value/fee splitting also enables RWA asset owners to directly receive fees or value the moment tickets are sold. I do apologize but I compulsively have to drop one of my impossibly complex diagrams(yes i will go into rehab for this habit, soonish).
In future editions of the RWA series we will go into more detail on how these tokenized fee NFTs work and are issued (hint you can buy them with OPN only).
What is next?
In the past we have done several pilots of the event financing module. At the moment we are gearing up for a more continious permanent deployment but we are still working out final details of a new legal structure for the counterparty of the lenders (as RWA assets have a legal component as well).
In the next RWA blog of this series we will go deeper into the role of the OPN token within the RWA module. Stay tuned!
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