Currently, the vast majority of security tokens are a tokenized representation of a single underlying asset. As the space evolves, we will see new forms of security tokens that represent complex underlying pools of assets. This was outlined in some initial ideas about this concept in articles about collateralized multi-asset security tokens (Part I and Part II). Today, it’s a deep dive into one of the forms of multi-asset security tokens that may surface in the near future: collateralized debt positions (CDPs).
The concept of CDPs is the crypto-variation of infamous financial market derivatives such as collateralized debt obligations(CDOs). The concept has been spearheaded by projects like MakerDAO but some of the principles have materialized on other crypto-protocols. Fundamentally, a CDP represents a debt position that is backed by an underlying pool of assets. In the context of security tokens, a CDP represents a debt contract collateralized by a group of crypto-securities. CDPs represent a specialization of the collateralized multi-asset security token thesis in which the token itself is a debt position.
In their simplest form, security tokens can represent a tokenized representation of an existing security or a brand-new form or security. A second dimension is based on whether security tokens are backed by a single asset or a pool of assets. Finally, security tokens can correlate exactly with the underlying assets or represent a derivative. CDPs are a new form of security which is a derivative on the value of an underlying group of assets. Visualizing these different dimensions, we can clearly identify the place of CDPs in the overarching security token landscape.
In the CDP model, a user registers an existing group of security tokens and receives another security token which value is collateralized by the underlying securities. The CDP can then be used for transactional activities as a form of stablecoin. Eventually, the underlying assets can be withdrawn by paying down the outstanding debt in the CDP smart contract.
The challenge with structuring security token CDPs is that a single crypto-security tokens can be collateralized by assets of different quality levels. As explained in the previous section, the behavior of a security token CDP can be influenced by three main factors related to its underlying assets: liquidity, value and risk. In that context, how can we use those dynamics to structure a security token CDP that behaves fairly for different types of assets and token holders? One interesting idea is to design a CDP score based on the corresponding liquidity, value and risk levels of the underlying assets.
Some of the principles behind CDPs are incredibly relevant for the next wave of security tokens. For starters, the concept has been validated by protocols like MakerDAO at a decent level of scale. Additionally, it is pretty obvious than security token will soon need to evolve from the current “one asset one token” model into more sophisticated financial structures. CDPs seem to provide the right balance between simplicity and financial incentives to become an important vehicle in the security token space.