In 2021, we witnessed numerous attempts to leverage Real World Assets. Whether it was purchasing real estate or pooling funds to own fractional shares of a property, these endeavors faced challenges. It became evident that we were ahead of our time. However, with the gradual pace of innovation in the DeFi space, there's ample opportunity to revisit and reimagine this approach.With Roots, our aim is to eliminate the necessity for traditional banks in providing coverage for mortgages, including collateral for houses and real estate. However, the crucial question isn't just "why" we're doing this, but rather "how" we plan to achieve it. Ensuring the safety and security of both lenders and borrowers is paramount. Additionally, maintaining the platform's security as our top priority is crucial. Yet, implementing such a platform comes with regulatory challenges and risks that must be carefully navigated. So let’s just start off by talking about that:
The risks we face are multifaceted. Firstly, there's the challenge of reconciling the fact that not all individuals in the crypto space are willing to undergo KYC procedures when purchasing a home or real estate. Our base model for roots:mortgages addresses this by supporting the anonymity of lenders, safeguarding their identities and providing accessibility to those who prefer on-chain anonymity. However, this approach poses regulatory challenges, as some countries may not accept such arrangements and may pursue legal action.
To navigate these challenges, Roots will operate under a parent company that holds a banking license and serves as a trustee between parties, akin to an escrow service. For example, this parent company, would acquire and transfer ownership of houses and real estate. The ownership of the property remains with Roots as a trustee until either full repayment or liquidation due to missed payments. The borrower would disclose the property they intend to acquire, with the parent company facilitating the transfer of ownership as necessary. This setup mitigates exposure for both parties, ensuring security and regulatory compliance within the Roots ecosystem.
While we have this plan laid out, our objective is to pool our collective expertise and devise a more decentralized approach. However, challenges regarding AML laws and regulatory issues are inevitable. Yet, as we advance with our initial plan, we're confident that we can optimize it to be more efficient and compliant. Let's concentrate on presenting the overall vision before delving into specific aspects and edge cases.
To deepen comprehension, Roots acts as the trustee with ownership of the designated house or real estate. The lender isn't required to undergo KYC procedures. Ownership transfer occurs once either party successfully claims the property on-chain. This claim process initiates once the property is fully paid off or in the event of liquidation.
How are liquidations facilitated in the case of underwater positions? Roots will implement a crypto subscription service. After depositing funds into a pool, the borrower makes monthly payments. If payments aren't made for, say, three months, liquidation occurs. The house can then be claimed by the lender (requiring sensitive data transfer via a service like Nillion) or traded OTC or via Marketplace on our platform for funds. Ownership on-chain transfers, yet the house remains an asset of Roots until claimed. In the event of liquidation, the borrower loses the entire collateral stack.
To offer a clearer understanding, let's visualize:
Now that we have this set, we would like to talk about how and where institutional adoption comes into place. We spoke about how borrower and lender can trade their homes/real estates without the necessity of claiming. Now let’s look at two more important things:Trading the debt + Risk Management & Tranching
First let’s look at a draft on how the debt would be structured:
It's crucial to clarify that the tradability of debt doesn't imply that the smart contract functions as a mortgage-backed security, a product favored by institutions. Instead, it involves tokenized debt with utility on an i ndividual basis.
When considering property assessments, how does the surveying process function for Roots? It's not as simple as Roots dispatching someone to inspect the property. Here's the underlying concept behind Roots: When a buyer initiates a request on the protocol, it would typically unfold like this:
When the request is initiated, the buyer/borrower should have already visited and inspected the property. This ensures that the house or property is eventually represented on-chain. Through a smart contract, the property becomes a tangible asset that can be traded. However, with trading comes the inherent risk of poor maintenance. To address this, we introduce our proprietary rating system and employ a tranches method, akin to real-world subprime, prime, and superprime loans (for reference, please watch "The Big Short" if you're unfamiliar). This method, combined with on-chain history tracking, allows us to manage lender risk and assess real estate demand in the area. Here's an illustrative example, bearing in mind that these details are subject to refinement as part of our ongoing vision development:
The property rating considers factors such as age, neighborhood, and the price per square meter/feet in EUR/USD, among others (specific criteria to be determined). Once the details are fully encrypted and submitted through Roots, the request is initiated, and the purchasing process takes place via the "Web3 Notary." If the details are accurate, the contract owner will change. The contract structure could resemble the following:
Let's delve into the concept of "Tranching" and why it can significantly enhance security for both lenders and borrowers. As previously mentioned, before initiating the on-chain request, the borrower must have observed and inspected the property. Upon confirmation of the property's condition, the borrower provides collateral into a pool to mitigate the lender's risk. With this assurance, the on-chain request can proceed, and collateral is placed into the pool.
Lenders have the option to utilize tranches to pool their funds and bid on properties falling within their designated tranche. The calculation of tranches involves three key checks:
Wallet History: A provider is utilized to scrutinize the wallet's history, flagging any potential money laundering activities. This step ensures compliance with AML laws and local regulations while assessing the risk associated with the requested wallet.
Details Verification: Provided details must align with the purchasing request verified by the "Web3 Notary."
Ranking: Properties are ranked based on the submitted information.
The Tranching system operates as follows:
Utilizing the tranches system provides lenders with increased security when issuing loans, as it helps assess risk based on wallet and property data. Let's explore additional scenarios where we can incorporate features as risk management tools for lenders:
Variable Interest Rates and Deposits: Higher interest rates and larger deposits could be required for pools deemed to pose a greater risk of liquidation. For instance, borrowers with lower-rated wallets and properties in less desirable areas may face higher interest rates and larger collateral requirements.
Tranch-specific Collateral Ratios: The tranches system can determine the ratio of collateral required based on the risk profile of the pool. For example, a pool categorized as BA (combining a B-rated wallet with an A-rated property) may have a lower collateral ratio, such as 1:7, resulting in a collateral amount of $71,428.57 for a $500,000 property.
Loan Terms and Monthly Payments: Assuming a 10-year mortgage term, the borrower would repay the remaining loan amount plus interest and taxes on a monthly basis. For example, with an average monthly payment of $3,500, plus interest and fees depending on the tranch rating.
Liquidation Process: A liquidation event occurs if the borrower fails to make payments for three consecutive months. In such a scenario, the lender can claim the property or sell it via the marketplace to recover the outstanding debt.
High-Risk Tranches: For pools categorized as EF (combining an E-rated wallet with an F-rated property), lenders may charge higher interest rates and request additional deposits to cover potential damages and resale risks. For instance, a collateral ratio of 1:3 (for $200,000 equals $66,666) plus a 10% deposit (equals $20,000) may be required, resulting in a higher monthly payment of around $2,000 or more.
In the event of liquidation, the lender receives the deposit and retains ownership of the property, which was flagged as a risky investment. The lender can then decide to claim or sell the property on-chain. These scenarios demonstrate how the tranches system, combined with variable interest rates, deposits, and collateral ratios, can help manage risk for lenders while offering borrowers access to loans based on their wallet and property ratings.To cover some of the edge cases:
The tranches system, utilizing two different rating components, mitigates risk and enables lenders to understand the risk involved. However, there are some open questions and edge cases that need consideration:
Rapid Property Value Decline: If a property is experiencing a rapid decline in value, there is no risk of liquidation unless overdue bills remain unpaid. Rapid loss of property value primarily affects tranches with higher risk, which is a risk assumed by the lender. The lender compensates for potential losses by receiving higher APY.
AML Law Violations by Lenders: Lender wallets undergo the same scrutiny as borrower wallets to ensure compliance with regulations and laws. Wallets found in violation of AML laws would be excluded from bidding and providing funds.
Property Damages, Insurance, and Taxes: Roots will deduct insurance fees and property taxes from the monthly bill. Damages for lower-risk properties are typically not covered, as the likelihood of liquidation is minimal. Insurance would cover damages to tenants occupying the property.
We understand that this may seem complex at first glance, but in reality, we are addressing this challenge with the robust power of blockchain technology and minimal assistance from the real world. Let's walk through the process flow from the perspectives of borrowers, debt buyers, and lenders, and cover how this entire system will operate. For this case, I will be showcasing more visuals to ensure thorough understanding, particularly for non-technical individuals and newcomers. From the borrower's perspective, we can see the following:
The first step involves selecting a property within our jurisdictional reach. Subsequently, the property information, along with the loan/mortgage request, is transferred. The lender is then presented with the loan, enabling them to place individual bids or bids based on tranches/regions. This process can be likened to an NFT marketplace where collectors can bid on collections or individual NFTs. Roots operates similarly, allowing lenders to bid on any tranche pool or specific loans requested. Roots promptly retrieves the rating from the roots:tranches directory and provides this information to lenders.
While a lender is being matched (or immediately matched through bids), a draft of property details and information is provided to the Web3 Notary for verification. If the provided information is confirmed, a purchasing request is initiated. During this period, the pool is locked until the status is updated. Subsequently, either a rejection (due to frontrunning of bids) or approval occurs, updating the status for both parties. If successful, the transfer is facilitated via Roots as the parent company, establishing legal ownership of the property, while the Web3 Notary executes the purchase for smart contract creation. Once the smart contract is generated, the lender becomes the sub-owner of the contract. If the requested amount is fulfilled, the borrower also becomes a sub-owner. Upon becoming sub-owners, a claim function is activated, requiring the new owner of the house to provide crucial information, which is then shared with the Web3 Notary for the transfer of house ownership.
The debt buyer’s perspective would appear as follows:
The Debt buyer will have the capability to bid on an entire tranches pool on the marketplace, indicating that if there is a matching liquidation or a paid-off loan, the subowner would transfer accordingly. The same principle applies to individual pools. Once the bid has been accepted, there will be a transfer of subownership, which will then be claimable for the debt buyer. Please refer to the picture description for further details on reselling.
To prevent fraud and attempts by hacked wallets to sell property on the marketplace, we propose two solutions: implementing a 2/3 multisig process that needs to be set during borrowers' requests and/or imposing a 2-week transfer freeze for funds and ownership. These measures aim to address the issue in collaboration with law enforcement officers and our potential compliance department.
From the lender's perspective, the process would appear as follows:
The lender will have visibility into multiple pools similar to the debt buyer, enabling them to place bids into AA-Tranch, AB-Tranch, and so forth. Additionally, individual bids are available. Once a counterparty has been found, the lender will only be able to view the status and the contract creation. Upon status update, a dashboard will display the lender's APY, bill payments, and other relevant information.
We could delve deeper into tradable debt, such as currently running loans being transferred to debt buyers, but this aspect will not be covered in the visuals. The debt owner could trade and exchange the debt on the Marketplace, potentially improving liquidity, as loans are typically locked for years unless there is a liquidation event. However, fraud protection measures must be in place to prevent potential wallet hacks, employing a similar approach as with the debt buyer after full liquidation or paid-off loans.
Upon reading and comprehending this concept, it becomes evident that it represents a significant and optimistic endeavor to handle not just decentralized mortgages, but also to bring them onto the blockchain. The Roots team holds a strong ambition towards this approach, as it addresses the longstanding issue of mortgages not being on-chain based. While companies like Milo offer mortgages with crypto as collateral, Roots aims to go further by not only tokenizing the house but also eliminating the need for intrusive credit score checks and proof of employment. Imagine a mortgage that is peer-to-peer based and on-chain, without reliance on traditional banks. This comes with inherent risks, which we endeavor to mitigate over time.
Crypto enthusiasts have persisted over the years because it offers them not only freedom but also something to believe in. At Roots, and with the aim of fulfilling this product after securing proper funding, we believe that we can significantly reduce the necessity for traditional banks. What we envision resembles an on-chain BlackRock controlled by P2P backed loans. By challenging traditional banks, we not only disrupt the existing financial system but also usher in a new wave of possibilities.
The legal battles and technical challenges ahead are daunting, but we are prepared. This vision holds the promise of making lives easier by providing fast, affordable loans backed by a mostly decentralized protocol and its lenders. Just as the release of the Bitcoin Whitepaper signaled a decentralized and coordinated attack against banks, Roots' approach to providing on-chain mortgages via P2P backed loans represents a decisive step towards the total elimination of the necessity for traditional banks.
Once Roots establishes itself as a flagship entity on the Canto Blockchain and expands its Total Value Locked (TVL) across other chains, we will initiate a Seed Round followed by a potential Series A. These fundraising efforts will lay the groundwork for our ambitious proof of concept, enabling us to explore legal and technical avenues to expand the protocol's functionalities for the RWA sector.
However, none of this will be possible without contributions and funding. We encourage those interested in this vision to contribute by proposing edge cases and technical solutions to realize it. Additionally, we urge readers to share our vision with potential Angel Investors and VCs who align with our goals.
While we may not be the ones to realize the full potential of this platform, we believe fervently in its vision. Someone, perhaps a larger entity, may seize upon it and bring it to fruition. Though relinquishing control may be bittersweet, seeing our vision materialize would be immensely gratifying.
If you are an Angel Investor intrigued by our vision, we invite you to reach out to us through the following communication channels:
Telegram: @zeng_18
Twitter: @zerocousin
Discord: @zerocousin
Email: contact@rootsfi.com(Pitch deck on request)
Follow us on Social Media
Discord
https://discord.com/invite/arvPZZc4Vt
Edge Cases
Now that we've covered all these aspects, you might be wondering how Roots will address the issue of squatters taking over properties and handle cases of borrowers overstaying after liquidation. Let's address squatters first. Some countries have peculiar laws regarding the occupation of homes by squatters, such as the UK and Spain. A notable example of this is the recent squatters at Gordon Ramsay's restaurant, which was reported by the BBC. You can find more information about this via the following link:
https://www.bbc.com/news/articles/cxr351ewpedo
The same issue is a significant concern in Spain as well. One of the largest European real estate marketplaces also reports it as a widespread problem.
As we strive to make this proof of concept foolproof, it's crucial to emphasize that Roots does not have direct access to lawyers and professional real estate advisors/consultants who can provide proper guidance on preventing and addressing this offense through legal means (yet). The objective of Roots is not only to support countries that are legally aligned with the protocol's approach but also to comply with local laws that prevent such occurrences. Consequently, support for countries will be rolled out gradually after thorough consideration. This approach mirrors Airbnb's expansion and subsequent engagement with legal forces to address aspects of their business model. Should the need arise, Roots will be prepared to confront this issue effectively.Next, let's address the handling of keys. One potential solution for this scenario is to utilize web2 providers such as Keynest. These providers can not only supply keys but also receive them and update their status using their API. It's important to note that while Keynest is mentioned as an example, other web3 solutions for this purpose may be considered if they become available.
In the event of a liquidation and subsequent transfer of the contract to a debt buyer, the keys should be returned promptly. Delay in returning keys could potentially lead to legal complications, similar to issues with squatters or borrowers overstaying after a liquidation event. Therefore, the system will track the return of keys to ensure timely resolution of this matter.