Article by Samantha Marin Edited by Frank America

TradFi is coming, but it’s not coming for us. It’s coming to join us.

At least that’s what Société Générale, a French bank amongst the world’s largest investment institutions, is doing.

Société Générale’s investment arm, SG-Forge, is raising a $20 million loan through MakerDAO’s DeFi lending protocol to refinance their on-chain covered bond issuance backed by real estate, called OFH tokens. Reading their official proposal from September 30th is like entering an alternate reality — one where TradFi and DeFi aren’t at odds, but are able to work together.

This 20 million DAI loan will refinance OFH tokens that SG-Forge issued in 2020 on the Ethereum chain. OFH stands for “Obligations de financement de l’Habitat,” or housing finance bonds. These bonds are made of housing mortgages and are currently owned by SocGen, the bank that owns SG-Forge. The AAA-rated bonds will mature in 2025 and are estimated to be worth 40 million EUR at the peak of its maturity. They earn 0% interest. There are 350,976 mortgages in the pool that encompasses the bonds, the average value of the mortgage is 122,749 euros, and 99% of them are fixed-rate. More details on the contents of the bonds can be found here.

This historic move marks the first time a major bank has ever borrowed money from a DeFi protocol.

Currently, all of the OFH tokens are held by SocGen, which eases the process of swapping OFH for DAI, because they won’t need to get approval from investors. But the bank plans to offer tokenized refinancing opportunities like this one for its clients starting next year, according to SocGen CEO Jean Marc-Stenger in an interview for MarketWatch.

SocGen is a reputable player in the TradFi space. It’s known for experimenting in blockchain technology by tokenizing some of its assets on Ethereum. Image source.

The team at SocGen knows just how monumental their proposal was. At the top of the proposal they referred to this new endeavor as an “experiment at the crossroads between regulated and open source initiatives.” And just like any good experiment, many things need to be put in place to make it work.

The inception process is as follows: SocGen, the bank, will transfer ownership of the OFH tokens to SG-Forge, the investment arm, which will then pledge the tokens into the Maker Protocol as collateral. SG-Forge will borrow DAI from the Maker Protocol in return, which SG-Forge will swap into fiat currency via an exchange agent, then transfer it to SocGen. Winding up, complete.

When the unwinding process occurs, roughly 6–9 months after inception, it will work backwards: SocGen will transfer its fiat currency to SG-Forge, which will use an exchange agent to swap it into DAI. SG-Forge will deposit the DAI into the Maker Protocol, which will unlock the pledged OFH tokens. Then, SG-Forge will give the OFH tokens back to SocGen. Maturity is achieved, and the full loop is complete.

This visual rendering breaks down the process. Steps 1–4, shown in blue, are the inception, and steps 5–10, shown in red, are the unwinding.

This depiction of the loan refinancing from inception to maturity was included in the MakerDAO forum proposal on September 30th.

While getting on the good side of a large traditional bank is good news for MakerDAO and DeFi as a whole, the actual OFH tokens won’t be bringing in interest to the Maker treasury. The bonds earn 0% interest, so it’s no surprise why SocGen is seeking a chunk of USD to invest instead. But given the tight credit spreads and negative real interest rates (when the interest rates are lower than the rate of inflation), 0% for a bundle of AAA bonds is the norm. The reality of the European bond market is that no one can expect high returns on bonds.

This all results in a pretty good deal for Maker. One DAO member, Jason, pointed out on the forum that, “The risk that the bond value will change is minimal, the counterparty risk (SG-Forge) is really low, the regulatory risk is likely lower, and the pool will be overcollateralized. From that perspective it seems like an excellent experiment and a safe, non-correlated asset for the Maker Vaults. I just wish it paid some interest.”

But this historic move is more than a way to make a buck — it’s an example of how real-world assets can make their way on-chain.

Someone’s home mortgage was sold to a bank. That bank bundled several similar loans into a bond. Then, that bond made its way on-chain into a token that represented the underlying bond security, the OFH. Then that token ended up in MakerDAO’s vault, which issued DAI to SG-Forge in return. SG-Forge swapped that DAI for USD by using an exchange agent. That exchange agent swaps with other people, who end up with the DAI. So that person holding DAI is holding DAI that is backed, among other assets, by a fraction of those tokenized bonds.

If you think about it hard enough, that DAI is a representation of a bundle of real-world “things” that ended up on-chain.

And that’s pretty incredible.

It’s no surprise that SocGen came to MakerDAO, one of the flagship DAOs in the greater Web3 ecosystem and the first DeFI lending protocol, for the loan. Maker’s stablecoin DAI is considered one of the premiere stablecoins on the Ethereum chain.

The concept of DAI is simple: users can mint DAI by depositing assets as collateral. Excess collateral backs every DAI in circulation, which means that the value of the collateral in the treasury is greater than the value of the DAI in circulation.

According to the MakerDAO site, DAI is the “first unbiased currency.” The price of DAI is pegged to the U.S. dollar, which means DAI are issued to keep the price in line with USD. When a loan is issued, DAI are minted. When a loan is repaid, DAI are destroyed.

The DAI stablecoin, with a market cap of $9 billion, is a popular stablecoin for DeFi protocols built atop Ethereum. Image source.

Even though MakerDAO is so reputable that it’s on the way to becoming the de facto stablecoin choice in the Ethereum ecosystem, it has a few hurdles to jump before it can execute a deal with the third largest bank in France.

To combat this, SocGen is using SG-Forge, a Maker representative paired with a security agent, and a separate exchange agent, all to make the deal viable. This raises the question: if MakerDAO has to jump through so many hoops, will other DeFi protocols and DAOs do the same?

If the deal goes well, MakerDAO could set a new precedent of DAOs working with traditional banks. The entire landscape of TradFi and DeFi could change for the better.

“The RWA (real world asset) strategy is acting as the medium for Maker and the Ethereum ecosystem to increase its impact on a global scale and for TradFi to innovate,” said Nadia Alvarez, Head of Growth MakerDAO. “It is giving us the opportunity to create new financial services, mixing the best of both worlds.”

Web3 thinkers see hope for DeFi in this new adoption by a major institution.

“It’s not surprising to see SocGen involved in this, as they’re a proven innovator,” said Alvo von A, a member of BanklessDAO who works in finance. He acknowledged that this deal is not an easy thing to do, though. “This is a good reminder of how complicated integrating DeFi in TradFi will be,” he said.

If TradFi players are wary of crypto, they’re downright terrified of DeFi. And any company that touches fiat currency — no matter how decentralized it aims to be — must be highly regulated. This built barriers between TradFi and DeFi, so they operate in two entirely different worlds. The vocabulary in which DeFi is discussed — onramp, offramp, to the moon — gives it an otherworldly feel, while TradFi is firmly mired in brick-and-mortar here on earth.

Could SocGen be the bank that takes the rocket ship to join DeFi on the moon? One could easily imagine Banks accepting DAI as collateral on a mortgage and Zillow generating a Web3 wallet plug in for the real estate market.

“The fact that they’re struggling through the red tape could be big,” Alvo continued. In other words, the fact that SocGen is fighting through the regulation is a majorly bullish sign for MakerDAO and DeFi as a whole.

“Generally, regulators are uneasy with new things and only comfortable once a precedent has been set,” he said. But SocGen doesn’t need that precedent — they know MakerDAO is worth the struggle into the unknown, boarding that rocket ship to the moon.

“Ground control to Major Tom.”

- TradFi

Others are just as hopeful as Alvo.

Crypto Twitter responded to the news happily. Lark Davis posited on Twitter that SocGen’s proposal is an extremely bullish sign. One so bullish that being bearish isn’t an option!

The tweet reads, “this week in #ethereum land….Societe General planning to bring bonds to MakerDAO….And some people are bearish on ETH, lol” Image source

We’re still a long way off from mass TradFi adoption of DeFi. But, with SocGen pioneering the TradFi side, we’re one step closer.

“At the end of the day, being an open source project, MakerDAO can be agnostic to work with both DeFi protocols and TradFi players,” said William, a member of MakerDAO. “Having counterparties such as SocGen committed to long term strategies in on-chain securitization is a key factor to determine success in Maker’s real-world assets journey.”

The MakerDAO community knows how important this moment is, even amidst the hoops to jump through and the regulatory barriers awaiting them on the other side. The top comment on the proposal forum reads, “Maker and SocGen-Forge are standing at the precipice of financial history. What a time to be alive.”

We couldn’t agree more.

Samantha Marin writes about DAOs and the humans behind them. She is a senior content writer at Aragon and author of the Quorum Newsletter.

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