Deriveum Europe

Business Canvas
Timeline of the Deriveum Project

Summary

- Impact Potential:

Deriveum Europe aims to tackle the risk allocation dysfunctionality caused in the EU’s corporate bond market by the Covid-19 economic fallout. By providing increased certainty to bond investors we will have the potential to attract €50 billion of private capital back to bond market. This in turn has the potential to translate in over 150 000 jobs created across the EU.

- Technical Complexity:

Deriveum is the world's first self-executable crypto commodity, a blockchain solution based on R3's Corda. This new collateral class was originally developed for emerging economies and during the hackathon we adapted it to the European market to tackle the current issue. The innovation is complex in its legal specifics (use of virtual asset as a commodity), as well as technical (smart contract with multiple parties) and economic aspects (specific price stability mechanisms).

- Prototype Completion:

As the EU market is quite different from the emerging markets, a number of features and functionalities from our working model need to be adapted, a rather complex technical task. However, during the Hackathon we have created a basic demo describing the features of the adapted smart contract. You may access it at https://deriveum.com/demo/. Please use username: EUvsVirus and password: EUvsVirus.

- Business Plan:

During the Hackathon we have adapted our emerging markets business model and outlined a detailed business plan. With an initial investment of €250’000 and follow up investment of €500’000 we can complete the regulatory licensing procedure, adapt the smart contract, market the collateral, list it on regulated exchange and start trading in Q1 2021. We anticipate to make profit operating the collateral registry through two revenue streams – fixed sales fees and additional services (legal and technical consultancy to users).

The Problem Deriveum Europe Solves

In this global pandemic outbreak (like in every financial crisis), investors tend to 'flight-to-safety', withdrawing their investments from assets where the measurable risk is hard to be determined. This leads to a substantially reduced liquidity available for corporations, especially Small & Medium Enterprises, who in effect are unable to attract financing key to their operations. This lack of private investment will make credit less accessible for the economy reconstruction and growth projects as well as the sustainable jobs they will bring.

During a crisis, investors are unable to distinguish between well performing companies and ones on the brink of collapse. An existing product, called a Credit Default Swap (CDS) has historically been available for investors to effectively insure the credit risk through a financial institution by paying a certain premium for this service. However, following the financial crisis of 2008, regulatory changes were agreed within G-20, effectively invalidating CDS execution in a period of systemic crisis - exactly the time when these instruments are most required and useful for investors. This has greatly reduced the global CDS market, given the severely reduced enforceability of the CDS contract.

The Solution We Bring To The Table

Enter Deriveum - world's first self-executable crypto commodity, a financial instrument developed to support CDS contracts between the investor and financial institution, regardless of the security size that is to be insured against. It ensures the enforceability of CDS contracts while being cost-effective and fully regulated.

Deriveum is a new collateral class, that we started creating in 2019 in collaboration with the European Central Bank /Bank of Lithuania to solve the problem of risk allocation in the emerging economies. As the European market currently requires solutions for improved risk allocation and transparency, for the hackathon we worked to adjust the idea to adapt this solution to the European market by adding new team members, that aided us in designing a roadmap for adaptation of the solution to the European market and speed up the process.

Deriveum Europe uses the same collateralization process as Deriveum intented for Emerging Markets. Deriveum is a blockchain based commodity regulated by the European Central Bank / Bank of Lithuania, that guarantees 100% payment of all insured contracts. It is used to ensure that the Credit Default Swap holder (corporate bond investor) will be paid in a default event, regardless of the liquidity position of the insurer (financial institution). This is currently not the case (as Lehman Brothers and AIG showcased back in 2008 across the Atlantic) and up until now the legal-economic-technological mix to address it was not available. Deriveum changes the paradigm.

The protection seller (financial institution) purchases Deriveum to cover the agreed amount of corporate bonds. The insured bonds are purchased by Investors with a determined collaterization of the exposure, payable through smart contract with collateral – the Deriveum commodity. The Business/Job Creator (Bond Issuer) has therefore access to increased liquidity and thus is able to support new job creation so needed for the recovery from the Covid-19 crisis.

In case of contract expiry (no default event) the Deriveum is transferred back to the financial institution and it can sell it or use it for another contract. If there is a credit event the smart contract is triggered and the Investor is paid 100% on the agreed upon coverage (insurance).

The technical ability to create self-executable contracts became possible in 2016 and the legal framework allowing it to be used as a commodity was effectively enacted in 2018. Together those two elements allowed for the Deriveum concept to be developed in 2019.

In short, we bring to the table an innovative solution, which, with some adjustments, can be applied for the European market and will be fully compliant and prudently regulated by the European Central Bank/ Bank of Lithuania.

What Have We Done During The Weekend

Firstly we have gathered a brilliant team of Hackathon participants from across the continent. Our first challenge was to adapt the business model and functionalities developed for the emerging economies to the realities of the developed EU bond market.

Second, we concentrated on the roadmap and the business plan that followed the adaptation of the model (please check the Business canvas attached to this DevPost submission), in order to ensure long term business revenues and thus operations. We started developing a marketing strategy, identifying key stakeholders and involved parties who should be contacted as a priority, given the potentially restrained budget.

Third, we have created a basic prototype (https://deriveum.com/demo/; you may check it by username: EUvsVirus and password: EUvsVirus) based on the features and functionalities that need to be adapted in the smart contract specifically designed for the requirements of the European bond market.

These were complex and critical tasks but together we were able to hack them!

The Solution’s Impact On The Crisis

As mentioned above, the corporate bond market is facing a wave of fear as risk is currently dislocated. Based on the Simulation executed in the regulatory sandbox of the European Central Bank/Bank of Lithuania, we estimated safe levels for concentration of risk backing fully reserved CDS exposure, without the possibility to create systemic impact in a default waterfall. Extrapolating the results to the Eurozone, we concluded the safe exposure position to be of €50 billion or less. Thus we will hard-cap the Deriveum Europe to not exceed that valuation. As this number represents less than 0.5% of the EU’s total corporate bond market, we feel that this is a fairly realistic goal to be reached in the next three-to-four years.

Assuming Deriveum provides the certainty of risk-sharing to investors, a total of €50bn could potentially become unlocked within the European business ecosystem. The academic literature estimates that a long-term high-paying job requires an investment of around €300’000. Thus we can arrive at an estimation of a potential net gain of c. 150’000 jobs across the EU.

We are aware that our solution is not a silver bullet that would remedy the economic devastation the virus will leave behind, but the potential of adding 150’000 jobs are a lasting legacy for our highly complex and extraordinary innovation.

The Necessities In Order To Continue The Project

Our business plan indicates that we require a relatively moderate initial investment of €250’000 to adapt the smart contract from the needs of the emerging markets to the European context, cover licensing fees and expenses and code the unique algorithmic Price Stability Mechanism. We would require a €500’000 follow-up investment for dissemination and regulated exchange listing.

We expect to start trading in Q1'2021 and our revenue streams would cover our expenses, while we are expected to make profit of €175’000 - €225’000 in 2021, profit of €350’000 - 475’000 in 2022 and of over €750’000 in 2023.

The Value Of Your Solution(s) After The Crisis

In the case of corporate bond markets the Covid-19 induced crisis is expected to have a long term ripple effect. The economic consensus currently suggests that a period of risk dislocation will start to ease in 2023-2024, with full recovery to pre-crises levels not expected to happen before 2026-7.

There are two potential scenarios for Deriveum Europe after 2026:

The first one is natural death – meaning that financial institutions and investors will simply gradually stop using our collateral. The Price Stability Mechanism ensures that users will be able to convert their collateral back to euros. As soon as our reserves start to shrink a wind-up plan will be activated. Deriveum Europe will quietly and orderly settle all its dues, convert all outstanding collateral to euros, distributes the residual reserves as profit among the shareholders and cease to exist
The second scenario is that financial institutions and investors will find the instrument useful for high-risk or tailor-made investment products in the long term. In that case Deriveum Europe will continue to operate and facilitate economic growth and job creation in the post-crisis Europe.

The URL to Our Prototype

You may access a preview of the functionalities and features of Deriveum Europe at https://deriveum.com/demo/. Please use username: EUvsVirus and password: EUvsVirus.