Introduction

Canto strides to advance as a forward-thinking entity, moving beyond the standard norms of L2s and conventional DeFi to focus on the integration of Real-World Assets (RWAs). The collaboration between Canto and Polygon Labs focuses to accelerate the RWA movement. . Through this alliance, Canto claims to make a marked entry into the burgeoning domain of 'NeoFinance,' promoting a surge of application-layer around RWAs. In a setting where RWAs and blockchain technology converge to alter financial frameworks, can this alliance really serve as a conduit between traditional assets and DeFi? This report endeavors to probe further into such assertions to ascertain the truth.

In this report, we will examine the evolution in Canto’s infrastructure (from v1 to v2), explore its assertions regarding NeoFinance, review Canto's Ecosystem roadmap, analyze its unit of account token, and investigate the overall risks.

Canto V1 and V2:

Canto 1.0:

Canto 1.0 aimed to propel the DeFi movement further, focusing on transparency, decentralization, and open accessibility. It utilized Tendermint consensus secured by Canto validator nodes and featured an EVM execution layer via Cosmos SDK. The integration of Cosmos SDK facilitated the creation of multi-asset public PoS blockchains, aligning with the objective of promoting a Free Public Infrastructure (FPI).

1.0’s Pros:

• Permissionless nature enables open participation and innovation.

• Utilization of Cosmos SDK allows for the creation and integration of custom blockchains, promoting flexibility and interoperability.

• Contract Secured revenue - read more here 

1.0’s Cons and Limitations:

• Limited to the functionalities and capabilities of the Ethereum Virtual Machine (EVM).

• Potentially less efficient and scalable compared to Layer 2 solutions.

• Lack of deeper liquidity limiting confidence - mainly stemming from the fact that it was not Ethereum secured.

Canto 2.0:

With a forward-looking vision, Canto transitioned into Canto 2.0, partnering with Polygon Labs to establish a ZK Layer 2 on Ethereum aimed at real-world asset integration. Canto 2.0's establishing an entire new category called NeoFinance is one to pay close attention to. The migration to a ZK chain with the help of Polygon Chain Development Kit (CDK) not only retains the core principles of permissionless sovereignty but also amplifies liquidity and user security through the best ZK prover rooted in Ethereum's cryptographic security.

NeoFinance:

For NeoFinance to effectively expand on a larger scale, it requires a substantial liquidity pool while ensuring security, embodying a scenario where trustlessness and decentralization are predominant. Can Polygon CDK help facilitate such a scenario?

Polygon Labs in their Polygon 2.0 paper presents a solution where all the app chains built using the CDK shall converge onto a common aggregation layer to establish atomic cross-chain communication, share liquidity and other resources. Utilizing the tools provided by this development kit, Canto aims to become the L2 for all things RWAs just like IMX (the go to gaming chain for Polygon). The concept of fluid interoperability of ZK L2s, while maintaining independence and modularity, is a unique offering from Polygon Labs, and Canto acknowledges the potential by accepting this idea.

2.0’s Pros:

• Migration to a ZK L2 enhances scalability and lowers transaction costs.

• Plonky2 ZK proving implementation alongside a PoS validator set ensures decentralized sequencing (in the future), elevating trustless guarantees.

• Seamless interoperability with the larger Polygon ecosystem facilitates increased liquidity and cross-chain communication without the need for risky bridges.

2.0’s Cons and Limitations:

• Dependence on Polygon CDK and Ethereum’s infrastructure could potentially introduce external vulnerabilities or dependencies.

• Integration of real-world assets might face regulatory hurdles and practical challenges, slowing down the envisioned NeoFinance revolution.

What do the big boys think about RWAs?

The healthy market cap of Polygon and strategic institutional partnerships with huge Traditional Finance banks like Franklin Templeton and Hamilton Lane depict robust institutional acceptance. This alliance seems to embolden Canto's position in the ecosystem, aligning with the burgeoning trend of asset tokenization as revealed by the BNY Mellon Report.

Evaluating the Roadmap and Value Propositions

An Attempt Towards Building a Thriving Ecosystem

Canto, with its emphasis on Real World Assets, has developed an entire ecosystem of new primitives including Canto DEX, Canto Lending Market (CLM), and the $NOTE unit of account. Canto DEX is designed to be a platform for liquidity providers, offering zero-fee trades. CLM serves as a marketplace to facilitate borrowing and lending, aiming to mirror the ease of traditional financial transactions. $NOTE is described as a fully collateralized, decentralized, and automated unit of account token.

NOTE and The Secrets of Burgeoning Yield on RWAs

$NOTE

The $NOTE is a fully collateralized unit of account token within Canto's ecosystem. Its algorithmic construction has provisions for maintaining price stability, aiming for a balanced, capital-efficient, and automated financial model.

The backing by other stablecoins like USDC and USDT provides a level of protection against depegging risks, which can contribute to the reliability and stability of the Canto chain. Its price stability is overseen by an accountant contract, which adjusts interest rates to strive for balance and ensure proper management of the counterparty risks in $NOTE.

The Opportunity to Carry Trade on RWAs

Although RWAs provide investors with very small interest rates annually, users on Canto can take a leveraged opportunity to earn multiples. This can be made possible through a  mechanism known as the Carry Trade which involves the following steps:

1. Systematic compliance onboarding with the RWA issuer, ensuring that the necessary legal and procedural bases are covered.

2. Following the compliance onboarding, investors then proceed to mint RWA Tokens. These tokens essentially represent a traditional financial instrument – for ex. Treasury Bills – on the CANTO L2.

3. Once the T-Bill RWA Tokens are minted, they are posted as collateral on the Canto Lending Market, an innovative platform that interfaces real-world assets with decentralized lending. This action is crucial as it underpins the borrowing capacity of the investor within the decentralized finance ecosystem of Canto.

4. With the collateral in place, investors will be able to borrow NOTE, a decentralized stablecoin, against their T-Bill RWA Tokens.

5. Having borrowed the NOTE, investors proceed to sell the NOTE for USDC, thereby completing the loop of the Carry Trade.

The math underpinning the expected returns is compelling. With a t-bill rate of 5.5%, a NOTE rate of 5.15%, and a mere t-bill margin requirement of 1%, the carry trade seems structured for optimal return. Assuming assets worth $1M are deployed, with a debt amounting to $990K, the position value stands at $10K. This arrangement leverages the APR to 35%, a figure that significantly outstrips conventional returns in traditional financial markets.

veRWAs and Enhanced Yield

On the financial yield aspect, there's an anticipated target of 10-15% annual percentage yield (APY) on cNOTE, enhanced with additional Canto incentives, which will be subjected to a governance vote.

Post-approval, Canto plans to introduce T-bills as collateral markets to the Canto lending market. Following this, the launch of the veRWA primitive, entailing CANTO subsidies, is on the horizon.

This veRWA launch, inspired by the veTokenomics of Curve protocol, will coincide with the initiation of the first independent lending market accepting other RWAs as collateral. The integration of veRWA primitive is poised to boost the Annual Percentage Rate (APR) on cNOTE deposits.

Depegging Risks

One notable risk for the counterparty, particularly the asset issuer or the borrower of $NOTE, is a major depeg, coupled with risks associated with the vulnerability of the Canto chain. In the context of $NOTE depeg, being an over-collateralized algorithmic stablecoin, it can only be borrowed against tBills. Therefore, a depeg situation could only arise in instances of an exploit or if the tBills are not redeemable instantly (or extended duration risk).

An interesting way to incentivize stablecoin depth on Concentrated liquidity pools is liquidity mining on specific ranges chosen by issuer (or later on community).

Conclusion

The collaboration between Canto and Polygon Labs ventures into NeoFinance is one we will be closely monitoring. Moving from Canto 1.0 to 2.0 aims to improve scalability, liquidity, and security, though it potentially introduces external vulnerabilities.