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The Denota Protocol

The protocol that powers onchain reversibility


The Denota Protocol harnesses the power of NFTs to tokenize payment risks, transferring them to a third party in return for a fee. We're delving into two primary methodologies to realize this vision: the coverage model and the collateralized model. Both models offer distinct advantages contingent on the context. There are scenarios where the capital efficiency of the coverage model is paramount, while in other cases, the protections offered by the collateralized model might be more fitting. It's essential to understand that these models aren't binary but rather exist on a continuum, allowing for adaptive implementations based on specific requirements.

Coverage Model

In this model, the "nota" NFT acts as a representation of the onramp's coverage for a specific payment. For every payment they wish to safeguard, the onramp procures a nota by paying a fee. Should a chargeback arise, the onramp has the option to cash in the nota for a compensation. The pricing of a nota hinges on the potential risk of that payment leading to a chargeback. To ensure favorable returns for liquidity providers, we aim to set nota prices at a premium of 10-20 basis points over the projected chargeback risk. A pivotal aspect is the onramp's provision of payment risk data. If they employ vendors like Sift or Sardine for risk assessment, such data can be instrumental in determining nota pricing effectively.

Reserve Pools

The "reserve pool" smart contract amasses proceeds from risk fees, along with supplementary buffer funds contributed by liquidity providers (LPs). This arrangement's core objective is to maintain an ample capital reserve to cater to all recovery requests. By analyzing historical chargeback rates of our clientele, we can fine-tune the optimal levels for these reserves. The buffer funds from LPs play a crucial role in ensuring this stability. Recognizing the inherent risks LPs undertake, they are awarded the surplus fees after all claims are settled.
Coverage Model

Collateralized Model

Just like the coverage model, there is an NFT representation of payment risk, pricing mechanics, and risk transfer. However, the difference arises in the mandatory fund lockup by the onramp and the subsequent provision of liquidity by liquidity providers upon the sale of the nota. The downside: this requires enhanced liquidity provisions. The upside: this offers more protections for users, given that funds are firmly locked in place.
The core distinction in this model lies in the direct fund lockup within the “nota” NFT. Unlike merely symbolizing coverage, the nota here directly encapsulates funds that are designated for payout if no chargeback materializes within a predefined window. If a chargeback is initiated, the locked funds are reverted to the onramp. To ensure liquidity for the end-user, the NFT, or nota, is traded at a markdown on a secondary market.

Secondary Market & Liquidity Dynamics

The secondary market operates as a liquidity pool, procuring the notas and holding them up to the point of their maturity. Upon the maturity of a nota, the corresponding proceeds are funneled into the pool. A pivotal consideration is ensuring that the pool has sufficient liquidity to cover user withdrawals, and this liquidity must be denominated in the appropiate token. With the vast diversity in tokens available on exchanges, especially the long tail of less common tokens, maintaining appropriate liquidity becomes a major challenge. Moreover, tokens from non-smart contract platforms, such as Bitcoin, introduce another layer of intricacy. In light of these challenges, the coverage model is a more pragmatic choice for such scenarios.
Collateralized Model