Real-world tokenized assets could be DeFi’s next frontier
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What happened
In recent months, traditional funds and asset issuers have launched programs to tokenize alternative assets via public crypto networks. Recent asset issuance has reinvigorated interest in bringing real assets (RWAs) on-chain, opening new revenue generation opportunities within decentralized finance (DeFi).
Private equity firm Hamilton Lane has partnered with digital asset issuance platform Securitize to tokenize a portion of its flagship $2.1 billion equity fund on the Polygon network. The fund requires a minimum investment of $20,000, well below the typical $5 million minimum buy-in for private equity investors.
Hamilton Lane is one of the largest private equity managers, having invested over $37 billion in private markets as of 2021. The company has $824 billion in assets under management.
Similarly, the Monetary Authority of Singapore (MAS) announced Project Guardian, a pilot program to tokenize bonds and deposits that can be used in various DeFi strategies.
A bank participating in the program would be able to tokenize bonds and deposits that could be used in eligible liquidity pools. This capital could be lent to DeFi applications like Aave and Compound to earn interest or serve as collateral to access credit. The pilot project has won JPMorgan, DBS Bank and Marketnode as first partners.
broader context
Ever since the first DeFi protocols gained prominence in 2020, they have been a driving force in attracting users and traders to the crypto space. Experiments within DeFi have delivered innovative financial applications such as decentralized automated market makers, stablecoins, lending, insurance, swaps, synthetic assets and derivatives.
The Total Value Locked (TVL) within DeFi applications, roughly translated as the amount of capital under management, rose to a peak of $248 billion in December 2021 as asset prices soared and new users joined. TVL has been bolstered by liquidity mining programs, where protocols have accelerated growth by temporarily siphoning out yields and offering users tokenized rewards of the protocols’ native tokens (i.e. compound rewarded by lenders with COMP tokens).
These returns were unsustainable as token prices fell and general interest in crypto waned during the 2022 bear market. Stablecoin USDC’s historical lending rates peaked in December 2020 at 18% for Aave and 8% for Compound. Those yields are down today to 0.75% and 1.62%, respectively.
DeFi yields have fallen
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With the one-year Treasury yielding around 5%, investors have flocked to the safety of government securities. Treasury yields have skyrocketed as the Federal Reserve abandoned its zero interest rate policy, with the one-year note rising from its December 2021 yield of 0.3%.
The Treasury yield has risen as interest rates have risen
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As the risk-free interest rate rose in traditional finance and DeFi yields fell, investor participation in the latter has declined significantly in recent months, with TVL falling 73% from its peak in December 2021 to $66 billion today.
DeFi TVL has been declining since its peak in 2021
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To attract fresh capital, DeFi protocols are starting to use RWAs as a source of collateral or for new investment opportunities, offering investors more consistent returns.
The tokenization of real assets such as real estate, commodities, private equity and credit, bonds and art is a concept that has been quietly trickling since 2018. Formerly referred to as “security tokens” or “tokenized securities,” tokenized RWAs use blockchain technology to bring traditional assets on-chain.
The tokenization of RWAs offers tangible benefits, including lower minimum investments and improved access through fractional ownership, increased trading of previously illiquid assets, improved transparency and security as the blockchain maintains an immutable record of transaction history, and automated ownership management and compliance.
key quote
“Tokenized RWAs benefit DeFi by allowing it to serve businesses and customers that are not cryptonative. DeFi lending is limited as long as we only accept Bitcoin or Ethereum as collateral. The ability to accept tokenized real estate or collateral over a company’s property reduces risk for crypto lenders and investors as it enables real-world companies to leverage DeFi.” – Sidney Powell, CEO and co-founder of Maple Finance
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Aggregating seven of the largest RWA personal loan blockchain protocols, historical loan value is $4.2 billion and active loans are $456 million. These protocols use DeFi to provide private lending to businesses and include Maple, Centrifuge, Stieglitz, Credix, TrueFi, Clearpool, and Ribbon Lend. They offer an average APR of 12.63%.
DeFi lending has also fallen
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Outlook and Impact
DeFi needs to offer higher returns than traditional investments to remain competitive and attract capital. DeFi applications like Maple Finance, Goldfinch, and Centrifuge pool funds from crypto holders and lend them to generate returns through various strategies.
Maple Finance is a platform for institutional borrowers to tap into the DeFi ecosystem for unsecured lending. Pool delegates are loan professionals who underwrite and manage pools on the platform, and they source institutional borrowers by structuring the terms of each loan pool. Lenders can then deposit crypto funds into the pools they wish to support and lend their assets for a return. Maple has facilitated nearly $1.8 billion in total loans to date.
Goldfinch focuses on facilitating lending to real companies in emerging markets. Borrowers must undergo a credit check to determine their creditworthiness. Once approved, they can create pools and set loan terms such as interest rate, loan amount, term, and late fee. Lenders can choose to provide capital to individual pools and are the first to incur capital losses on impaired loans, giving them a higher return. Alternatively, liquidity providers can provide capital that is distributed across all borrower pools, providing a lower rate of return with less risk of capital loss.
While Maple and Stieglitz focus on private lending, Centrifuge allows for more forms of real assets to be brought into the DeFi ecosystem, such as: B. Real estate loans and freight bills. On Centrifuge’s Tinlake marketplace, a creator converts a real-world asset into a non-fungible token (NFT) and attaches the appropriate legal documentation. Asset pools are created using the NFT as collateral, which represents the RWA. Investors can then allocate capital to the pools that suits their risk preferences.
Tokenizing real-world assets is enabling DeFi to tap into some of the largest financial markets. Global real estate was valued at $327 trillion in 2020 and non-financial corporate debt at over $87 trillion in 2022. These are colossal markets that tokenization can bring more liquidity and new investors to.
decision points
When evaluating revenue-generating opportunities, investors should look at the track record of existing DeFi applications leveraging real assets. Have you suffered payment defaults? What is the underwriting and due diligence process and how are risks managed? Underwriters that require borrowers to be overcollateralized, have access to insurance, or have safeguards in place in the event of default may perform best over time.
Specifically, in December 2022, Maple Finance had a $36 million loan default on one of its loan pools. Borrower Orthogonal Trading suffered losses due to the FTX default. In response, Maple launched its version 2.0, which introduced a faster default and liquidation process for loans that were so sour. This points to the need for better risk parameters and sector diversification among borrowers for undercollateralized DeFi lending platforms like Maple.
Instead of lending capital directly, investors can also bet on the success of RWA-focused DeFi protocols by buying their native tokens. The prices of these tokens will correlate with the rest of the crypto market but may show greater appreciation for winning platforms.
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