Real World Assets (RWA)represent a fascinating intersection between the physical and digital realms of finance. In simple terms, RWA involves the tokenization of tangible assets from the real world, converting them into cryptocurrency form. These tangible assets can encompass a wide range of valuables, including real estate, commodities, art, and even U.S. Treasury bonds. These assets are a cornerstone of traditional finance and represent an enormous portion of global financial value.
In the realm of Decentralized Finance (DeFi), RWA is gaining prominence as it offers a bridge between the traditional financial markets and the burgeoning world of cryptocurrency. But what role does RWA play in DeFi, and how does it impact investors?
The Role of RWA in DeFi
DeFi has been making waves in the financial world, offering novel ways to earn yield and access financial services in a decentralized manner. However, as the DeFi space matures, yields have gradually approached those in traditional finance, raising questions about its long-term appeal.
This is where Real World Assets (RWA) come into play. RWA tokenization, including assets like real estate, loans, and even U.S. Treasuries, introduces a new source of yield in DeFi. It provides opportunities for higher returns and portfolio diversification. Investors seeking sustainable yields have started exploring RWA, as it offers a different method to generate returns, potentially less affected by the volatility inherent in cryptocurrencies.
Despite the advantages of RWA in DeFi, there's a lingering concern - the default risks faced by RWA protocols due to undercollateralized loans. This risk highlights the need for careful consideration and due diligence when entering this space.
The Growth of RWA in the Crypto Space
The growth of Real World Assets in the crypto space is evident in the Total Value Locked (TVL) metrics. As of July 2023, RWA has a TVL of over $770 million, marking its increasing presence within the DeFi ecosystem.
But it's not just about bringing tangible assets onto the blockchain; there's also a surge in the issuance of capital market products on-chain. This includes partnerships like Mitsui enabling asset management with digital securities, opening up investment opportunities in stable, operating real estate and infrastructure for retail customers.
Institutional players are also entering the space. In April 2023, financial institutions joined the Avalanche Evergreen Subnet, Spruce, to explore on-chain execution, settlement, and the use of DeFi applications for foreign exchange and interest rate swaps. They are even considering tokenized equity and credit issuance, trading, and fund management.
On-chain protocols are also showing a growing interest in integrating real world assets. For example, Avalanche Foundation has allocated $50 million to invest in tokenized assets created on Avalanche. This funding serves as an incentive to attract builders to create real world assets on Avalanche, further supporting its growth.
Generating Yield Through Traditional Investments
One of the reasons for the increasing interest in real world assets comes from DeFi protocols that generate yield by investing user assets, typically stablecoins, into traditional investments such as government and corporate bonds.
One noteworthy example is stUSDT, the first RWA platform on the TRON network. stUSDT enables users to stake USDT on the platform and earn a 4.18% APY. Users receive stUSDT as proof of their investment in real world assets, allowing them to earn passive income. The RWA DAO manages the investment of user assets, with stUSDT yields reportedly coming from government bonds.
Ondo Finance, on the other hand, invests in highly liquid exchange-traded funds, providing stablecoin holders with opportunities to earn yield on their assets. It involves exchanging users' stablecoins for USD, which is used to purchase assets. New fund tokens reflecting these investments are minted and deposited into users' wallets. Depending on the risk level, Ondo Finance offers APY ranging from 4.5% to 7.76%.
Backed Finance is another player in this space, tokenizing structured products tracking publicly traded securities. These tokens are backed 1:1 by equivalent securities held by regulated custodians. Backed Finance aims to democratize access to publicly traded securities, particularly benefiting people in emerging markets who often struggle to access such investment opportunities.
These examples demonstrate how DeFi is evolving to provide investors with novel ways to generate yield through traditional investments, bridging the gap between traditional and decentralized finance.
Credit Protocols and Their Tokens
In recent years, we've witnessed the rise of credit protocols tapping into credit markets, a fundamental component of traditional finance. These protocols enable businesses, especially those in emerging markets, to access loans more easily, effectively lowering the barrier to entry for borrowers.
Let's explore some of the prominent players in this sector:
MakerDAO has been actively working on integrating real world assets into its operations. An estimated 80% of its fee revenue is generated from real world assets. With a strong cash flow supporting its treasury, MakerDAO is well-positioned in the DeFi space.
Creditcoin (CTC) is designed to integrate with fintech lenders in emerging markets, connecting them to DeFi investors. It records borrower loan performance on-chain, offering trustless and transparent financial auditing for investors.
Maple Finance (MPL) serves as an institutional capital market infrastructure, allowing institutional borrowers to tap into the DeFi ecosystem for loans. It involves institutional borrowers, lenders, and pool delegates who underwrite and manage the pools on Maple Finance.
Goldfinch (GFI) focuses on lending to real world businesses, particularly those in emerging markets. It offers attractive yields, with some pools reaching up to 30%.
Centrifuge (CFG) introduces a unique twist to on-chain credit by incorporating Non-Fungible Tokens (NFTs). Asset originators tokenize real world assets into NFTs, enabling a broader range of assets to enter the DeFi ecosystem.
These credit protocols provide businesses with opportunities to access capital efficiently and in a decentralized manner, contributing to the growth of DeFi.
Advantages of Credit Market Protocols
Credit market protocols offer several advantages from different perspectives:
For DeFi Participants
These protocols often provide higher yields compared to many other DeFi platforms.
DeFi participants can diversify their portfolios by investing in undercollateralized loans.
Borrowers can build their on-chain credit profiles by repaying loans, potentially increasing their borrowing capacity in the future.
For Emerging Markets
Credit protocols make it easier for businesses in emerging markets to receive undercollateralized loans, reducing the barriers set by traditional financial markets.
By borrowing on-chain, businesses can build trust and gain access to capital more efficiently, which is crucial for scaling.
However, it's important to acknowledge the risks associated with credit market protocols.
Disadvantages of Credit Market Protocols
The primary risk stems from borrower defaults. Since these are undercollateralized loans, lenders may not recover their full capital in the event of a default. Some protocols have experienced defaults, highlighting the challenges in this area.
Despite the use of stablecoins to reduce crypto volatility, credit protocols are not immune to market downturns. This is evident from cases where defaults occurred after significant market volatility.
Another challenge is the potential for human bias in the KYC and AML processes and borrower whitelisting. These protocols rely on human decision-making, which can introduce errors or biases in the lending process.
Token Performance
The performance of tokens associated with RWA protocols can be quite dynamic. These tokens often react to various factors, including the overall sentiment in the DeFi market, changes in the underlying assets, and the performance of the protocols themselves.
It's worth noting that these tokens are not immune to market volatility. Investors in RWA protocol tokens should exercise caution and conduct thorough research before investing.
In Summary
Real World Assets (RWA) are becoming a significant player in the DeFi landscape, offering opportunities for both investors and businesses to tap into the benefits of blockchain technology and decentralized finance. However, it's essential to approach this space with a thorough understanding of the risks and rewards it presents. As the crypto and DeFi ecosystems continue to evolve, RWA is likely to play a vital role in bridging the gap between traditional and decentralized finance.
