Real World Assets

The crypto industry is known to the layman as a market where only shitcoins and useless JPEGs in the forms of monkeys called NFTs are traded. We know that this is far from the truth. Bringing real-world assets (RWA) onto the blockchain is an emerging trend in DeFi which will have a lasting effect on the field. Bridging RWA with the DeFi industry and tokenizing those RWA will create a value worth trillions of dollars.

RWA have the potential to change the future of financing. In 2021, Societe Generale, a large multinational financial services company, raised $30 million using its AAA rated bonds. (AAA or triple-A is the highest credit rating issued by rating agencies.)

It worked in the following way. An investment arm of SocGen called SG-Forge accepted the ownership of OFH bonds from SocGen. Then, it used those bonds as collateral to MakerDAO to mint DAI which was converted to fiat. The fiat funds were transferred to SocGen.

This example shows how RWA and DeFi in general can change the finance by working with traditional finance actors. It has the potential to free otherwise locked up and illiquid assets leading to better capital efficiency.

What are real-world assets?

RWA can be but are not limited to real estate, loans or mortgages, contracts, carbon credits, tangible assets of high value, such as jets and yachts. Any physical or non-physical asset that can be represented on-chain and that has a cash flow can be regarded as RWA.

But why is there a need for transporting RWA to DeFi? There are many reasons among which the intermediation costs are one of the most important ones. Financing costs are still unreasonably high in many parts of the world because currently the system depends on and is operated by middlemen, e.g. investment banks, brokers, and rating agencies. 

Liquidity is another big issue in many financial markets. Lots of physical or financial assets , however valuable, lack liquidity, thus are not tradable and are not available to most investors. Tokenization of these assets will bring higher liquidity to traditional financial markets and DeFi. 

Bridging RWA to DeFi will also benefit business owners in emerging economies where borrowing foreign capital may be difficult due to inaccessibility to financial markets.

The primary use case of the RWA space is using these assets to borrow a loan, typically issued in stablecoins. Once the collateral of the borrower is assessed by the protocol, the total value of the loan available to the borrower is calculated. The debt then is represented in the form of NFTs which are sold to lenders. So, at the end of the RWA tokenization process, lenders get RWA-backed NFTs for which they pay stablecoins, and the borrower receives those stablecoins.

There are already several protocols making significant progress here.

Centrifuge

Centrifuge is one of the first protocols transporting RWA to DeFi. The platform supports assets of various kinds, such as an invoice, a mortgage or physical assets. All of these assets can be used as collateral by an asset originator. Once an originator links his RWA to Centrifuge’s Tinlake market, NFTs are issued.

So what Centrifuge essentially does is to provide loans to small and medium enterprises at a reasonable cost and giving DeFi lenders real yield.

In June 2022, the protocol launched Centrifuge Connectors. It is a cross-chain solution to the problem of bringing assets first to the Centrifuge chain to provide liquidity the pools. Due to Centrifuge Connectors, investors can supply liquidity from any supported blockchain without transporting them to the Centrifuge chain.

Goldfinch protocol

Goldfinch aims to create a global credit marketplace where anyone can originate a loan. The process begins with the Borrowers proposing deal terms for credit lines called Borrower Pools which are smart contracts containing information on the loan, such as interest rate and payment schedule.

Once Auditors verify a Borrower Pool, investors can provide liquidity by adding USDC to the pool. There are two kinds of investors on Goldfinch: Backers, who directly supply liquidity to the Borrower Pools’ junior tranches, and Liquidity Providers who diversify their capital by investing in many pools’ senior tranches across the protocol.

Borrower pools on Goldfinch consist of junior and senior tranches. A repayment made by a borrower to a Borrower Pool first goes to the payment of principal and interest owed by the senior tranche. Once the senior tranche is paid, any remaining part will go towards to the payment of the interest and principal of the junior tranche.

This is by design – it aligns the incentives of participants. Recall that the system depends on the Backers who assess the viability of Borrowers. Since they take highest risk by supplying first-loss capital into the junior tranche, they have to do a good job to evaluate an individual Borrower Pool. Liquidity providers, on the other hand, are more secure because they have first lien on the pools. This means in case of default, they will be the first to be repaid. Since they bear less risk than Backers, senior tranches’ APY are less than that of junior tranches.