What are RWAs and which DeFi protocols are being introduced into RWAs

The financial industry is on the verge of transformation. DeFi is gradually expanding beyond cryptocurrencies to have an impact on the real world. As more and more assets are tokenized, traditional capital markets are also moving towards blockchain.

At the same time, due to rising interest rates, declining DeFi demand, and a sluggish global macroeconomic environment, the opportunity cost of transferring funds on-chain is at its highest level in cryptocurrency history. Real-world assets (RWAs) offer income-poor DeFi investors a unique opportunity to access different off-chain debt markets, while also allowing TradFi (traditional financial) institutions to tokenize and issue debt/assets regardless of market geography.

What are RWAs?

RWAs are tokens (fungible or non-fungible) that can be traded on-chain and represent real assets. Examples of RWA relate to real estate, loans, contracts and guarantees, and any high-value project applied to a transaction.

RWAs break down many of the traditional restrictions. Let’s say there is a mid-sized fintech company in Indonesia called Bali, and Bali wants to raise funds to promote its own development and marketing activities. Within hours, the company was able to raise more than $100,000 not from traditional banks or venture capital firms, but through the issuance of tokenized bonds. This bond token can be packaged with many similar Indonesian fintech bonds and sold at different capital levels.

Like other on-chain assets, Bali’s finances are transparent. As Bali’s gains and costs change, so does the token price, and changes in credit risk are automatically reflected in the loan.

Thanks to RWAs, Bali is able to borrow at a competitive interest rate of 7%, compared to the usual borrowing rate of 14% for fintech companies in Indonesia, and investors are able to obtain competitive real-world lending rates with lower DeFi yields. RWAs enable economic growth to be independent of geographical location, and companies can raise capital through digital or traditional means to achieve long-term stability.

Why RWAs?

The success of securitization in the 90s of the 20th century is an example of how improvements in standards and norms have changed capital formation. Securitization is simply a system of creating, aggregating, storing and diversifying risk. By proposing benchmarks (maturity, risk, etc.) that assets must meet, liquidity is significantly improved and funding sources expanded. Mortgage, corporate and consumer loans were institutionalized and deployed through securitization, providing more affordable financing for consumers, companies and home buyers.

Securitization 30 years later is basically the same; Financial markets have not evolved to adapt effectively to the development of the Internet. Due to the existence of a network of intermediaries, including investment banks, custodians, rating services, service providers, etc., borrowing costs exceed the appropriate level. Most assets cannot be securitized because the production process of the assets does not fully correspond to the requirements of securitization. Most business owners still do not have access to international financial markets. In Africa and Asia, basic resources like insurance are still hard to come by. This begs the question: how can the digital capital market cross the TradFi moat?

LHGGWmnGfrB44PG8nSTlASdRu7sM0M5auarbyW0O.png

For DeFi to be successful, its main goal must be to establish a connection between the crypto world and the real world. While the digital asset market is still small ($1 trillion), the real-world asset market is huge ($> $600T). If cryptocurrencies are to have an impact on business operations, they must unlock this ocean of value.

Asset custody

Given the proliferation of digital assets and the influx of new institutions, the importance of solid institutional custody of digital assets cannot be overemphasized. Over the past few years, DeFi managed service licensing platforms like Anchorage Digital and Copper have proliferated. Some credit agreements, such as Maple, guarantee their tokens on these permissioned platforms that serve institutions.

As it stands, escrow is largely guaranteed by the legal structures generated with the creation of asset pools, as well as through standard KYC/AML procedures. Take Centrifuge as an example – after interacting with the pool, the investor signs an agreement with the pool’s issuer to set the pool as a Special Purpose Vehicle. The agreement provides for the issuer’s liability for future repayment.

All financing transactions and payments take place directly on-chain between borrowers, special purpose vehicles and investors. In the future, credit protocols will be more integrated with decentralized identity projects (DIDs) like Kilt to support asset verification. The underwriters are then integrated into third-party risk assessment agencies instead of the existing status forecasting system.

liquidity

Specific tokenized assets, such as real estate transactions, can be highly illiquid. The liquidity of an asset pool depends on the maturity of the assets and the inflow and outflow of investors. The revenue-based incentive model is another lucrative source of liquidity.

In addition, the protocol can work with decentralized exchanges (DEXs), automated market makers (AMMs), and other DeFi applications such as Balancer and Curve to create liquidity. A notable example of this is Goldfinch, whose members created a liquidity pool on Curve using FIDU and USDC, which are tokens deposited in premium pools on behalf of liquidity providers. This allows FIDU-USDC Curve LP positions to receive GFI liquidity mining rewards.

Credit agreements

The biggest reason for institutions’ unease with DeFi is the lack of a standardized reputation system, such as credit scoring. Lacking the ability to force repayment in the event of a future default, DeFi protocols have had to use liquid tokens as collateral. This excludes credit risk, but also limits the number of financial products that may be available. Credit agreements are using complementary strategies to give loans a creditworthiness component. Some strive to bring off-chain reputation into the on-chain world, while others are genuinely committed to creating an on-chain reputation system.

While the specifics differ, this is the target of major credit agreements such as Maple, TrueFi, Goldfinch, Centrifuge and Clearpool.

tiHvD55X1PO4iM0TaoPxlOvS4w0PPMf2PuAf6nCZ.png

Goldfinch

Goldfinch is developing a decentralized loan underwriting protocol that will enable anyone in the world to issue loans on-chain as an underwriter using data representing KYC/KYB such as Unique Identity (UID) NFTs. Their argument is based on two basic principles:

  • Over the next decade, investors will need new investment opportunities due to the overall transparency and efficiency of DeFi, and the overall environment that suppresses interest rates, which is now changing. Investors will also demand investment opportunities with higher returns than traditional banks and institutions offer.
  • Global economic activity will shift to an on-chain model that makes every transaction transparent, creating a new public good: an immutable, publicly available credit history and lower significant transaction costs associated with banking.

Collecting information generated in real life and online is the main goal and using this information to build a reputation of users that can be applied on-chain.

Like all credit institutions, the system is not without risk. Ways to protect lenders include preventing defaults or, in the event of default, compensating lenders if possible.

Goldfinch relies on its backers, investors who provide USDC to the borrower pool, to monitor the health of the pool and provide liquidity. They do this because in the event of a default, the first thing they lose is their liquidity. Similar to TrueFi, Goldfinch offers smart contract insurance through Nexus Mutual.

vggpdCMt9YkuFNiifjnj2I3f52ktpozi6rtVVqSU.png

Centrifuge

Centrifuge is a network that provides fast, low-cost funding for small businesses, providing investors with stable income. Centrifuge bridges real-world assets to DeFi, reducing financing costs for small and medium-sized businesses and providing DeFi investors with a stable source of income that is not affected by fluctuations in crypto assets. Centrifuge’s reliable lending and low default rate rely on asset originators and issuers. Centrifuge’s junior tranche investors will be the first to bear the loss in the event of default.

Tinlake is their first user-facing product that provides an easy way for all companies to access DeFi liquidity. For investors, these assets will bring safe, consistent returns on their investments, unaffected by the volatile conditions of the cryptocurrency market. Their native token, the Centrifuge token (CFG), uses a proof-of-stake consensus approach to stake validator nodes and provides incentives for adoption. Through on-chain governance, CFG holders can positively influence the development of Centrifuge.

Tinlake’s valuation methodology is based on a discounted fair value cash flow model, and their approach can be summarized as follows:

  • Calculate expected cash flow: For each outstanding financing of an asset, calculate the expected cash flow. Calculated based on the expected repayment date and expected repayment amount.
  • Risk-adjusted expected cash flow: Cash flow is risk-adjusted for credit risk through expected losses. The expected loss is calculated as: expected loss = expected cash flow * PD (probability of default) * LGD (default loss rate), and subtract the expected repayment amount to adjust for credit risk.
  • Discounted risk-adjusted expected cash flow: Discounting the expected risk-adjusted cash flow at an appropriate discount rate (depending on the asset class and asset pool) to arrive at the present value of the financing.
  • Calculate NAV (Net Asset Value): Add the present value of the expected risk-adjusted cash flows of all financing in the pool to obtain the NAV.

TrueFi

TrueFi is the mainstream credit protocol that provides a wide range of real-world and native crypto funding opportunities for on-chain capital markets. As of November 2022, TrueFi has issued more than $1.7 billion in unsecured loans, paying over $35 million to lenders, with every dollar distributed and reported on-chain. Through a path of gradual decentralization, TrueFi is now owned and governed by TRU token holders, underwritten by TrueFi DAOs or independent portfolio managers.

TrueFi serves (and is largely made up of) its four main players and acts together:

  • Lenders use TrueFi to capture opportunities across a range of portfolios.
  • After review, borrowers rely on TrueFi to quickly access funds at competitive interest rates without locking in collateral, maximizing the borrower’s capital efficiency.
  • Portfolio managers use TrueFi to build on-chain portfolios that incorporate blockchain benefits into their investment activities, such as round-the-clock connectivity opportunities with global lenders, greater transparency, and lower operating costs.
  • TRU holders effectively own and manage the TrueFi protocol, making key decisions and contributions to the development of TrueFi through open discussion and on-chain voting.

TrueFi’s core contributor, Archblock (formerly TrustToken), initially set foot on real-world assets in 2018 with the launch of the hugely popular TUSD stablecoin. Starting in early 2022, TrueFi has further penetrated into real-world assets by launching capital markets, allowing traditional funds to move their lending portfolios on-chain. Today, TrueFi’s portfolio facilitates Latin American fintech companies, emerging markets, and even crypto mortgages.

The process of becoming a borrower or portfolio manager on TrueFi is similar to most other credit agreements: each applicant must submit a public loan application describing their business and use of the funds, subject to community approval, and also meet the underwriting requirements of the TrueFi credit committee (such as controlled capital, maximum leverage, and asset exposure). Successful applicants are whitelisted to borrow from TrueFi’s pool of permissionless DAOs or design and launch their portfolios.

37II1Dq6pJ07Lvx3Ezql6oohMQLHPgxpzY76pDqU.png

TrueFi has taken some unique measures to protect lenders. In addition to managing a rigorous underwriting process under the leadership of the DAO Credit Committee and committing to regular code audits during major protocol upgrades, TrueFi has three tiers of recourse in the event of a breach. First, forfeit up to 10% of TRU pledges to compensate for the lender’s losses; Following this, TrueFi’s User Security Asset Fund (or “SAFU”) may deploy its reserves to cover any further losses; Finally, any successful collection action against defaulting borrowers will be properly paid through the DAO. In addition, TrueFi offers a smart contract insurance plan, which can be purchased through Nexus Mutual, providing insurance coverage in case a smart contract is attacked.

After a process of gradual decentralization, TrueFi is now owned and governed by TRU token holders. TrueFi DAOs now own and manage TrueFi’s permissionless pools, repositories, and roadmaps. The DAO has set its sights on deeper institutional adoption and DeFi integration, introducing features such as tiering and optimized investment composability.

Maple

In 2021, Maple launched a low mortgage project for licensed KYC loans.

Unlike the standard DeFi model, which relies on collateral to compensate for cuts in mortgaged assets in case of underpayment, Maple allows users to offer low mortgages to reputable companies based on creditworthiness. There are currently borrowers from other pools such as Alameda Research, Framework Labs and Wintermute Trading.

The protocol is governed by two tokens (MPL and xMPL), enabling token holders to participate in governance, share fee income, and provide Pool Cover guarantees to lending pools.

Maple token (MPL) holders can participate in governance and make a profit by:

  • Passive MPL holders receive a portion of the account opening fee.
  • Savvy MPL holders can earn extra income by choosing a liquidity pool to stake.
  • Stake MPL-USDC 50-50 BPTs as a provision for loan default to receive a portion of ongoing charges.

As Maple moves towards full decentralization, MPL holders will be able to submit proposals and vote on changes such as increasing pool delegates, adjusting fees, and staking parameters. For pool reps, Maple is a tool to attract funds and earn returns.

1xpkfycZa5hTlSX8AhDB63RYC7rEhCsgmCpMwl2A.jpeg

Pool representatives are crucial in this process of Maple. Pool representatives go through a strict approval process as they are responsible for maintaining the stability of the Maple lending pool. This is achieved by authorizing loan requests, screening borrowers, and initially establishing a lending pool. Finally, Maple requires each pool representative to stake MPL tokens as the first losing capital. Therefore, if the borrower defaults, the pool representative will also suffer. However, in the event of a default, Maple adopted the Pool Cover (essentially a first-to-lose pool), funded by pool representatives and MPL holders.

Conclusion:

As the industry develops, the efficiency of capital flows will increase by an order of magnitude. In a fully efficient market, one pre-approved borrower might take a $5 million loan, pay it off in 30 minutes, and then watch as another borrower quickly gets the same amount. This flow will be driven by a credit model that constantly assesses each borrower’s risk of default and responds adequately to any new information available. In such a future, every amount of money is immediately allocated to where risk-adjusted returns are highest. Credit agreements such as TrueFi, Centrifuge and Goldfinch will play an important role in guiding the financial industry in this direction.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/what-are-rwas-and-which-defi-protocols-are-being-introduced-into-rwas/
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

Like (1)
Donate Buy me a coffee Buy me a coffee
Previous 2022-10-26 11:21
Next 2022-10-26 11:23

Related articles