Core Viewpoint
1. The digital encryption ecosystem and traditional finance need each other. Although the combination is not completely compatible in the case of incomplete infrastructure, the combination of the two can still solve practical problems.
2. The introduction of blockchain technology alone cannot solve the division of judicial power. RWA lending business has not brought the advantage of trustlessness into traditional finance, but has instead introduced the default risk of traditional finance into the blockchain. In the context of not being able to achieve trustlessness, some projects have tried to solve the industry difficulties through the method of multi-party trust. This is a rare business innovation.
3. Participation qualifications are inherited from the traditional world. No permission is required, which is not a feature of RWA business. Permission is an important governance power. Some projects attribute power to the team, while others implement token governance. Whether the governance power is decentralized is a rare breakthrough in RWA lending business.
4. Although RWA is not beautiful, the pie is big enough.
background
One of the emerging trends in the blockchain and cryptocurrency world is the use of real-world assets to expand on-chain credit. This involves leveraging blockchain technology to create digital representations of real-world assets, such as real estate, commodities, or artwork, and using these digital assets as collateral to issue on-chain credit. By doing so, borrowers can obtain credit more easily and cheaper than traditional loans, while lenders can earn interest on the assets they hold by providing liquidity to the market. This approach has the potential to democratize access to credit and make it more inclusive, especially for underserved or marginalized communities that have difficulty accessing traditional financial services. Additionally, by using real-world assets as collateral, on-chain credit markets can be more stable and less susceptible to the volatility and speculation that can plague other forms of cryptocurrency lending.
Overview of traditional global bond markets
The traditional bond market has a long and rich history, dating back to the 17th century, when the Dutch East India Company issued bonds to finance its trading activities. Since then, financial markets have grown significantly, and bonds have gradually become an important means of financing for governments, businesses and other institutions.
In modern times, the traditional bond market can be summarized as a decentralized global network of buyers and sellers that trade debt securities, or bonds, issued by borrowers seeking to raise capital. The market is highly diverse, with bonds issued by governments, corporations, municipalities, and other entities, and can be further categorized based on a range of factors such as the bond's maturity, credit rating, and currency denomination.
Market Situation Summary
The traditional bond market is massive, with an estimated $123 trillion in bonds outstanding as of 2021, according to the Bank for International Settlements. The market is also highly globalized, with bond issuance and trading occurring primarily in major financial centers such as New York, London, Tokyo, and Hong Kong, as well as in regional markets around the world.
Data from the Bank for International Settlements show that the United States and Japan together accounted for nearly half of global bond issuance in 2020, while Western Europe and China accounted for another quarter. This reflects the strong presence of developed countries in the market, which have well-developed financial systems, deep capital pools, and stable political and economic environments that are attractive to borrowers.
In contrast, developing countries have traditionally had a smaller presence in traditional bond markets, in part due to their relative lack of financial infrastructure and political and economic instability. However, in recent years, there has been a trend towards greater participation from emerging markets, with issuers from countries such as Brazil, Mexico and Indonesia becoming more active in the market.
Despite this trend, there are still significant disparities in the distribution of traditional bond markets. For example, according to the International Monetary Fund, developing countries account for only about 20% of global bond issuance, despite representing about 2-third of the world's population and a significant share of global economic growth.
One factor that contributes to these differences is the so-called “interest rate gap,” which refers to the difference in interest rates between developed and developing countries. Interest rates are generally lower in developed countries, reflecting their stronger financial systems and stable political and economic environments. This makes it more difficult for developing countries to compete in traditional bond markets because they must offer higher interest rates to attract investors.
The vertical structure of the bond market
The financial infrastructure of the traditional bond market includes a range of participants such as issuers, underwriters, dealers, and investors. The process of issuing bonds usually includes several steps, such as selecting the type and structure of the bond, determining the interest rate or coupon, and finding buyers for the bond. Issuers can work with underwriters who help market and sell the bonds to investors, or they can issue bonds directly to the public through a public offering.
After a bond is issued, it is typically traded in the secondary market, where investors can buy and sell it based on market value, which is determined by a number of factors, including the bond's credit risk, liquidity, and prevailing interest rates. The market price of a bond is also influenced by the yield curve, which reflects the relationship between bond yields and maturity, as well as other macroeconomic factors, such as inflation and monetary policy.
Traditional bond markets have historically played a key role in supporting economic growth and development, providing a reliable source of financing for a wide range of projects and initiatives. However, the market also faces a number of challenges and limitations, such as the risk of borrower defaults, the complexity of some bond structures, and the potential for market volatility. As a result, there has been a growing interest in alternative financing models, such as blockchain-based lending platforms that use real-world assets as collateral.
Challenges of Traditional Lending
Traditional financial lending faces many challenges that have led to a growing demand for blockchain-based lending solutions. Some of the main challenges include:
1. High transaction costs: Traditional financial lending often involves a large number of intermediaries, each of which takes a cut of the transaction. This can lead to high transaction costs, making it more difficult for borrowers to obtain credit and for lenders to generate adequate returns.
2. Lack of transparency: Traditional financial lending can also lack transparency, with borrowers often unaware of the terms and conditions of their loan or the fees and charges associated with borrowing. This can lead to a lack of trust between borrowers and lenders, making it more difficult to build long-term relationships.
3. Slow and inefficient processes: Traditional financial loans can also be slow and inefficient, with borrowers often required to provide extensive documentation and go through a lengthy approval process. This can be particularly challenging for small businesses and individuals who may not have the resources to navigate these processes.
4. Limited access to credit: Finally, traditional financial lending may be hampered by limited access to credit, particularly for individuals and businesses in developing countries or with limited credit histories. This can make it difficult for these individuals and businesses to obtain the capital they need to grow and prosper.
These challenges have led to a growing demand for blockchain-based lending solutions that offer a range of benefits, including increased transparency, reduced transaction costs, and faster, more efficient processes. As blockchain technology continues to mature and develop, we are likely to see continued innovation in this space as developers and entrepreneurs seek to leverage the unique advantages of blockchain technology to create new and innovative lending products and services.
Blockchain lending with real-world assets as collateral
DeFi represents a significant shift from the traditional financial system, providing greater accessibility, transparency, and efficiency. As the technology continues to develop and mature, we can expect to see continued innovation in this space, with the launch of innovative products and services designed to meet the needs of users around the world.
A. Definition and characteristics of real-world asset blockchain lending
Blockchain lending for real-world assets (RWAs) involves using blockchain technology to create digital representations of real-world assets, such as real estate, commodities, or art, and using those assets as collateral to extend loans or other forms of credit. This type of lending is often referred to as “asset-backed lending” and has a number of key characteristics.
First, stability. The use of RWAs provides a more stable and reliable basis for the valuation of blockchain-based financial products and services, helping to reduce risk and increase the stability of the blockchain ecosystem. This is because RWAs are backed by tangible assets that have intrinsic value and are tied to real-world cash flows, making them less prone to volatility and speculation than purely cryptocurrency-based lending.
Second, democracy. Blockchain lending with RWAs can democratize access to credit and make it more inclusive, especially for underserved or marginalized communities that may have difficulty accessing traditional financial services. This is because RWAs can be used as collateral to issue loans and other forms of credit that are easier to obtain and less expensive than traditional loans.
Third, transparency. Using blockchain technology can improve the transparency and accessibility of the lending process, as all transactions are recorded on a public ledger that is accessible to all participants. This helps reduce the risk of fraud and improves trust between lenders and borrowers.
Overall, blockchain lending with real-world assets has the potential to revolutionize the lending industry by making credit more accessible, stable, and transparent. The new mechanism will reduce risk for all participants.
B. Advantages of blockchain lending and traditional lending
Blockchain lending using real-world assets represents a significant departure from traditional lending models in several key ways.
First, one of the most notable differences is international accessibility and global market integrity. Unlike traditional lending, which is often subject to geographical restrictions and regulatory limitations, blockchain lending is available to borrowers and lenders anywhere in the world. This is because blockchain lending operates on a decentralized network that is not bound to any specific geographic location or jurisdiction. Therefore, blockchain lending with real-world assets can provide borrowers and lenders with greater flexibility and access to capital that they may not be able to obtain through traditional lending channels.
In addition to the international accessibility mentioned earlier, blockchain lending using real-world assets also provides greater accessibility to crypto-financial instruments. An example of this is the ability for certificates issued by RWA lending projects to be refinanced by other DeFi projects. This creates a more interconnected lending ecosystem, enabling borrowers to access funding from a wider range of sources. Additionally, on-chain activity can serve as evidence for DeFi-based identity (DID) and reputation systems. This means that borrowers' behavior and payment history can be tracked and used to build trust and reputation in the DeFi ecosystem. Finally, blockchain lending can also provide borrowers with greater flexibility, as they can choose different borrowing assets with different risk exposures based on their personal risk tolerance and investment goals.
Finally, blockchain lending of real-world assets is consensus-based and democratic. The decentralized nature of blockchain lending means that all participants in the network have a say in the decision-making process. This is in stark contrast to traditional lending, which is often controlled by a small group of institutions or individuals who decide who can borrow and at what interest rate. In the blockchain lending space, decisions about who can borrow and at what interest rate are made through a consensus-driven process, which ensures that all participants have a say in the lending process. This democratic approach to lending helps to increase transparency and fairness, while also reducing the risk of bias and discrimination that may exist in traditional lending models.
In summary, blockchain lending offers several key advantages over traditional lending with real-world assets, including greater international accessibility, accessibility to crypto-financial instruments, and a more democratic decision-making process. These factors help make lending more inclusive, transparent, and convenient for a wider range of borrowers and lenders, while also promoting stability and reducing risk in the lending ecosystem.
C. Limitations of blockchain lending with real-world assets
While blockchain loans using real-world assets offer many advantages over traditional loans, there are also some limitations that must be considered.
First, while blockchain technology provides a trustless and transparent platform, blockchain lending using real-world assets introduces credit risk. Even if the assets are backed by real-world assets, borrowers can choose to default, exposing real-life settlement and jurisdiction issues. Of course, in this case, the consensus on the blockchain has failed, and the aura of trustlessness cannot be sprinkled on the real-world collateral assets. In addition, there may be challenges related to asset valuation, which may make it difficult to assess the appropriate level of collateral required for the loan.
Secondly, global compliance issues may arise when lending across borders. Different countries have different regulatory frameworks and compliance requirements, which may pose legal and operational challenges to blockchain lending platforms operating across multiple jurisdictions. Complying with anti-money laundering (AML) and know your customer (KYC) regulations may be particularly challenging for blockchain lending platforms, which may need to work closely with regulators in various countries to ensure compliance.
Third, blockchain lending still has technical risks. Blockchain technology is still evolving, and there may be technical challenges related to security, scalability, and interoperability that may affect the stability and reliability of blockchain lending platforms. There may also be challenges related to smart contract programming and execution, which may affect the performance and accuracy of lending contracts.
Overall, while blockchain lending offers many advantages over traditional lending with real-world assets, it is important to consider the potential limitations and risks associated with this new form of lending. By carefully assessing the risks and implementing appropriate risk management strategies, blockchain lending platforms can ensure the continued growth and development of this innovative emerging industry.
Case Study of Blockchain Lending Project
After the FTX crisis, the DeFi boom and RWA-related DeFi have subsided. The main players in RWA in the last bull market have scaled down, and survival has become the primary purpose. But their strategies are still worth paying attention to. At least, in the bull market, they created an explosive business scale.
“Waterfall” Financial Structure
To mitigate the credit risk of real-world asset contamination, most RWA lending introduced a waterfall structure. Now, it seems to be the mainstream in the RWA lending industry.
The waterfall structure in a CLO (collateralized loan obligation) refers to the priority of payments to the parties involved in the CLO. This structure is called a "waterfall" because the payments flow down in a predetermined order, like water flowing down a waterfall.
The waterfall structure is typically divided into several "tranches," which are different layers of debt issued by the CLO. Payments are arranged in order of priority, with the most senior tranche receiving payment first, followed by the next most senior tranche, and so on. The payment waterfall starts at the top of the structure and flows down through each tranche until all payments have been made.
This structure was first invented in the 1980s, but became popular after the 2000s. There are three main reasons for its popularity: 1. The development of financial technology allows institutions to measure risks more accurately; 2. Electronic trading systems reduce transaction costs; 3. In the case of low interest rates, this structure can provide additional returns as long as you have additional risk information.
There is an outlier in RWA, led by Ondo Finance, which provides loan financing with high-quality assets such as US Treasury bonds as collateral. Because the risk of default is extremely small (including US interbank bonds), there is no need to adopt a "waterfall" structure to deal with the risk of default.
A. Centrifuge Products:
Centrifuge has the largest RWA collateral lending market. As it claims: "Centrifuge is the infrastructure for decentralized financing of physical assets natively on the chain, creating a fully transparent market that enables borrowers and lenders to trade without unnecessary intermediaries."
TVL：192.1M
FDV：112.2M
Investment agency:
mechanism:
Features:
On-chain-off-chain structure
As a pioneer in the RWA lending industry, Centrifuge adopts both on-chain and off-chain structures to reduce credit risk. In the off-chain structure, it has established an SPV structure, and the collateral will be easily liquidated when a default occurs. It uses centralized KYC and AML services to comply with regulations in different countries. In addition to the signatures and transaction records on the chain, investors can also sign a subscription agreement with the issuer.
Diverse RWA Collateral
Collateral is diversified, including emerging market consumer loans and structured credit. Each project will have an independent SPV wallet to control its fundraising. Interest rates range from 3%+ to 10%+.
High default rate
The default rate of its completed loans is 5.6% by size. A high default rate does not mean failure, but rather that it is more inclined to adopt riskier financial strategies. Since it has no intentional process for selecting investment projects, it does not bear any responsibility when the projects fail.
B. Maple Products:
Maple is transforming capital markets by combining industry-standard compliance and due diligence with the transparency and frictionless lending made possible by smart contracts and blockchain technology. Maple is the gateway to growth for financial institutions, pool representatives, and companies seeking on-chain capital.
TVL: 28.4M
FDV: 78.7M
supporter:
mechanism:
Maple converts traditional CLOs (Collateralized Loan Obligations) into cryptocurrency. Each project has a representative who is also the provider of first-loss capital. The representative is also responsible for executing the impairment in the event of a default. The representative needs to be verified by the Maple team.
Features:
Black Box and Centralization:
The power to determine who can become a representative is controlled by the Maple team. Currently 62% of active loans are delegated to Maven 11. Has a recovery plan and legal agreement with the borrower in the event of a default.
Moderate default rate
Its default rate is 2.935%, but given the proportion of exposure to M11, I think it presents too much risk.
C. GoldFinch
Goldfinch is a decentralized protocol for crypto lending without cryptocurrency collateral. The Goldfinch protocol has four core participants: borrowers, backers, liquidity providers, and auditors. Unlike other protocols, Goldfinch attempts to establish a unified risk asset (RWA) associated with real assets. All assets in the premium asset pool face the same risk.
VAT: 101.6M
TVL：66M
Supporting Organizations:
mechanism:
Features:
1. Decentralization:
The project has a decentralized decision-making process, where supporters collectively decide whether the project can successfully raise funds and how large it can be.
2. Innovative credit model:
The project adopts a leverage model and a dynamic supporter incentive mechanism. The leverage model determines the amount of capital allocated by the premium asset pool to each borrower pool based on the trust level of each borrower pool. When more supporters invest in a borrower pool, the borrower pool appears more reliable and can obtain more leveraged capital.
3. Diversified borrowers:
The project spreads capital across different types of borrowers and lending situations, ranging from fintech in emerging countries to consumer debt-backed loans in developed countries. The decentralized nature of borrowers means that default risk is also dispersed.
4. Unified Risk and Liquidity:
The project has a unified pool of senior assets with liabilities and interest rates consistent across the range.
5. Low default risk:
So far, the default risk is zero, indicating that the project has a low risk of default.
D. Believe
product
Credix is a next-generation credit ecosystem that enables institutional borrowers to access liquidity and creates attractive risk-adjusted investment opportunities for institutional investors, credit funds and accredited investors.
Supporting Organizations:
mechanism:
Features:
Centralization:
The project has a centralized underwriting process, with one person responsible for screening, due diligence, and investment structuring. This is similar to how one entity in traditional finance has control over the investment process.
Market Specific:
When a new lending project is created, a unique LP token is generated to distinguish investments in different liquidity pools in different markets. However, this can lead to weaker liquidity because liquidity demand and supply are split.
Non-transferable:
The tokens used in the project are non-transferable and can only be traded in accounts that meet regulatory requirements. Although this design helps with compliance issues, it may make it difficult for individual investors to participate in the market. Therefore, many investors may be excluded from participation due to the platform's strict requirements.
Three layers of default protection:
Credix uses a variety of methods to ensure that funds in senior security can be repaired. In addition to funds in overcollateralized assets and subordinated security, it can also use the gap between the fintech company's revenue and the interest it pays to Credix for repair.
E. TrueFi:
product:
TrueFi is an unsecured lending protocol based on on-chain credit scoring, controlled by TRU holders. It is part of the TrustToken ecosystem. There is no clear solution when overdue or default occurs. The quality of each loan project is highly dependent on the decision of the portfolio manager. It is also a centralized structure.
Supporting Organizations:
mechanism:
The portfolio manager provides detailed information on each deal and the borrower chooses whether to accept it. Deals can also be divided into three risk tiers. Different tiers have different default liabilities and interest rates.
Features:
TrueFi has chosen a gradual decentralization process. Currently, the solution is very centralized. No default recovery plan is considered at the platform level. So far, its default rate is 0.258%, which is relatively low. But this is not the result of TrueFi's systemic credit solution. There is no need to use physical assets (RWA) as collateral, and loans rely purely on the credit or reputation of the borrower.
comparative analysis:
1. KYC and Compliance:
Since the business involves real-world assets, cash flow, and settlement in case of default, local government support, KYC, and compliance issues are crucial. All of these projects take these matters very seriously and introduce third parties related to this business. As we mentioned before, the largest part of the financial cost of lending is the compliance cost, and none of these projects has more advantages over traditional finance in this regard. In order to meet compliance requirements, even the voucher tokens are designed to be non-transferable.
2. Credit:
On-chain credit is a good thing for open finance. But none of these projects have tried to introduce on-chain credit into project credit assessment. On the one hand, DeFi has a short history and limited on-chain activities. On the other hand, the cost of creating an anonymous account is almost zero. On-chain data cannot represent personal credit. Only GoldFinch tries to allow each entity to have only one unique account on the platform.
3. Credit default rescue plan:
Maple Finance, GoldFinch, and Centrifuge provide solutions when credit default occurs. For off-chain collateral, these projects prefer to use SPV to control the disposal rights. Credix tells users that they have a team to manage collateral. TrueFi does not have a clear explanation for default. Interestingly, when FTX collapsed, Justin SUN transferred $6 million from Alameda Research.
4. Transparency:
All on-chain behaviors are transparent. However, off-chain cash flows and off-chain information related to debt credit need to be disclosed regularly. Centrifuge claims to have a peer-to-peer network to share information. However, since the crypto industry is brand new, whether information disclosure should comply with securities laws still needs to be discussed.
5. Liquidity:
Centrifuge provides margin for others to withdraw. GoldFinch has unique credit risk assessment and liquidity from a unified pool of high-quality assets. As the business scales, its liquidity will also increase. Credix has poor liquidity, especially when its loan pool is exhausted. Maple Finance does not specify how it will build liquidity.
conclusion and suggestion
This is not good business, it is huge business.
Real world finance is much larger than DeFi, and the decentralized world is still in its infancy compared to traditional industries. Even if a small portion of traditional finance moves to blockchain, it will be a huge success for DeFi and its infrastructure.
The crypto world needs real assets (RWA) to enhance its credit value.
There are fewer stable businesses in the emerging decentralized world. Therefore, the discount rate for collateral is much higher than that for physical assets. We can see that if USDC and USDT support a blockchain, the blockchain will have better liquidity and it will be easier to build DeFi. The same is true for other business areas. The crypto world needs stable assets in the real world to improve its credit. The largest category of RWA on-chain assets is actually stablecoins. If we retrieve the number of authorizations of centralized stablecoins in different ecosystems, we will find that: the higher the authorization, the higher the chain valuation. This is why RWA is so important to the crypto industry.
The imbalance in the development of the global financial system provides room for RWA lending.
In the traditional world, especially in some developing countries, financial infrastructure is limited. Many business opportunities are missed due to the lack of a credit system. The real world needs blockchain to help build a credit system. There are huge differences in financial levels between countries and regions. For example, in Kenya, the financial network is not nationwide, and many cities do not have a financial system. The accessibility of crypto finance is much higher than traditional finance.
Lack of infrastructure
Even though we know that using blockchain has many advantages, the process of handling each lending case involving the real world and different jurisdictions affects the lending risk. In the real world, the settlement of RWAs and other financial and compliance services are very time-consuming and expensive. In my opinion, GoldFinch is the most innovative and decentralized RWA lending project in my mind. However, even GoldFinch does not introduce the credit score of the endorser to measure the lending risk. All solutions to default risks rely on individual regulations in various jurisdictions in the traditional world. As long as these regulations are not blockchain-based, most of the financial costs cannot be reduced.
KYC and compliance are only a passive requirement for customers
When we read the documents of these projects, there are few lines showing the connection between KYC and security. All the compliance efforts seem to be just for compliance with the law, not for the safety of customers' funds. All these reasons lead to the existence of a huge RWA collateral lending market, but crypto projects cannot expand their business in the short term.
