Original author: armonio,AC Capital Research
1. Digital encryption ecology and traditional finance need each other. Although in the case of incomplete infrastructure, the joint surface does not fit perfectly. The combination of the two can still solve practical problems at present.
2. The introduction of pure blockchain technology cannot solve the separation of judicial power. The RWA lending business does not currently bring the advantages of no need for trust to traditional finance, but instead allows the default risk of traditional finance to be transmitted to the blockchain. Under the background of not being able to achieve no trust, some projects try to solve the industrys difficulties in the way of multi-party trust. This is a rare business innovation.
3. Participation qualifications are inherited to the traditional world. Licensing is not a hallmark of the RWA business. Permissions are an important governance power. Some projects attribute power to the team, and some land on token governance. Whether the governance right is decentralized or not is a rare breakthrough in the RWA lending business.
background
background
One of the emerging trends in the blockchain and cryptocurrency world is the use of real-world assets to extend on-chain credit. This involves using 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, and lenders can earn interest on the assets they hold by providing liquidity to the market. This approach has the potential to democratize and make access to credit more inclusive, especially for underserved or marginalized communities that struggle to access 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 trade activities. Since then, financial markets have grown significantly, and bonds have become an important means of financing for governments, corporations, and other institutions.
In modern times, the traditional bond market can be summarized as a decentralized global network of buyers and sellers trading 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 including the bonds maturity, credit rating, and currency denomination.
Summary of market conditions
The traditional bond market is massive, with an estimated ***$123 trillion*** of bonds outstanding as of 2021, according to the Bank for International Settlements. The market distribution is also highly globalized. Bond issuance and transactions mainly take place in major financial centers such as New York, London, Tokyo, and Hong Kong, as well as in regional markets around the world.
The U.S. and Japan together accounted for nearly half of global bond issuance in 2020, with Western Europe and China accounting for another quarter, according to the Bank for International Settlements. This reflects the strong presence in the market of developed countries with well-established 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 share of traditional bond markets, partly due to their relative lack of financial infrastructure and political and economic instability. In recent years, however, there has been a trend towards greater participation in emerging markets, with issuers from countries such as Brazil, Mexico and Indonesia becoming more active in the market.
Despite this trend, there are significant differences 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- a third of the worlds population and a significant share of global economic growth.
One factor contributing 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 in developed countries are generally lower, reflecting their stronger financial systems and stable political and economic environments. This makes it harder for developing countries to compete in traditional bond markets, as they must offer higher interest rates to attract investors.
The Vertical Structure of the Bond Market
The financial infrastructure of a traditional bond market includes a range of participants including issuers, underwriters, dealers and investors. The process of issuing a bond usually includes several steps, such as selecting the type and structure of the bond, determining the rate or coupon, and finding a buyer for the bond. Issuers may work with underwriters, who help market and sell the bond to investors, or they may issue the bond directly to the public through a public offering.
After the bond is issued, it is usually traded in the secondary market. Investors can buy and sell the bond according to the market value. The market value is determined by a series of factors such as the bonds credit risk, liquidity and prevailing interest rate. The market price of bonds is also influenced by the yield curve, which reflects the relationship between bond yields and maturities, 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 constraints, such as the risk of borrower default, the complexity of some bond structures, and the potential for market volatility. As a result, there is 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 major challenges include:
1. High transaction costs: Traditional financial lending often involves a large number of intermediaries, each of which takes a commission from the transaction. This can lead to high transaction costs, making it harder 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 not knowing the terms and conditions of their loans or the fees and charges associated with borrowing. This can lead to a lack of trust between borrowers and lenders, making it harder to build long-term relationships.
3. Slow and inefficient process: Traditional financial loans can also be slow and inefficient, with borrowers often required to provide extensive documentation and go through lengthy approval processes. This can be especially challenging for smaller businesses and individuals who may not have the resources to navigate these processes.
4. Limited access to credit: Finally, traditional financial lending may suffer due to limited access to credit, especially in developing countries or individuals and businesses with limited credit histories. This can make it difficult for these individuals and businesses to obtain the capital they need to grow and thrive.
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 evolve, 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 major shift in the traditional financial system, offering greater accessibility, transparency, and efficiency. As technology continues to evolve and mature, we can expect to see continued innovation in this space, launching 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 (RWA) 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 issue loans or other forms of credit. This type of loan is often referred to as an asset-backed loan and has a number of key characteristics.
First, stability. The use of RWA provides a more stable and reliable basis for the valuation of blockchain-based financial products and services, helping to reduce risks and improve 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 borrowing and lending.
Second, democracy. Blockchain lending with RWA could democratize credit access and make it more inclusive, especially for underserved or marginalized communities that may struggle to access traditional financial services. This is because RWA can be used as collateral to issue loans and other forms of credit that are more accessible and less expensive than traditional loans.
Third, transparency. Using blockchain technology increases 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 increases trust between lenders and borrowers.
Overall, blockchain lending has the potential to work with real-world assets by making credit more accessible, stable, and transparent. The new mechanism will revolutionize the lending industry by reducing 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 geographic restrictions and regulatory restrictions, 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 tied to any particular geographic location or jurisdiction. As such, 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 aforementioned international accessibility, blockchain lending using real-world assets also offers more accessibility to crypto financial instruments. An example of this is the ability of certificates issued by RWA lending projects to be refinanced by other DeFi projects. This creates a more interconnected lending ecosystem, enabling borrowers to access funds 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 the behavior and payment history of borrowers can be tracked and used to build trust and reputation within the DeFi ecosystem. Finally, blockchain loans can also provide borrowers with greater flexibility as they can choose different borrowing assets with different risk exposures according to their personal risk tolerance and investment goals.
Finally, blockchain lending of real-world assets is characterized by consensus and democracy. **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 rate. In the blockchain lending space, decisions about who can borrow and at what rate are made through a consensus-driven process, which ensures that all participants have a voice in the lending process. This democratic approach to lending and lending contributes to greater transparency and fairness, while also reducing the risk of bias and discrimination that may exist in traditional lending models.
All in all, blockchain lending has several key advantages over traditional lending over real-world assets, including greater international accessibility, accessibility to encrypted financial instruments, and a more democratic decision-making process. These factors help make lending more inclusive, transparent, and accessible to a wider range of borrowers and lenders, while also promoting stability and reducing risk in the lending ecosystem.
C. Limitations of Blockchain Lending and Real World Assets
While blockchain lending using real-world assets has many advantages over traditional lending, there are also 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 when assets are backed by real-world assets, borrowers can choose to default, exposing real-life settlement and jurisdictional issues. Of course, in this case, the consensus on the blockchain has expired, and the halo of trustlessness cannot be sprinkled on real-world mortgage assets. Additionally, there may be challenges associated with asset valuation, which can make it difficult to assess the appropriate level of collateral required for a loan.
Second, global compliance issues may arise when borrowing across borders. Different countries have different regulatory frameworks and compliance requirements, which can create legal and operational challenges for blockchain lending platforms operating across multiple jurisdictions. Complying with anti-money laundering (AML) and know-your-customer (KYC) regulations can be especially challenging for blockchain lending platforms, which may need to work closely with national regulators to ensure compliance.
Third, there are still technical risks in blockchain lending. 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 the blockchain lending platform. 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 has many advantages over traditional lending over real-world assets, it is important to consider the potential limitations and risks associated with this new form of lending. By carefully assessing risks and implementing appropriate risk management strategies, blockchain lending platforms can ensure the continued growth and development of this innovative nascent industry.
Case Studies of Blockchain Lending Projects
After the FTX crisis, the DeFi boom, and RWA-related DeFi, has faded. The major players in RWA in the last bull market have downsized and survival has become the primary objective. But their strategy is still worth watching. At least, in a bull market, they create an explosive business size.
Waterfall financial structure
To mitigate the credit risk of real-world asset contamination, most RWA lending introduces a waterfall structure. Now, it seems to be mainstream in the RWA loan industry.
The waterfall structure in a CLO (Collateralized Loan Obligation) is the priority of payments to the parties involved in the CLO. This structure is called a waterfall because payments flow down a predetermined sequence, like water flowing down a waterfall.
Waterfall structures are usually divided into several tranches, which are different layers of debt issued by the CLO. Payments are ordered in order of priority, with the most senior payment receiving payment first, followed by the next most senior payment, and so on. The payments waterfall starts at the top of the structure and flows down through each section until all payments are made.
This structure was originally invented in the 80s, but became popular after the 2000s. There are three main reasons for the prevalence: 1. The development of financial technology enables institutions to measure risks more accurately; 2. Electronic trading systems reduce transaction costs; 3. In the case of low interest rates, as long as you have additional risk information, this structure can provide additional benefits.
image description
product:
A. Centrifuge
product:
Centrifuge has the largest RWA collateral lending marketplace. As it claims: “Centrifuge is an infrastructure for decentralized financing of physical assets localized on-chain, creating a fully transparent marketplace that enables borrowers and lenders to transact without unnecessary intermediaries.
TVL： 192.1 M
FDV： 112.2 M
Investment agency:
Features:
Features:
On-chain-off-chain structure
A pioneer in the RWA lending industry, Centrifuge employs on-chain and off-chain structures to reduce credit risk. In the off-chain structure, it establishes the SPV structure, and when there is a default, the collateral will be easily liquidated. It uses centralized KYC and AML services to comply with regulations in different countries.
Financial agreement:
In addition to the signature and transaction records on the chain, investors can also sign a subscription agreement with the issuer.
Diverse RWA collateral:
Diversified collateral, including emerging market consumer loans and structured credit, etc. Each project will have an independent SPV wallet to control its fundraising. Interest rates range from 3%+ to 10%+.
High default rate:
product:
B. Maple
product:
Maple is transforming capital markets by combining industry-standard compliance and due diligence with the transparency and frictionless lending enabled by smart contracts and blockchain technology. Maple is the growth gateway for financial institutions, capital pool representatives, and companies seeking on-chain capital.
TVL: 28.4 M
FDV: 78.7 M
supporter:
mechanism:
Features:
Features:
Black box and centralization:
The power to determine who can be a delegate is controlled by the Maple team. Currently 62% of active lending goes to Maven 11.
Have a recovery plan and legal agreement with the borrower in case of default.
moderate default rate
product:
C. GoldFinch
product:
Goldfinch is a decentralized protocol for crypto lending without crypto collateral. The Goldfinch protocol has four core participants: Borrowers, Backers, Liquidity Providers, and Auditors. Unlike other protocols, Goldfinch attempts to build a unified risk-on-asset (RWA) relative to real assets. All assets in the advanced asset pool face the same risks.
FDV： 101.6 M
TVL： 66 M
Supporting Organizations:
Features:
Features:
1. Decentralization:
The project has a decentralized decision-making process where supporters collectively decide whether the project will be successful in raising funds and how large it will be.
2. Innovative credit model:
The project employs a leverage model and dynamic backer incentives. The leverage model determines the amount of capital that the senior pool allocates to each borrower pool based on the trust level of each borrower pool. When more backers invest in a borrower pool, the borrower pool looks more reliable and has access to more leveraged capital.
3. Diverse Borrowers:
The program spreads capital across different types of borrowers and lending situations, ranging from fintech in emerging countries to consumer debt-backed lending in developed countries. The decentralized nature of borrowers means that the risk of default is also spread.
4. Unified risk and liquidity:
The program has a unified pool of senior assets with responsibilities and interest rates consistent across the spectrum.
5. Low default risk:
product:
D. Credix:
product:
Credix is a next-generation credit ecosystem that enables institutional borrowers to access liquidity and create attractive risk-adjusted investment opportunities for institutional investors, credit funds and accredited investors.
Investment agency:
Features:
Features:
Centralization:
The program has a centralized underwriting process with one individual responsible for screening, due diligence and investment structuring. This is similar to the situation in traditional finance where one entity has control over the investment process.
Market specific:
When a new lending program is created, a unique LP token is generated to differentiate investments in different liquidity pools in different markets. However, this can lead to weaker liquidity as liquidity demand and supply are split.
Non-transferable:
Tokens used in the project are non-transferable and can only be traded in accounts that meet regulatory requirements. While this design helps with compliance issues, it may make it difficult for individual investors to participate in the market. Consequently, many investors may be excluded from participation due to the strict requirements of the platform.
Three layers of default protection:
product:
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. When overdue or default occurs, there is no clear resolution. The quality of each loan program is highly dependent on the decisions of the portfolio managers. It is also a centralized structure.
Supporting Organizations:
mechanism:
Features:
Features:
comparative analysis
comparative analysis
1. KYC and compliance:
As the business involves real world assets, cash flow and settlement in case of default, local government support, KYC and compliance issues are critical. All of these projects take these matters very seriously and bring in third parties involved in this business. As we mentioned before, the largest part of the financial cost of loans is the cost of compliance, and none of these projects have more advantages over traditional finance in this regard. To meet compliance requirements, voucher tokens are even designed to be non-transferable.
2. Credit:
On-chain credit is a good thing for open finance. But none of these projects attempted to introduce on-chain credit into project credit evaluation. On the one hand, DeFi has a short history and limited on-chain activity. On the other hand, the cost of creating an anonymous account is almost zero. Data on the chain cannot represent personal reputation. Only GoldFinch attempts to allow each entity to have only one unique account on the platform.
3. Rescue plan for credit default:
Maple Finance, GoldFinch, and Centrifuge provide solutions when credit defaults occur. For off-chain collateral, these projects prefer to use SPVs to control disposition. Credix tells users that they have a team to manage collateral. TrueFi was not explicit about the circumstances of the breach. Interestingly, Justin SUN moved $6 million from Alameda Research when FTX crashed.
4. Transparency:
All on-chain actions are transparent. But off-chain cash flows and off-chain information related to debt credit need to be regularly disclosed. Centrifuge claims to have a peer-to-peer network to share information. But since the crypto industry is brand new, there is still debate about whether disclosure should comply with securities laws.
5. Liquidity:
Centrifuge offers withdrawal deposits for others. GoldFinch has a unique credit risk assessment and liquidity of a unified high-level asset pool. As the size of the business grows, so does its liquidity. Credix is illiquid, especially when its loan pool is depleted. Maple Finance did not specify how liquidity will be built.
conclusion and suggestion
Its not a good business, its a huge business.
The crypto world needs real assets (RWA) to enhance its credit value.
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 of collateral is much higher than that of physical assets. We can see that if USDC and USDT support a certain blockchain, the blockchain will have better liquidity and it will be easier to build DeFi. The same is true for other areas of business. The crypto world needs real world stable assets to boost its credit. The largest classification of RWA assets on the chain is actually stable coins. If we retrieve the number of authorizations of centralized stablecoins in different ecosystems, we will find that chains with higher authorizations have higher valuations. 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 to survive.
In the traditional world, especially in some developing countries, financial infrastructure is limited. Due to the lack of a credit system, many business opportunities were missed. And 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 does not spread throughout the country, and many cities do not have a financial system. The accessibility of encrypted finance is much higher than that of traditional finance.
lack of infrastructure
Even though we know that there are many advantages of using blockchain, the process of each lending case involving the real world and different jurisdictions affects the lending risk. In the real world, the settlement of RWA 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 the risk of default rely on the individual regulations of each jurisdiction in the traditional world. As long as these regulations are not blockchainized, most of the financial costs cannot be reduced.
KYC and compliance is only a passive requirement for customers
When we read the documents of these projects, there are few lines that show the connection between KYC and security. All the compliance efforts seem to be just to comply with the law, not for the safety of customers funds.
Reference source:
Reference source:
Financial Infrastructure and Access to Finance: A Global Perspective
Financial Infrastructure, Group Lending and Funding Costs in Developing Countries
https://uploads-ssl.webflow.com/62d551692d521b4de38892f5/631146fe9e4d2b0ecc6a3b97_goldfinch_whitepaper.pdf
https://rockawayx.com/comms/centrifuge-analysis
