PSE Trading: Examining the underlying business model of RWA and contemplating sustainability.
Original author: PSE Trading Analyst, @Yuki
Under the backdrop of the Fed's interest rate hike, the United States has entered a "high interest rate era." Faced with the continuously rising US bond yields, the low-risk returns in the DeFi world are clearly under pressure. The cryptocurrency market is caught in a dilemma of funds flowing out into traditional financial markets.
"Introducing real-world asset returns into DeFi" will be an important measure to retain funds within the field and attract external funds. Based on this, the cryptocurrency market is refocusing on the RWA (Real World Assets) concept that emerged in 2020, attempting to explore the best methods for fund circulation between the traditional financial market and the cryptocurrency market through different business models.
This article will start from the underlying assets most suitable for RWA in the medium to short term, and sort and analyze the existing RWA business models in the cryptocurrency market.
1. Exploring RWA Underlying Assets
1.1 Background and Current Situation
Currently, although the total market value of the cryptocurrency market is still maintained around one trillion US dollars, stable low-risk sources of return are lacking in the market. Only ETH collateralized liquidity based on the PoS mechanism has gained recognition and support from participants. This indirectly indicates the inevitable rise of LSDFi.
Data from ultrasound.money shows that since Ethereum's self-transition to PoS, it has generated yields from collateralizing 1.4 million ETH, while its current staking rate is only 22.03% of the total supply. This means that Ethereum has become a yielding asset with an interest rate of 5.3% (Staking Rewards/ETH staked), and has brought in a fundamental income of 2.4 billion US dollars to the market (at the time of writing, ETH is priced at $1720 per coin).
Therefore, following the same line of thinking, RWA tokenization is the direct mapping of the "equity value" of various real-world assets onto the blockchain in the form of digital currencies, endowing the "equity value" with the attribute of transaction and circulation. In other words, RWA brings the returns of real-world assets into the cryptocurrency industry and can inject better liquidity and vitality into the entire market as a real return asset.
Currently, the scale of the stablecoin industry is around $74.3 billion, but most USD-pegged stablecoins (U-based assets) do not have stable real yields compared to the 5% staking yield of ETH. If RWA can bring the same level of real yields to U-based assets (close to 5% APY), it can stimulate further growth of the stablecoin industry by generating an additional $3.7 billion in annual basic income.
According to statistics from rwa.xyz, the accumulated borrowing volume of existing RWA private credit agreements is only slightly over $500 million (excluding MakerDAO), and the tokenized US Treasury bonds only have a scale of $640 million (excluding indirectly introduced models), totaling less than $1.2 billion.
For example, taking short-term US Treasury bills, the average interest rate announced by the US Department of the Treasury on July 31st this year is 5.219%, and the overall scale is $47.69 trillion. If RWA can bring this portion of income into the crypto market, ideally, it will generate a revenue scale of $2.489 trillion. For the cryptocurrency industry with a total market value of just $1 trillion, this flood-like liquidity will irrigate the entire industry and revitalize it.
BCG, in collaboration with ADDX, released a report predicting that global tokenized assets (such as real estate, stocks, bonds, and investment funds) will grow to $16.1 trillion by 2030, bringing more attention to the crypto market.
In summary, current RWAs are still in the early stages of development, but they have tremendous potential. Just as the real returns of ETH-based assets have driven the exponential growth of LSDFi, RWAs can also drive incremental growth of the entire crypto market as real return assets based on U.
The crypto market has also keenly sensed the enormous potential behind RWAs, and DeFi OG projects such as MakerDAO and Compound are actively positioning themselves.
1.2 Best Mid-term Underlying Asset: Bonds
Since RWAs need to tokenize traditional off-chain assets, the choice of underlying assets becomes the most crucial issue. This is because the underlying assets have a significant impact on the complexity and flexibility of subsequent tokenization, as well as the difficulties of asset management and risk management.
Based on the logic of "RWAs as the real returns of the crypto market based on U," the author directly categorizes RWA underlying assets into two major types:
Interest-bearing RWA (analogous to ETH after the transition to PoS): bond-like assets, mainly short-term US Treasury bonds or bond ETFs
Non-interest-bearing RWA (analogous to PoW-based ETH): real estate, art, gold, etc.
Based on these considerations, taking into account the liquidity, standardization, security, and yield of underlying assets, we can find that interest-bearing RWAs (primarily bonds) have obvious advantages in liquidity and standardization, despite potentially lower yields compared to non-interest-bearing RWAs (higher potential returns for real estate and art). Only underlying assets with better liquidity and standardization can support the large-scale application and expansion of RWAs.
In addition, similar to interest-bearing assets based on ETH, interest-bearing RWAs can enhance protocol-layer composability and drive more DeFi innovation by providing stable "interest," even if the underlying asset yields are not high.
Given the above, the author believes that the best underlying assets for mid-term RWA (Risk-Weighted Asset) are debt assets primarily consisting of short-term US government bonds or bond ETFs. These interest-bearing assets not only perfectly satisfy the market's desire for low-risk income sources in the cryptocurrency market, but their high liquidity and high level of standardization also facilitate the large-scale application of RWA.
Therefore, in the following sections, the author will discuss in depth the "business models" of representative RWA projects based on US bonds or bond ETFs as underlying assets.
2. Business Models of RWA Based on US Bonds / Bond ETFs
Starting with RWA based on US bonds, it can be observed that the mainstream RWA models can be categorized into three tiers:
Infrastructure layer: responsible for on-chain representation of US bonds RWA
Intermediate layer: responsible for on-chain representation of US bonds RWA and introduction of US bond returns to DeFi
Top layer DeFi business: directly or indirectly incorporating US bond returns into project returns
The difficulty level, flexibility, and target customer groups differ greatly among the three business models of RWA tokenization.
Specifically, the infrastructure layer's main business of RWA tokenization does not require direct interaction with retail users (C-end), but focuses on business-to-business (B-to-B) projects. The step of "on-chain representation of real-world assets created off-chain" not only needs to address the identity consistency between on-chain and off-chain, but also consider asset security, regulatory risks, and implementation costs. Often, this type of business is the most challenging and complex, yet it is also an essential component of RWA.
As for the top layer DeFi native applications, they do not need to consider the tokenization event itself. Instead, they can directly or indirectly introduce RWA returns based on completed RWA tokenization, often through cooperation with infrastructure projects or by building DeFi products based on RWA tokens. Therefore, they mainly target retail users (C-end).
The intermediate layer combines elements of the infrastructure layer and the top layer. They not only achieve the tokenization of RWA, but also develop suitable on-chain products for their own RWA tokens, enabling direct introduction of RWA returns and integration into the DeFi world.
In general, projects involved in RWA tokenization have strict KYC (Know Your Customer) requirements. On the one hand, this is for the sake of security and compliance, but on the other hand, it contradicts the core spirit of freedom in DeFi, inadvertently raising the entry threshold for RWA.
2.1 Infrastructure Layer: RWA Tokenization
The essential step to bring real-world assets onto the chain is to package the assets, presenting them in a digital form based on compliance standards while retaining important information such as value, ownership, and maturity. This layer of business is as important as laying a solid foundation for building a skyscraper.
2.1.1 Business Model One: SPV Tokenization
The most mainstream approach currently for tokenizing RWA is to reference the concept of asset securitization, establishing a Special Purpose Vehicle (SPV) to hold the underlying assets and achieve control, management, and risk isolation.
Representative project: Centrifuge
Although Centrifuge is an RWA lending protocol, its SPV tokenization approach has important implications for various DeFi protocols aiming to realize RWA. The launch of Centrifuge Prime aims to provide technical and legal frameworks for DAOs to invest in RWAs.
In February 2021, MakerDAO and New Silver issued the first RWA 002 Vault through Centrifuge. Since then, the adoption of RWA on a larger scale has followed the SPV tokenization approach.
The RWA business model implementation path for Centrifuge is as follows:
The Asset Originator establishes a legal entity, i.e., an SPV, for each pool. The purpose is to isolate financial risks and provide funding for specific RWAs as underlying assets of specific Centrifuge pools;
Borrowers tokenize off-chain assets into NFTs through AO (underwriter) to be used as on-chain collateral;
Borrowers enter into financing agreements with the SPV and require AO to lock their NFTs in the Centrifuge pool associated with the SPV;
After the NFT is locked, DAI is extracted from the Centrifuge reserve and transferred to the SPV wallet. The SPV wallet then exchanges DAI for USD and transfers it to the borrower's bank account;
On the maturity date of the NFT, the borrower repays the financed amount plus financing fees. The repayment can be made directly in DAI on the chain or transferred in USD to the SPV. The SPV converts the USD to DAI and pays it to the Centrifuge pool. The fully repaid and locked NFT is returned to the AO and destroyed.
Source: https://docs.centrifuge.io/learn/legal-offering/#offering-structure
Although Centrifuge has implemented SPV risk isolation and has put a lot of effort into KYC/AML compliance verification in collaboration with Securitize, its RWA asset pool still has some bad debt issues. According to rwa.xyz data, Centrifuge has a total of 13,210,882 defaulted loan amount, accounting for 3.01% of the total loan amount (438,341,921).
2.1.2 Business Model Two: Tokenization of Fund Shares
Another common way to tokenize RWA is to launch compliant funds based on short-term US Treasury bonds and record the fund's transaction data on the chain to achieve "tokenization of fund shares".
Representative projects: Superstate, Franklin Templeton
Compound founder Robert Leshner announced the establishment of a new company, Superstate, in June, officially entering the RWA market. Superstate plans to launch a fund based on short-term government bonds and has submitted relevant application materials to the SEC for approval. It is worth noting that Robert Leshner himself has a background in the US Treasury Department, so he has some advantages to some extent.
Source: https://www.sec.gov/Archives/edgar/data/1982577/000110465923074744/tm2319534d2_n1a.htm
The implementation path of Superstate's RWA business model is as follows:
Superstate launches funds based on US Treasury bonds and government agency securities for US residents;
Users subscribe to the funds and become shareholders of the funds;
Shareholders can convert their fund shares into corresponding token forms and record them on Ethereum;
Fund share token holders need to register their addresses as whitelists of the funds, and non-whitelist addresses cannot execute transactions;
Official records for fund transfers are still managed in book-entry form. When there is a conflict between on-chain and off-chain records, fund managers will update the on-chain records based on the off-chain records.
Franklin Templeton, a publicly listed fund management company with assets under management of trillions of dollars, has adopted a business model similar to RWA and Superstate. In 2021, they launched the government money market fund Franklin OnChain U.S. Government Money Fund - FOBXX) on the Stellar blockchain, tokenizing the fund shares with BENJI tokens.
2.2 Middle Layer: RWA Tokenization + Interoperability with DeFi
In the middle layer, the RWA project's business model includes a direct link and circulation with DeFi. Similar to a "self-production and self-sales" model, it allows for independent design from the underlying layer to the upper layer, making it easier to expand the project scale while controlling risks. However, due to the need to comply with strict legal regulations in the tokenization of U.S. treasuries, KYC cannot be avoided.
2.2.1 Business Model Three: Fund Share Tokenization + DeFi Protocol
Representative Project: Ondo Finance
Ondo Finance offers services to institutional-level users through exempt issuance. Exempt issuance has stricter requirements for users and must meet the definitions of "qualified investors" and "qualified buyers" as defined by the SEC.
Ondo's RWA business model implementation process is as follows:
Users deposit USDC (or other stablecoins) into Ondo's fund product and receive a corresponding amount of fund tokens;
Ondo will convert stablecoins to USD (hosted by Coinbase) and hold them in a bank account;
Then purchase US Treasury ETFs through Clear Street, which has brokerage and custody qualifications;
When these underlying assets generate income, the income will be reinvested to purchase more assets, achieving automatic compounding;
At any time, if a user wants to redeem their USDC, the corresponding fund tokens will be burned and USD will be received.
Ondo currently offers four RWA products for US users, supported by different underlying assets, providing diversified choices for investors with different risk preferences.
The largest fund among them is OUSG. To expand the use cases of OUSG, Ondo has developed its own decentralized lending protocol, Flux Finance. OUSG holders can collateralize OUSG through Flux and borrow stablecoins such as USDC, DAI, and Frax.
Flux itself does not have KYC restrictions but adopts a whitelist liquidation mechanism. The significance of Flux lies in helping Ondo further integrate RWA into the native DeFi world and strive to create an "ecosystem loop".
Source: https://fluxfinance.com/markets
For non-US users, Ondo plans to launch a new product called USDY, which is a tokenized note backed by short-term US Treasury and bank current deposits. After purchasing USDY for 40-50 days, users can transfer it on-chain.
2.2.2 Business Model Four: SPV Tokenization + DeFi Protocol
Representative projects: Matrixdock, Maple Finance, Kuma Protocol
Matricdock is a bond platform launched by Matrixport, which has introduced STBT (Short-term Treasury Bill Token) products based on short-term US Treasury bonds. STBT is an ERC 1400 standard token that determines the interest base daily, with underlying assets being US Treasury bonds and repurchase agreements with a maturity of within 6 months.
The implementation path of Matrixdock's RWA business model is as follows:
A separate SPV established by Matrixport as the issuer of STBT;
Investors deposit stablecoins into the SPV, and the SPV mints the corresponding amount of STBT through smart contracts;
The SPV exchanges stablecoins for fiat currency through Circle and pledges the held US Treasury bonds and cash assets to the holders of STBT;
The fiat currency is entrusted to a qualified third-party custodian, and the qualified third-party custodian purchases short-term bonds with a maturity of six months or invests in the overnight repurchase market of the Federal Reserve using a traditional financial institution's US Treasury trading account;
STBT holders have the first priority repayment right over the underlying asset pool.
Mint and redeem mechanisms of STBT, source: https://stbt.matrixdock.com/
It should be noted that only investors who have passed KYC can invest in Matrixdock's products, and the transfer of STBT is only allowed between whitelist users, including STBT in the Curve pool. The decentralized RWA lending protocol T Protocol has built a permissionless investment pool for investing in US bonds using STBT.
Maple Finance used to be an unsecured lending project based on RWAs, but the high risk of unsecured lending model led to Maple's huge bad debt of over $50 million. Therefore, in April of this year, Maple changed its strategy and launched a new cash management pool (similar to Matrixdock), allowing non-U.S. qualified investors and entities to directly participate in U.S. bond investments with USDC. The RWA business model implementation path is similar to Matrixdock, so it will not be repeated here.
It is worth noting that Maple has recently completed a $5 million financing, which will be used to promote the expansion of its loan department Maple Direct. Maple Direct aims to provide a simplified way for DAOs, web3 companies, and other clients to access US bond yields on-chain.
Kuma Protocol is an RWA protocol launched by Mimo Labs, which introduces RWA yields into DeFi through the issuance of regulated NFT-backed interest-bearing tokens (KIBT). Currently, Kuma only accepts NFTs backed by sovereign bonds (U.S. Treasuries).
Essentially, KIBT is a interest-bearing stablecoin, and its balance increases as the underlying assets generate interest. The significance of KIBT is that "users can enjoy the RWA yield while using it in the defi world".
The RWA business model implementation path of Kuma Protocol is as follows:
Mimo Labs has established an SPV: Mimo Capital AG, and issued KUMA NFTs backed by sovereign bonds;
Users purchase KUMA NFTs with stablecoins, and then mortgage NFTs through KUMA Swap to mint interest-bearing tokens KIBT;
KIBT is a rebase ERC 20 token, currently there are two types of KIBT
KIBT related to KUMA NFTs supported by 740-day Euro sovereign bonds are named EGK
KIBT related to KUMA NFTs supported by 1-year US sovereign bonds are named USK
The key of the Kuma Protocol is to expand the use cases and liquidity of its interest-bearing token KIBT. Currently, the project is still in its early stage, and its feature of not requiring KYC is the biggest highlight at this stage.
2.3 Upper Layer: DeFi with RWA Yield
As native applications of the upper layer DeFi, they don't need to consider the "tokenization" event itself and potential risks of KYC when conducting RWA business, but can directly or indirectly introduce RWA yields on the basis of already tokenized RWAs. The implementation paths are mostly through cooperation with infrastructure projects or building DeFi products based on RWA tokens.
2.3.1 Business Model 5: Indirectly Introducing RWA Yields
When native DeFi applications want to conduct RWA business, there are generally two approaches: one is to directly build projects based on RWA yields, and the other is to indirectly introduce RWA yields as protocol income. The most successful project in implementing the "indirect introduction" model is MakerDAO.
Representative projects: MakerDAO, Frax Finance
Dai, although already with billions of volume, has always been unable to break through to a larger scale. Therefore, Rune, the co-founder of MakerDAO, proposed to introduce RWA as a transition. According to data from MakerBurn, MakerDAO has now introduced a total of 10 RWA projects, with $2.413 billion in assets as collateral. These RWA assets contribute over 50% of MakerDAO's income. The increase in DSR interest rates is also closely related to RWA income.
Source: https://makerburn.com/#/rundown
The largest RWA asset currently held by MakerDAO is Monetalis Clydesdale. This was formed by the MIP 65 proposal put forward by Monetalis founder Allan Pedersen in January 2022.
The purpose of MIP 65 is to generate stable income by utilizing a portion of stablecoins held by MakerDAO, and the method is to invest in high liquidity, low-risk bond ETFs.
The implementation path of Monetalis Clydesdale's RWA business model is as follows:
After MakerDAO's approval, Monetalis is appointed as the executor and regularly reports to MakerDAO;
Monetalis, as the project planner and executor, has designed a complete trust structure based on BVI (as shown in the following figure) to bridge the synergy between on-chain and off-chain;
All MKR holders of MakerDAO are the overall beneficiaries and provide instructions for the purchase and disposal of trust assets through governance;
Coinbase provides exchange services for USDC and USD;
Funds are used to invest in two types of ETFs: Blackrock's iShares US Treasury Bond 0-1 yr UCITS ETF and Blackrock's iShares US Treasury Bond 1-3 yr UCITS ETF;
The income from the US Treasury ETFs belongs to MakerDAO, and MakerDAO distributes the protocol revenue to DAI holders by adjusting the deposit interest rate of DAI.
Source: DigiFT Research
Although this complex and feasible trust structure indirectly introduces US Treasury income into MakerDAO, it also comes with high expenses, including initial costs and ongoing expenses paid to relevant institutions to maintain the trust operation. As the size of RWA gradually expands, MakerDAO needs to explore more cost-effective ways.
Sam, the founder of Frax Finance, recently stated that Frax V3 will enter the RWA track and initiated a proposal on the governance forum to expand RWA business through FinresPBC. The implementation path (according to the proposal) is nothing more than establishing an SPV off-chain to hold RWA assets and converting the income into protocol revenue to expand the scale of the FRAX stablecoin.
Clearly, after MakerDAO has proven the feasibility of the RWA path, more and more old DeFi projects will follow suit and find reasonable risk-free returns for idle treasury funds. In addition, stablecoin projects like Frax cannot afford to miss the opportunity of RWA income in order to increase market share.
2.3.2 Business Model Six: Direct Introduction of RWA Income
Representative projects: T protocol, AlloyX
T Protocol is an RWAFi protocol based on MatrixDock for STBT. The project aims to eliminate the whitelist restrictions of STBT through token wrapping, enabling permissionless tokenization of US Treasury bonds and lowering the investment threshold for users.
The RWA business model implementation path of T Protocol is as follows:
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T Protocol has introduced TBT, which is an encapsulated version of STBT. TBT distributes US Treasury bond profits using the rebase mechanism, with its price pegged to 1 USD;
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Investors deposit USDC into T Protocol and receive minted TBT in return, along with a deposit certificate called rUSTP;
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T Protocol acquires STBT through a partnership with MatrixDock, where MatrixDock collateralizes STBT and lends USDC;
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rUSTP accumulates profits through rebase and can be exchanged 1:1 with the protocol stablecoin USTP;
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T Protocol exchanges USDC from the Curve liquidity pool (suitable for small trades) or conducts OTC exchanges with MatrixDock to return USDC to the users (suitable for large trades).
Source: https://www.tprotocol.io/
T Protocol aims to become an intermediary between non-MatrixDock users and MatrixDock, lowering the investment threshold for investors and seamlessly integrating US Treasury bond profits into native DeFi. T Protocol's no KYC strategy may become mainstream in the future, and its issued TBT could be a potential competitor to stablecoins.
AlloyX is a DeFi protocol based on RWA, primarily providing investors with different combinable investment strategies by integrating other credit protocols. The protocols that AlloyX has integrated include: Credix, Goldfinch, Centrifuge, Flux Finance, and Backed Finance, etc.
The implementation path of AlloyX's RWA business model is as follows:
AlloyX determines the specific investment strategy through DAO voting and launches corresponding vault products;
The borrower provides funds to the vault product in the form of USDC and receives vault tokens based on the floating exchange rate, earning returns;
The borrower can exchange the vault tokens back to USDC.
Source: https://alloyx.gitbook.io/alloyx-documents/vault/overview
What makes AlloyX unique is its integration of many credit protocols, allowing user funds to be flexibly allocated to different protocols to maximize returns, minimize risks, and have strong composability. However, the problem lies in the integration of third-party credit protocols. Once a credit protocol faces default issues (AlloyX cannot guarantee the security of credit protocols), AlloyX investors will bear greater risk exposure.
3. Reflection and Summary
RWA can have many underlying assets, but the most suitable for the crypto industry at present must be bonds (mainly short-term US bonds and ETFs). Compared to real estate, art, gold, and other assets, bonds have the strongest overall advantages in terms of standardization, liquidity, and tokenization costs.
Therefore, in the short to medium term, the RWA direction with bonds as the underlying asset deserves more attention. And aiming to establish interest-bearing assets in the internal U denomination of the crypto market, it can be discovered that US bond RWA carries risk-free returns during the high-interest-rate era, perfectly matching the market's demand.
Based on the US Treasury RWA, there are currently three main business models, namely the underlying infrastructure business, the intermediate hybrid business, and the upper DeFi business. The difficulty and flexibility of tokenizing RWA in the three-tier business models, as well as the target customer groups, vary greatly. However, considering legal regulatory risks and development limits, the ceiling of the upper DeFi business is higher. The on-chain of US Treasury RWA is only the first step, but exploring the composability around the "yield attribute" and native DeFi is a more worthwhile direction. There have been different attempts in the market, such as stablecoins based on US Treasury RWA and permissionless lending.
In the long term, RWA will become an important carrier to fully connect TradFi and DeFi, forming liquidity interconnection, low (or no) threshold fund conversion, and value sharing.
4. Reference
https://foresightnews.pro/article/detail/38819?utm_source=substack&utm_medium=email
https://docs.centrifuge.io/getting-started/privacy-first-tokenization/
https://tprotocol.gitbook.io/tprotocol-documentation-v2/white-paper/tprotocol-v2-documentation
https://tprotocol.gitbook.io/tprotocol-documentation-v2/white-paper/tprotocol-v2-documentation
