MakerDAO issued the world’s first real asset loan based on DeFi. As the asset originator, New Silver, the Fix&Flip loan pool on Tinlake, a lending platform based on the Centrifuge protocol, used MakerDAO as a credit tool to obtain the first loan.
MakerDAO accepts real-world assets as collateral, heralding the rise of a new track. DeFi startups like Centrifuge, NAOS Finance, ShuttleOne, and Persistence are working to close the gap between DeFi and CeFi, bringing real-world assets that generate income to the chain, such as consumer loans, supply chain finance, corporate credit, and real estate rents , Which greatly expands the boundaries of DeFi. If real-world assets are brought into the DeFi world, the current market size of DeFi assets is insignificant.
High-speed growth under DeFi innovation
At present, the development trajectory of DeFi is expanding horizontally on the balance sheet, but expanding vertically on the interest rate market. In less than a quarter, many bold ideas and predictions are being tested. With the enrichment of interest-bearing target or synthetic asset classes, more and more lending agreements begin to support LP Token mortgages, and the DeFi financial system is becoming more diversified, systematic and multi-dimensional. The development of DeFi will never be possible without assets, and there are three main ways to generate excess returns: leveraged trading, extension of the term, and introduction of new credit.
DeFi users are generally proficient and familiar with leveraged trading, and will use complex interest rate market tools for a long time. The fastest growing trend now is to introduce more types of credit into the blockchain as assets on the chain, and add these assets to collateral, release liquidity by introducing more collateral, and expand DeFi’s balance sheet.
In addition to the aforementioned original cryptocurrency assets as an innovative way of collateral, along this route, we were pleasantly surprised to see that DeFi began to be accepted by new users by connecting real-world assets.
Mapping traditional finance to DeFi
The business model of DeFi startups is not complicated. In the real world, many CeFi financial technology companies are providing basic asset financial services based on specific income streams, reflecting the logic of “structured finance” in traditional financial markets.
In the traditional financial structured business, the financial package will have future income flow to the basic assets into SPV (a trust or asset management product), and issue priority files and secondary files, which provide security for repaying the principal of the priority files buffer.
If the priority or sub-files are listed on any exchange, this will become a relatively familiar part of asset-backed securities. In this process, fintech companies will be responsible for investigation, asset management, operations, information disclosure, risk control, settlement, etc. In the DeFi agreement, such as Centrifuge and NAOS Finance, the positioning of financial technology companies in CeFi structured financing is mapped to the blockchain. Eventually, “NFT+DeFi” will appear to replace off-chain business processes, and use NFT to tokenize assets and map them to the DeFi protocol.
NFT will be generated through the tokenization of basic assets with revenue streams (such as accounts receivable, etc.), and the overcollateralization of NFT (such as TVL is 70%, and the loan value is 70% of the face value of the asset) will be handed over to the loan agreement. Such as Compound or MakerDAO; then the dealer converts stablecoins or other cryptocurrencies into U.S. dollars and lends them to real-world borrowers; investors can earn interest by investing in corresponding assets through the DeFi protocol. In this process, Centrifuge and NAOS Finance use DeFi to package the entire cumbersome business chain of SPV and structured financing. They conduct structured financing in a decentralized manner and make full use of DeFi’s fund pool function to convert P2P ( Peer-to-peer) transactions are transformed into peer-to-peer pools, which changes the structure of risk management and improves the efficiency of fund matching.
DeFi connecting real-world assets should be the closest to the original intention of Internet finance. We look forward to seeing that the next development of DeFi is expected to quickly replicate the early barbaric growth stage of P2P as it did a few years ago, and bring major business opportunities for DeFi users, but this process will also breed risks.
NFT+DeFi increases market penetration
For the native DeFi market, real-world assets on the chain essentially introduce a new credit category, which is completely different from the current native cryptocurrency assets, creating a new asset category and providing DeFi users with richer asset management options , Thereby promoting the expansion of DeFi balance sheet.
In the CeFi financial market, similar structured financial products require qualified investors. Through NFT+DeFi, investors can obtain thresholdless returns from the structured financial market. This important investment opportunity will further increase DeFi’s market penetration rate and user adoption rate.
Similar underlying assets have fixed maturity dates and interest rates. With the introduction of real-world assets, the DeFi interest rate market will have a foundation for development. Users will invest in new asset classes through various types of interest rate agreements, catalyzing the simultaneous growth of penetration and TVL. The explosion of the DeFi fixed income market is only a matter of time.
The most innovative idea is to combine protocols such as Centrifuge and NAOS Finance with other stablecoin protocols such as MakerDAO. That is, MakerDAO uses real-world asset NFT as collateral to cast more stablecoin DAI into the DeFi economy, and the stablecoin will truly flow to the entity Economy, embrace the reality of payment, lending and business scenarios. The stablecoin agreement is expected to become a monetary policy tool. Stablecoins will naturally circulate across borders, and physical assets are tokenized into NFTs. We expect to see global financial assets exchange value in a borderless blockchain network.
The introduction of real assets into DeFi brings huge challenges
1. Liquidity crisis
In view of the complexity of the structured financing business and the huge gap between the risk-return characteristics of the underlying assets and the native cryptocurrency assets, many investors are still wary of the turbulence of the past P2P squeeze, including self-financing, debt capital pools, Maturity mismatch and frequent default events. Investing in real-world assets in the DeFi market will inevitably face similar risks.
In the early stages of P2P, P2P companies often pool short-term funds and invest in long-term financial assets with high credit risk in the form of black boxes. This kind of debt fund pool makes every investment of a user unable to correspond to a specific single basic asset, and the risk borne by the user has changed from the default risk of a single basic asset to the risk assumed by the P2P company as a whole. In addition, the maturity mismatch causes the risk of P2P companies’ liquidity fragility to accumulate. Once a single basic asset defaults, there may be a huge liquidity crisis.
But unlike the P2P of traditional financial technology, DeFi runs on a public ledger. For example, in the design of agreements such as Centrifuge and NAOS Finance, the investment of a single user can be matched with a single underlying asset NFT, which can reduce the risk of debt pools and the occurrence of maturity mismatches, and greatly reduce the possibility of the overall liquidity crisis of the agreement.
2. The impact of large losses and unfamiliar risks
In addition, since the business involves real-world assets, it is inevitable to face the credit risk of the underlying assets themselves and the moral hazard of the asset manager. This is also the biggest risk in the P2P industry.
For example, supply chain assets have very complex rights and verification risks. The default rate of such receivable assets is the highest among all financial assets. Some small business loans may face a default rate of 50%, and some basic assets cannot even be realized. Cause bad debts. Obviously, DeFi users are vulnerable to large losses and unfamiliar risks.
In extreme cases, traditional P2P companies will also incorporate junk assets into asset packages, fabricate non-existent underlying assets, and even set up shell companies to self-finance or embezzle user funds to the founder’s personal account. This is completely financial fraud. event. However, due to the asymmetry of information and the lack of legal compliance and regulatory authority, investors basically have no control over the underlying assets and off-chain businesses. DeFi cannot eliminate these core risks fundamentally and technically.
Therefore, we need to rely heavily on the expertise of Centrifuge, Naos, ShuttleOne, and Persistence to limit moral hazard and control the authenticity and quality of the underlying assets under the chain. Second, in the event of default, investors can only rely on the DeFi agreement and its partners to dispose and liquidate collateral in the real world.
Therefore, when selecting such real-world assets, users should carefully consider the risk-return characteristics of the underlying assets. The agreement may promote the low default rate of its assets, but this statement is difficult to prove and is not sufficient as an effective reference, so we need to pay more attention to the risk control measures introduced by the DeFi agreement against these risks.
Centrifuge introduced the over-collateralization of NFT value to reduce the credit risk of high-level investors by means of structured financing; Naos introduced the design of insurance mining funds to insure real-world assets based on real-world assets and carry out credit enhancement. In addition, it has obtained a license from Southeast Asian countries to meet the compliance and regulatory requirements of business development. These risk measures can help DeFi and investors control risks in the early stages of development.
to sum up
In short, the competition between these new DeFi players will be extremely complicated. In addition to expertise in technology, product, and asset management, it also needs to compete in the ability to acquire users and assets, the quality of assets and credit risk, and the ability to respond to regulation, compliance, and risk management. We firmly believe that DeFi must embrace real-world assets. When DeFi and CeFi collide in the field of financial technology, it will be a big explosion of the next generation of mobile financial infrastructure.
Author/ Translator: Jamie Kim
Bio: Jamie Kim is a technology journalist. Raised in Hong Kong and always vocal at heart. She aims to share her expertise with the readers at blockreview.net. Kim is a Bitcoin maximalist who believes with unwavering conviction that Bitcoin is the only cryptocurrency – in fact, currency – worth caring about.