TEXT: TIOGA CAPITAL, TZEDONN, MICHIEL LESCRAUWAET, NICOLAS PRIEM
Compile: Block unicorn
If software is eating the world, cryptocurrencies are eating capital markets.
Tokenization is not a new concept, it has been explored by startups, banks and stock exchanges since before 2017. However, the current moment presents an unprecedented opportunity for mass adoption. With stablecoins proving their effectiveness as a medium of exchange and DeFi infrastructure proving their reliability following DeFi Summer 2020, we are at the forefront of massive on-chain inflows into real-world assets.
In the field of Web3, RWA refers to the tokenized equity, debt, real estate, etc. of "real world assets". Not to be confused with "RWA" in traditional finance, which stands for "Risk Weighted Assets".
In fact, stablecoins currently account for 0.7% of the U.S. M1 money supply (about $130 billion), while the total M1 money supply is $18.6 trillion, with a peak market share of about 1.0%. For comparison, Tesla currently has a market share of 0.63% in the U.S. auto market.
On the other hand, the Total Value Locked (TVL) in DeFi has exploded from just $6 billion in 2020 to about $50 billion today, a staggering 80-fold increase. This impressive performance outpaced the 8x increase in the price of Ethereum.
Amid market chaos in 2022, centralized finance (CeFi) platforms such as FTX, Celsius, BlockFi, and Voyager Digital have suffered failures, while DeFi has shown great resilience. DeFi protocols — including Aave, Compound, Uniswap, MakerDAO — run seamlessly 24/7, and DeFi works brilliantly.
Therefore, we are ready for an era of bringing traditional financial assets on-chain. As DeFi develops, we expect "real world DeFi" to take a larger share of DeFi.
3 DeFi Arguments for the Real World
One: Real World DeFi allows you to unlock all financial assets and use them as collateral for any DeFi application
In traditional finance (TradFi), getting an equity-backed loan is a long and painstaking process involving many parties. It starts with your equity custodian sending a PDF to the bank to verify that you own the asset in their orphan database. The bank then guarantees your loan, the custodian transfers your equity to the bank, and you get a cash transfer. Finally, the terms of the loan are manually evaluated to check for any irregularities, all of which can take several days.
These high operating requirements and costs mean that usually only banks can provide such services to high net worth clients.
More generally, the IMF estimates that the marginal cost of DeFi platforms is reduced by ~2x compared to banks and non-banks in advanced economies, and by ~4-5x compared to emerging markets.
In real-world DeFi, this would take seconds. You push a few buttons, your equity tokens are cryptographically verified on the public blockchain, then collateralized via smart contracts, and the transaction is settled instantly. You receive digital cash (stablecoin) instantly and the terms of the loan are enforced in code.
And it doesn't stop there, in a world where one can control all tokenized assets (fiat, equity, real estate, art, etc.) performance improvements, automated portfolio management, and more.
Take PV01 (a Tioga portfolio company) as an example, they are working on tokenized bearer bonds issued on-chain. These bearer bonds will be composable natively on the blockchain, allowing users to easily use them as collateral.
From an entrepreneurial perspective, DeFi enables developers to gain access to a global customer base from day one. Entrepreneurs can also leverage existing DeFi infrastructure, which is essentially a native open API. For customers, low transfer costs encourage competition among entrepreneurs, thereby driving the development of the best possible product.
Intriguingly, ING Bank's profits nearly quadrupled as interest rates rose, while they continued to pay depositors 0.75% compared with 3.4% on euro government bonds. However, this is an extremely profitable business for ING Bank because of the high transfer costs. Banks are sticky and tend to only offer the best rates to their high net worth clients.
DeFi presents an alternative where you can switch from one service to another with just one click and without any restrictions. In addition, DeFi makes a clear distinction between cash (no credit risk) and savings accounts, so that private losses due to excessive risk-taking by banks do not have to be socialized afterwards.
While traditional finance (TradFi) exists in a siled tech stack, entrepreneurs can leverage native interoperable DeFi infrastructure.
Two: DeFi in the real world provides financial products with a smooth channel for all
Today, anyone can start their own private credit fund due to the efficiencies of running on the blockchain through DeFi applications such as Maple or Atlendis, which is a Tioga portfolio company.
For an established player like Blackstone (35% operating margin) that already has economies of scale, these back-end cost savings may be small, but emerging private credit funds can take advantage of DeFi infrastructure and increase operating margins from ~20 % increased to 35-40%.
In the words of Jeff Bezos, “The profit margin of traditional finance is the opportunity of DeFi.”
If you're Argentinian, you don't need to wait for banks to "back the dollar" or allow you to buy dollars at the "official rate" due to the rapid devaluation of the Argentine peso. You simply deposit any tokenized currency such as USDC directly into your wallet.
Banks and brokerages can no longer act as gatekeepers of financial products because consumers are no longer locked into their system. Instead, they can take advantage of the range of tokenized financial products and make their own decisions.
Real World DeFi allows you to find the best rates within DeFi due to its native composability and universal verifiability of assets. It is different from the need to open an account in each bank in the past, and then use their own separate systems to apply for loans or purchase financial products. Any financial product is now available to anyone with internet access.
Three: Self-hosting reduces counterparty risk and transparency improves risk management
Self-custody is a safeguard against counterparty risk, and while self-custody may still be intimidating at the moment, account abstraction, social recovery, and hybrid recovery methods will make the experience not too different from current bank logins.
When SVB had a banking crisis (similar to Lehman Brothers in 2008), there was little transparency. No one really knows if they are healthy, and the risk cannot be monitored, let alone externally verified.
Today, if Silicon Valley Bank were to run on the blockchain, we would have full transparency into their assets and liabilities, and could create a Dune dashboard to "monitor the chain." We can also monitor liquidity through risk management suites such as Chaos Labs for Tioga portfolio companies.
The collapse of Terra is a good example. Anchor Protocol suffered a bank run due to Luna price drop. Whereas we were left in the dark when Lehman Brothers collapsed in 2008, now we have minute-by-minute transparency on-chain, with retail users and institutions alike having access to this information to make optimal decisions. But where are we now on the adoption curve?
The Trojan Horse of RWA DeFi - Private Credit and Treasury Bonds
At the beginning of 2020, the total value locked (TVL) in DeFi was about 600 million US dollars, and then soared to more than 150 billion US dollars. Currently, DeFi’s TVL is stagnant at around $50 billion.
The DeFi of 2020 is today’s on-chain Real World Assets (RWA DeFi). Its TVL is currently at an all-time high of $600 million, with $340 million in private credit and $260 million in on-chain treasury bonds.
DeFi was able to take off thanks to a unique combination: the flood of liquidity brought on by the COVID stimulus checks, people had time to experiment when COVID hit, and new crypto primitives (e.g. AMMs, liquidity mining) were ready for alpha test.
We believe that today's $50 billion TVL provides us with strong evidence that DeFi can be the blueprint for the next paradigm shift in the financial industry.
The steady growth of RWA credit has nothing to do with the rise and fall of cryptocurrency prices, which shows that blockchain technology does not have to be used only for speculation, but can simply be used as a technology for value transmission. Hence the term "Internet Currency" - for the first time we are able to transmit self-sovereign value over the Internet.
Centrifuge is an RWA pioneer, and they have worked closely with MakerDAO since 2020 to fund RWA credits in areas such as financial transactions, structured credit products, revenue-based financing, and emerging market credits. Goldfinch and Credix primarily focus on emerging market credit in Latin America, Africa and Southeast Asia.
At the same time, a number of other credit agreements have been launched, focusing on African and Southeast Asian credits, such as Atlendis (a Tioga portfolio company), Bluejay Finance, Jia.
Recently, tokenized government bonds have gradually emerged as another asset class that has attracted much attention. In the first half of 2023, multiple national debt tokenization protocols have emerged, such as Ondo Finance, Matrixdock, Backed Finance, Swarm Markets, Franklin Templeton's Benji application, OpenEden, and Maple's cash management pool .
There is a strong impetus behind this momentum, as the roughly $135 billion in on-chain stablecoin funding may be looking for an easier way to access risk-free rates in traditional finance without going through the complicated The process of transferring out is driving a boom in the treasury sector.
Tokenized Treasuries went from zero to a $260M asset class in just 5 months (Source: Steakhouse Finance on Dune)
Some people may have doubts about the reasons for using tokenized government bonds-if I am a high-net-worth individual, can I buy government bonds through traditional brokerages? The answer lies in two subtle differences.
First of all, tokenized treasury bonds are not designed for ordinary users (but allow anyone to buy treasury bonds of any country), but for high net worth individuals (HNWI), traders or hedge funds, who prefer to avoid from The friction cost incurred in the process from the on-chain world to the off-chain world.
Tokenized treasury bonds are also beneficial for DAOs and startup capital reserves, especially those located outside the US, as well as permissionless compositional DeFi protocols that need to implement RWA.
As an example, Ribbon Finance just placed an order for $2 million in Backed tokenized treasury bonds, using the proceeds to purchase ETH options. Angle Protocol, on the other hand, is working on a proposal to use Backed tokens as collateral for their Euro stablecoin.
Second, for many established institutions, treasury bonds are very attractive as a marketing strategy due to the current interest rate arbitrage between DeFi and CeFi, and they demonstrate the technical and legal feasibility of tokenized assets.
In essence, tokenized treasury bonds may be a "Trojan horse" that introduces traditional bonds and other financial assets onto the chain.
Summarize
Real-world DeFi has matured and ushered in opportunities for disruption.
The real-world DeFi space is still in its infancy, but early signs of product-market fit are beginning to emerge. We see adopters starting to seek low-risk returns (Treasury bonds) from on-chain capital (crypto-native users, non-US crypto companies, the unbanked) and then gradually increasing risk (trade finance, bonds, private credit).
Next, we expect capital from the traditional financial world to be attracted by the unique capabilities of blockchain technology, such as collateralized loans against fully tokenized assets, better liquidity and capital management, and new investment products (bond issuance) . Finally, institutions will also come in due to efficiency gains and delivery of these blockchain-based services to customers.
Gradient overview of real-world DeFi adoption trends
Real-world DeFi is still in its early stages. In addition to tokenizing real-world assets, there are many areas we need to improve on blockchain scalability, privacy, and security before the inflection point of DeFi adoption arrives.
