In previous years, we have seen numerous attempts to bring real-world assets to the crypto market. However, none of them has proven to be massively adopted among retail crypto users and traditional financial players.
So, why hasn’t real-world asset tokenization become a massive trend?
You’ve probably heard how almost anything can be tokenized — securities, art, real estate, to name a few. And there were so many projects that promised to change the way we invest in assets, no matter the type. At the same time, no projects managed to get massive adoption on the market.
Traditional market professionals haven’t really found proof that tokenization improved current fundraising processes for them. Although, an overview of real-estate tokenization has been already discussed.
You may also struggle to find real retail investors who bought the rights to a famous art piece or a portion of Dracula’s castle. While most successful offerings were focused on private investors, basically nothing has changed in the process for the crypto market, even for the owners of tokenized assets.
Why didn’t these offerings manage to gain mass adoption? While the concept of tokenization promises a better and cheaper way to raise funds for issuers, there are almost no real benefits for the crypto market.
I’ve covered problems of tokenization in the form of security token offering before, but in short, it boils down to regulation (tokenized assets are regulated by the traditional rules) and a lack of a secondary market. Retail crypto investors can’t profit from these two issues, and there is basically no need for them to adapt to something new, especially now with the emergence of DeFi protocols.
What corporations are looking for while raising funds
Corporate institutions have to exist in a world with complex and outdated rules. Therefore, a clear legal model to attract or borrow funds is vital for them. With over $20 billion locked in decentralized finance at the moment, it might attract some interest from corporate institutions and make them consider entering the market — especially if we consider that the common annual percentage rate in DeFi protocols is just 2%–10% with no additional costs to attract funding.
Yes, there are no ready-to-go legal models built for corporates to attract or borrow funds from DeFi protocols on the market today. But it’s possible to build one with minimal effort, as the benefits of DeFi borrowing easily cover the efforts of building such a system. DeFi might be able to provide borrowing on perfect terms for corporate institutions, which is something that might make them consider entering the market. Meanwhile, corporate institutions will be willing to provide several types of stable assets to be used as collateral for their loans.
However, there is a real need for real-world assets to be used as collateral in DeFi protocols to prevent more market falls in the future, fixing the over-collateralization issue along the way.
Can current market players operate like this?
Right now, there are several attempts to bring real-world assets to the DeFi market. Most of them seem to accept a wide range of assets, mainly tokenized invoices.
The main issue related to using those assets in a protocol is an absence of publicly available sources for pricing. This relates to the lack of transparency and the need to rely on a centralized party (valuation firms, underwriters, etc.) in order to determine the price of the collateralized asset. There is also no mechanism to monitor the pricing in real-time (as it is done, for instance, when using crypto as collateral). Those assets are generally illiquid; they are not traded on any marketplace or digital OTC platforms; and there is no source for periodically updating information on their pricing — a crucial point to determine the moment in which the collateral will be liquidated.
There is no doubt that some of those assets could be insured, such as payment under invoices, meaning that the insurance company will pay in case of a default of the debtor. But again, the insurance process lacks transparency and lives completely off-chain, providing no real warranties for the investors or real-time knowledge whether or not the insured event has occurred.
Additionally, current solutions allow borrowing strictly in crypto, which won’t suit everyone. It’s not a bad thing, but it reduces the chance of attracting large institutions that need to receive financing in fiat, which is used for their day-to-day operations.
But the main question that arises is the possibility for big protocols to adapt and use real-world assets as collateral. And it will be extremely difficult, as they will have to change the borrowing process, build a system that will update the price of collateral, issue new assets, cooperate with regulated entities, and, generally, receive approval from the majority of current participants. Talks regarding the adoption of such a solution by Aave and Maker have been ongoing for over six months, with no clear date when it will actually go live.
What kind of infrastructure must be built to bring traditional institutions to the DeFi market?
A perfect solution that will allow the tokenization of traditional stable assets and that will be suitable for the DeFi market must meet several criteria.
Real-world assets used by the protocol must have a transparent source of pricing available on demand by any user of the protocol. This requires not only selecting an asset capable of fulfilling this requirement but also building a price oracle that will transfer information regarding the collateral. Such an oracle should be connected to a transparent and trusted pricing source, such as Bloomberg Terminal, rather than receiving proprietary data from a centralized party.Real-world assets used by the protocol should be as less volatile as possible, generate fixed income to provide real cash flows to liquidity pools, and have a certain level of liquidity and market in the real world to be able to process the liquidation event in case it occurs.The protocol must allow users to borrow money in fiat. For such purposes, there is a need for yet another intermediary to be connected to the protocol, to cover the exchange needs of users who want to borrow money in fiat, and fulfill the role of a payment agent for them.Real-world assets used by the protocol should have a digital presence, for example, be held on a secure accounting system. To achieve that, there is a need for an intermediary that operates such systems connected to the protocol.In order to defend the decentralized nature of the protocol and maintain the trust at the highest achievable level, intermediaries connected to the protocol must be regulated, insured, selected and overseen by the community of the protocol under established requirements. In addition, the community will decide any other crucial matters for the protocol’s development and economic sustainability, including selecting assets that may be admitted as collateral.
What should we expect in the future?
I expect that we will see several initiatives on building new, real-world, asset-backed protocols in 2021, and hopefully, they will be the ultimate solution to finally connect traditional financial and crypto markets. Existing protocols are more likely to adopt them in their current ecosystems only after new protocols will prove to be operational.
Another area in which real-world asset-based protocols could make an important impact is stablecoins. There is a current trend among regulators mostly in the United States that targets all stablecoins that have centralized issuers — such as Tether (USDT) or USD Coin (USDC) — with discussions about the potential need to impose the requirement for any of such issuers to have a banking license. Decentralized stablecoins backed by real-world assets might solve this issue; however, it is a topic for a separate discussion.
But what about other tokenization attempts and STOs? Of course, there have been successful cases before. Large financial institutions are still slightly interested in launching such products, as they may potentially save them money. But most likely, these initiatives will be focused on private offerings due to the aforementioned flaws.
It’s naive to believe that many crypto investors will be willing to make long-term investments in unfamiliar markets. Especially with great investment opportunities in the DeFi space. Until new regimes for the offering of tokenized instruments are built (and there are no bright signs in this direction), I believe real-world assets tokenization in a form of an STO will still be limited to closed offerings with no attention from the global market.