What Are Real-world Assets? DeFi’s Newest Yield

John Lee Quigley
John Lee Quigley October 28, 2022
Updated 2022/10/28 at 6:53 AM
14 Min Read
  • Real-world assets (RWAs) are tangible assets or financial primitives with the potential to serve as collateral in the DeFi industry
  • Real-world lending brings vast opportunities from emerging markets on-chain

The $50 billion decentralized finance industry has been at the forefront of financial innovation in the past few years. Decentralized finance — or DeFi — primitives such as stablecoins, swaps, lending, derivatives, insurance and prediction markets have been democratizing access to financial products. Nonetheless, DeFi returns have been hard hit by recent bearish conditions. Yields have hit rock bottom with investor participation also at an all-time low.

The reasons for DeFi’s rapid decline in assets under management are not overly complex. Aside from the industry’s nascent nature, yields typically come from a recursive on-chain activity tied to crypto assets. Investors earn yield by providing liquidity to borrowers and traders on decentralized exchanges (DEXes) or overcollateralized lending platforms, and they are rewarded for doing so with inflationary tokens or one-time treasury boosts. These chains of activities generate yield in a bull run but quickly turn into a death spiral when asset prices crumble and on-chain activity drops.

The DeFi landscape has struggled to scale because the underlying yield generation mechanism only works when prices are going up. The unsustainable yield model is best reflected by the cumulative total value locked (TVL) in DeFi protocols dropping from nearly $180 billion to nearly $50 billion since the market peak.

Source: DeFiLlama

The pressing need for sustainable income in DeFi has ignited the growth of protocols that generate a yield from real-world assets (RWAs). While many protocols were created to tokenize RWAs, only a few integrated this technology to provide investors across DeFi and TradFi yields that tap into some of the world’s biggest financial credit markets.

For example, Goldfinch’s lending protocol uses RWAs in a way that demonstrates higher stability and growth. According to LoanScan, its USDC yields outperformed Aave and Compound over the past year.

And when comparing Goldfinch’s revenue model to Aave’s, it is clear that the source of yield is fundamentally different:

To understand how this strategy is a fundamental shift in DeFi, we need to explain the evolution of RWAs.

What are real-world assets (RWAs)?

Real-world assets are tangible assets or financial primitives with the potential to serve as collateral in the DeFi industry. Here are the most popular examples of RWAs:

  • Cash
  • Metal (gold, silver, etc.)
  • Real estate
  • Corporate debt
  • Insurance
  • Salaries and invoices
  • Consumer goods
  • Credit notes
  • Royalties, etc.

RWAs compose the majority of global financial value. For instance, the fixed income debt market is worth an estimated $127 trillion, the total value of global real estate is approximately $362 trillion, and gold has an $11 trillion market capitalization.

RWAs already underpin lending and yield generation activities in the traditional finance world. However, they’re relatively untapped in DeFi. Unlocking the considerable value attached to RWAs, and to the off-chain financial system in general, is the key to sustainable yield DeFi models without the vast volatility that has historically been associated with the relatively nascent DeFi world.

How are real-world assets used in DeFi?

The term “real-world assets” emerged in recent years to differentiate cryptocurrencies from traditional financial holdings. Unlike cryptocurrencies that only exist in digital form, RWAs are usually tangible and tied to real-world organizations.

However, blockchain technology has unlocked the possibility of bridging real-world assets to DeFi. Developers typically use smart contracts to create a token representing an RWA while providing an off-chain guarantee that the issued token is always redeemable for the underlying asset.

Stablecoins are a perfect example of successful real-world asset use in DeFi, with three of the top seven crypto tokens by market capitalization being stablecoins (a combined $136 billion). Issuing companies such as Circle maintain an audited reserve of USD assets and mint USDC tokens for use across DeFi protocols.

Synthetic tokens represent another use case involving the bridging of RWAs to DeFi. Synthetic tokens allow on-chain trading of derivatives linked to currencies, stocks and commodities. Leading synthetic token trading platform Synthetix had $3 billion worth of assets locked in its protocol at the peak of the 2021 bull run.

Another exciting adoption of RWA in DeFi involves lending protocols. Unlike primitive lending protocols that rely on crypto-native borrowing, RWA-focused DeFi platforms service borrowers with real-world businesses. This model offers relatively stable returns insulated from crypto volatility.

How lending protocols leverage RWA to generate actual yield

The DeFi lending business model provides the most cost-effective way to pool and distribute capital between a vast group of lenders and borrowers. It cuts out intermediaries and automates money movement while offering users relative anonymity.

However, the focus on serving crypto-native investors creates significant limitations. The pool of capital in DeFi is underutilized, especially during bear markets. The funds are also inaccessible to the world’s biggest borrowers — real-world businesses with no crypto assets to post as collateral.

Lending protocols such as Goldfinch address these limitations by building a robust model for making DeFi capital accessible to businesses with real-world economic activity. These audited firms with millions of dollars tied in RWAs enter into a legally binding agreement to obtain loans issued with these assets as collateral. The DeFi protocol generates yield from interest paid on issued loans, along with yield enhancements from the treasury, which collects platform fees, and additional token incentives.

Active loans on Goldfinch | Source: Goldfinch dashboard on Dune

Most importantly, Goldfinch’s yield is insulated from crypto volatility as borrowers deploy funds in real-world ventures. With the average borrower pool loan term on Goldfinch lasting 3-4 years with a set interest rate, the protocol’s interest-sourced USDC yields remain stable despite volatility in the crypto markets. There is also sustainable capital demand, ensuring the lenders get the best rates for deposited assets. Let’s take a closer look at how this works under the hood.

How Goldfinch works

Goldfinch is pioneering an efficient DeFi lending model that supplies on-chain financing to offline businesses. These borrowers propose debt capital raises to the Goldfinch protocol. Once approved, they enter a legally binding agreement to post off-chain assets as collateral for the loan.

Goldfinch operates with a novel “trust through consensus” mechanism which allows borrowers to show creditworthiness based on the collective assessment of other participants, combining the trust of its tiered deposit model for investors, robust due diligence documentation, and a credit specialist community to verify that a borrower is creditworthy.

A common misconception is that approved borrowers can immediately access a pre-funded pool. In reality, a borrower proposes the terms it wants for its loan to the protocol, and the protocol’s participants actively choose whether or not to fund that specific deal.

First, borrowers propose the loan amount and terms they are seeking in the form of a borrower pool smart contract and provide due diligence information to the community of investors. There are two ways to invest: as a backer or as a senior pool liquidity provider. Backers actively evaluate individual borrower pools, and choose whether or not to invest USDC into a specific deal. Backers are incentivized to effectively evaluate loan terms by providing first-loss capital.

When backers invest, the protocol’s senior pool automatically allocates funds to the pool according to the protocol’s governance-set leverage model. Currently, that means the senior pool automatically supplies USDC at a 4:1 ratio to the USDC actively supplied by backers. While their investment is automatically diversified across the protocol’s loans, senior pool liquidity providers are protected by supplying second-loss capital, and 20% of the senior pool’s interest is reallocated to backers to reward their work evaluating pools.

So, while a borrower could be qualified to participate on the platform based on their proven track record of business success, history of repayments, or real-world assets to provide as collateral, their proposed loan could still not be funded if they are proposing terms that no backers deem a worthy investment.

This month, Goldfinch also announced the launch of a novel Membership Vault system. They stated that it is designed to enhance protocol participation and is the first step of a broader tokenomics redesign. The membership offers an opportunity to further align and incentivize Goldfinch investors’ interest in the long-term success of the protocol. And secondly, it rewards the global community of Goldfinch participants who continue to contribute to Goldfinch’s growth and resilience.

Goldfinch taps into blockchain’s immutability to incentivize borrowers to repay their loans. Borrowers must maintain a reputable on-chain credit history to qualify for future loans. Blockchain smart contracts also provide automated settlements, delivering superior efficiency to TradFi lending.

Goldfinch’s model is efficient for DeFi lenders and provides global access to capital for businesses. The two-sided marketplace gives DeFi lenders access to stable crypto yields backed by RWAs, while providing borrowers with faster, cheaper, and more efficient access to financing than traditional outlets can offer. It also unlocks lucrative lending opportunities in emerging markets that were initially only available to institutions and insiders.

Opportunities in emerging markets

Goldfinch’s approach to real-world lending brings vast opportunities from emerging markets on-chain. For instance, Africa is currently the world’s fastest-growing financial technology market with an explosion in the adoption of internet-connected devices. Yet, African tech startups lack access to requisite capital or pay extremely high interest rates to do so. They face international barriers, compete with government bonds, infrastructure, and wealthier enterprises.

DeFi lending allows these borrowers to access on-chain capital while using off-chain assets as collateral. In turn, lenders enjoy lucrative yields that are historically unavailable in developed markets.

There are more benefits. According to the IMF 2022 Global Financial Stability Report, the IMF estimates DeFi could provide up to 12% in annual savings to emerging market businesses.

Blockchain’s efficiency allows network participants to enjoy near-instant loan settlements, as opposed to the lengthy waiting times associated with moving funds through the traditional banking system. Furthermore, the entire system democratizes access as individuals can become business financers on Goldfinch, while businesses globally can tap into an exhaustive capital marketplace.

The adoption of RWAs within DeFi opens up the industry to the world’s largest debt markets. It also provides greater capital efficiency for lenders and unlocks a huge capital pool to borrowers in emerging markets. Over time, this approach will accelerate mainstream cryptocurrency adoption and provide a stepping stone for DeFi to reach its $100 trillion potential.

This content is sponsored by Goldfinch.

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