DeFi may usher in the next explosion point: real-world assets are being introduced and pushing DeFi into the mainstream

On August 7, trust company Delaware Trusts plans to cooperate with MakerDAO, with community bank WSFS Bank as the trustee, to use real-world assets to support the creation of decentralized credit tools, providing a new solution for all industries that need mortgage financing solutions.

For everyone, on-chain lending in the DeFi world is already a familiar operation, but this is basically centered around native assets on the chain such as Ethereum. MarkerDAO’s attempt at “DeFi supported by real-world assets” seems to be a relatively unfamiliar concept. So what is the significance of this?

01 Why do we need “DeFi backed by real-world assets”?

Since Compound ignited the DeFi summer last year, the entire DeFi world has ushered in rapid development. Among them, the most representative TVL (total locked volume of the protocol) has been rising all the way, once exceeding 130 billion US dollars.

Although the volume has nearly halved in about three months since April, as of August 15, TVL has quickly rebounded to above US$100 billion, almost recovering its lost ground.

Among them, lending protocols represented by Aave, Compound, and MakerDAO not only contribute the main share of funds, but also become the key infrastructure of a number of DeFi Lego protocols: other DeFi tracks such as transactions, derivatives, synthetic assets, insurance, etc. are almost all built on the capital volume of lending protocols.

In the early stages of DeFi development, circular credit expansion was achieved through on-chain forms such as mortgages and borrowing between native assets. I think this can even be understood as the "cold start" of DeFi to some extent, because on the one hand it solved the seed capital needs for early development, while also greatly stimulating various borderless innovations within the DeFi ecosystem that spontaneously improved the efficiency of capital use.

It can be said that it has made great contributions to the early development of DeFi, but at the same time, with the further development of DeFi, the bottleneck of on-chain native assets has gradually emerged. The most direct one is that the scale of high-quality assets on the chain directly sets a ceiling for the volume of DeFi. In order to solve this problem in the protocol, collateral is the key.

The current lending and collateral model is mainly based on over-collateralization, that is, to ensure that trustless loans can occur, borrowers will need to deposit collateral with a value greater than the loan amount, so it ultimately depends on the types of collateral and collateral ratios on various DeFi lending protocols.

In terms of collateral types, DeFi lending is still mainly limited to the field of digital assets, with little connection to real assets. They are basically native assets on the chain, which also leads to extremely limited choices - basically limited to a very small number of mainstream crypto assets such as Bitcoin and Ethereum. After all, the liquidity and transaction depth of long-tail assets are extremely poor, and if you are not careful, you will repeat the mistakes of Venus.

In terms of the collateral ratio of collateral, undercollateralized loans have been the holy grail of DeFi since 2017. Currently, Aave and others have also begun to gradually test undercollateralization, that is, pledging 100 yuan to borrow 200 yuan, which is equivalent to adding leverage. However, compared with it, the author can only regard it as an auxiliary technical means, which only treats the symptoms and not the root cause.

And Maker made great progress by accepting real-world assets such as real estate as collateral in April 2021. Therefore, it can be assumed that traditional finance and DeFi will be better integrated in the future.

Therefore, on the whole, "DeFi supported by real-world assets" is the key. The integration of real assets into the traditional world is an inevitable trend for DeFi to break through the bottleneck of existing development volume. Even the DeFi breakthrough trend we expect is inseparable from the continued exponential growth of the scale of physical assets outside the access circle.

02 MakerDAO, Aave, etc. have already started testing the waters

This is not just the beginning. In fact, there have been attempts in the industry before, including MakerDAO, a long-established leader in lending, which has been trying to do this - enabling asset originators to convert real-world assets into tokens for loan financing.

On April 15 of this year, the first entity financing execution proposal initiated by the MakerDAO governance promoter and smart contract team was passed. The proposal was about adding New Silver Series 2 DROP as collateral for the Maker protocol.

Among them, New Silver was founded in 2018 and mainly provides fixed-amount mortgage services for US real estate. It is an asset processor in the traditional financial world and one of the first traditional companies to introduce real-world assets (RWA) to MakerDAO.

This means that investing in New Silver Series 2 DROP Token is equivalent to financing real estate in 39 states in the United States, allowing New Silver, as an asset initiator, to obtain its first loan using MakerDAO as a credit tool and set a debt ceiling of 5 million DAI, with no default to date.

Among them, Centrifuge, which is cooperating with MakerDAO, is currently working with diversified asset initiators to provide financing for assets including invoices, real estate, etc. Centrifuge plans to expand the scale of real-world assets in the next 12 months to support MCD (Multi-Collateral Dai) to 300 million.

This also includes the proposal initiated by the Aave community on June 16 this year to establish a real-world asset (RWA) mortgage lending market. The proposal also suggested using Tinlake, the DeFi platform launched by Centrifuge, to establish the market.

According to Aave's design, users can mint RWA into a unique DROP and pledge it into Tinlake to borrow DAI. The tokens of the Tinlake platform include DROP and TIN. When mortgage lending occurs, users who purchase TIN will first gain benefits when redeeming the mortgage, but will also bear risks first in case of default. Both the benefits and risks of DROP buyers are delayed.

The Aave Centrifuge market will provide Aave with the adaptability components to issue DROP on Aave, and Aave can increase the liquidity of DROP. This will enable cryptocurrency investors to lend digital currencies to earn interest income, and borrowers can obtain short-term loans in cryptocurrency by using their real-world assets as collateral.

It can be said that the frontier innovations of leading DeFi projects are often the most trend-setting and direct, which can facilitate the decentralized credit market for a wider range of use cases and further promote DeFi towards the mainstream.

03 Breaking the bottleneck of volume and pushing DeFi into the mainstream

In fact, it is to connect DeFi with real-world assets, because one side provides the gameplay and the other side provides the funds. Unlocking the financing method of any type of assets through DeFi, opening the door for the real economy to enter DeFi liquidity, attracting trillions of dollars of value from traditional finance to meet its own development needs, while also revitalizing the application paradigm of real-world assets.

However, there are two main challenges at present: the potential liquidity of real-world assets is extremely poor compared to on-chain native assets, and the regulatory attitude remains unclear.

The former has recently begun to make new attempts to introduce NFT factors in combination with the NFT wave - representing real-world assets on the chain through NFTs, thereby imitating traditional mortgages in the form of NFT mortgages.

Such NFTs are actually the tokenization of real-world assets, and the tokenized physical assets can also achieve fragmented or shared ownership, while also giving them excellent liquidity (for real-world assets, liquidity is undoubtedly one of the important factors affecting valuation).

Faced with the challenge of unclear regulatory attitude towards the latter, DeFi leaders have begun to explore cooperation with traditional finance, and are even engaging in a tug-of-war with regulators.

For example, Compound recently built Compound Treasury based on the needs of financial institutions after months of customer and regulatory compliance research. The company has now begun accepting customers and can provide interest rate products with stable returns.

The products launched by Aave and Compound for institutional clients will also greatly expand the demand and amount of borrowing of crypto assets, and may become one of the catalysts for a new round of DeFi market.

When talking about DeFi backed by real-world assets, MakerDAO founder Rune Christensen considered it a "paradigm shift," saying it opened the door to scalable DeFi backed by real-world assets while protecting DeFi with the world's most powerful legal structure.

For DeFi, this is indeed a "paradigm shift" worth looking forward to, especially at a time when regulation is facing a critical turning point. Finding a way to legally combine DeFi and real-world assets will be the next "Compound detonation point" for DeFi.

At present, we have the confidence to look forward to its early arrival.