Real-World Assets as Collateral for DeFi, Made Possible with MakerDAO
The cryptocurrency space was borne out of a desire to bring about a better financial system and infrastructure that is inclusive for anyone, anywhere.
The crypto industry has matured significantly since 2010 when Bitcoin kicked off a new wave that today spawned a whole new industry. The crypto community continually progressed with new tools and capabilities being gradually built up.
Nonetheless these capabilities that promise quicker settlement times, trustless global accessibility and granular asset control have mostly remained gated within the crypto realm.
Bringing Together Real-World and Crypto Assets
Now, the ambition is to bridge the gap between real-world assets and cryptocurrencies. Specifically in the DeFi space, that aims to provide a borderless financing infrastructure, the first steps are being made to bring real-world assets as collateral for loan issuance.
The community of MakerDAO, that is behind the DAI stablecoin, arguably one of the most popular DeFi projects, has confirmed the vote on whether to allow real-world assets to be included as collateral options.
This comes following the effort led by the startup Centrifuge, that developed a protocol that lets users turn real assets into securities against which ERC20 tokens can be issued. This enables real world asset securitization as these tokens are interest-bearing and will be issued as NFTs (Non-Fungible Tokens).
DeFi applications built mostly on top of the Ethereum blockchain promise to give more people access to borrowing, lending, and other services because they eliminate the need to go and transact through a financial institution.
In the case of MakerDAO, the system built with Maker (MKR) and DAI lets users deposit cryptocurrency-denominated collateral to take out loans denominated in the U.S. dollar-pegged stablecoin DAI.
While recently the DeFi space celebrated a huge milestone with $1 billion locked in various applications across the board, participation in DeFi today is limited because it requires that users have purely crypto-native assets.
Getting real-world assets involved in the DeFi industry is what Centrifuge is pursuing with its Ethereum Dapp called Tinlake. The app allows for the securitization of real-world assets and have these represented on the blockchain as tokens, which can in turn be used to gain access to DeFi services.
What is Asset Tokentization?
Asset tokenization refers to the act of turning the ownership of a real-world asset into a digital token. This can be done in various ways, but all result in the legally-upheld bridge between the physical asset and its representative token.
Deeds, titles, and certificates are all traditional versions of a token. A deed to a house represents ownership of that house. The token refers to the digitally native asset which represents the real-world asset itself.
The first two types of assets that are available for tokenization are music streaming royalties enabled by PaperChain and ConsolFreight’s freight shipping invoices.
With the positive vote from the MakerDAO community, now anyone – be it individuals or companies – is able to utilize future cash flows from music streaming royalties or shipping invoices as collateral to take out loans for example.
Centrifuge’s Lucas Vogelsang notes the partnership could be the world’s first application of DeFi to a real-world business issue. Particularly, the solution helps ensure quick liquidity for artists and supply chain firms, without the hassles of going through traditional ways of financing.
MakerDAO’s Rune Christensen has also shared a highly optimistic vision as the two proposals represent the first step towards the expansion of DeFi’s field of application:
“These should be seen as the first two [RWAs] in the greatest portfolio of assets that’s ever been built. It’s just the first step. Thousands and thousands of assets will exist alongside them.”
There are still issues and restrictions when it comes to securitization of real-world assets and introduces new risks to the DeFi space.
For instance, Centrifuge’s tokenization process through its app still falls under the securities law. Since both Paperchain and ConsolFreight are based in the U.S. only accredited investors will have access to these assets.
Another compromise that was made in order to bring real-world assets to DeFi is Centrifuge setting up a special purpose vehicle (SPV) that will have the assets associated with, from a legal touchpoint. Lenders, in the event of default, would have to rely on the legal system to enforce their rights to the collateral, rather than an automated smart contract that can do so with on-chain assets.
While this is necessary to have a claim for the tokenized real-world assets, it represents a single-point of failure. But this is a trade-off that Centrifuge’s Lucas Vogelsang says is necessary in order to bring real world assets on-chain.