The financial system is on the verge of a radical overhaul as two irresistible trends rapidly converge. Decentralized finance is slowly pushing beyond its cryptocurrency-based roots into the real world. At the same time, traditional markets are moving closer to crypto through concepts like asset tokenization. It’s a paradigm shift that promises to evolve DeFi and TradFi until they become all but indistinguishable from one another.
In this brave new world of finance, capital markets will no longer be managed by human oversight. Instead, they’ll be automated by smart contracts in an investment environment that’s far more open and democratic than the one that exists today.
It’s 2035 and FutureKash is a hypothetical startup in Nigeria’s fintech scene, seeking to raise capital to fund the expansion of its payment app in neighboring Ghana. In a matter of minutes, it’s able to raise $250,000, but this money doesn’t come from traditional investors such as VCs. Instead, it issues a tokenized bond on the blockchain. This token is packaged along with hundreds of others created by various African fintech startups and programmatically sold within various capital pools. The tokens are priced in USDC, a stablecoin that’s pegged 1:1 with the U.S. dollar.
FutureKash’s finances are visible on chain 24/7 just like those of every other borrower in the pool. It’s a fully transparent process anyone can see. As the company’s revenue grows and its profit rises, the value of its token gains accordingly. Its loan terms are automatically modified based on the change in credit risk. Investors will receive real-time alerts on their positions, with immediate notification in case the health of a loan deteriorates, allowing them to react and adjust their level of exposure. But FutureKash is growing fast and it remains one of the safest bets, with its on-chain credit score enabling it to borrow at a rate of just 6%, compared to the 13% market average for other African fintech startups.
This is the miracle of smart contract-powered capital markets in the future. In just a few short years, investment banks, VCs and trustees have become all but irrelevant.
A Better Way To Ledger Real World Assets
This transformation of capital markets will be brought to fruition by the ability to tokenize real world assets (RWAs) such as bonds, stocks, invoices, real estate and more. As blockchain emerges as the standard trading venue for financial instruments of every kind, assets that do not live on-chain will become a rarity.
The tokenization of RWAs refers to physical and financial assets that are represented on the blockchain as digital tokens. The advantage of doing so is that these assets can then be traded with much greater ease, with reduced costs thanks to the automated nature of smart contracts, and immediate settlement. It will be an open and transparent process that creates new markets through fractionalized ownership, vastly improving liquidity in markets that were traditionally always illiquid.
DeFi is creating a new standard for the future of asset exchange, in the same way that the internet gave us a superior medium for exchanging text, images and videos. The markets for bonds, stocks and real estate and more are on the precipice of a revolutionary change.
We can draw a comparison with RWA tokenization now and the emergence of securitization back in the 1990s. The conversion of loans into securities is really just a protocol for the origination, packaging and distribution of risk. It introduced a new standard for assets to conform too in areas such as risk and duration, and it massively boosted liquidity in areas such as institutionalized mortgages, and consumer and corporate loans, leading to lower capital costs for borrowers.
Building The Infrastructure For On-Chain Capital
The transformation of capital markets is a slow and iterative process that won’t happen overnight. The infrastructure for tokenization remains nascent, and liquidity for RWAs is still minimal. But the potential of this new infrastructure is high enough that there’s a strong incentive to build it.
That explains why the DeFi sector is growing so rapidly, as various players vie with one another to create the framework to support a revolution in capital markets.
The infrastructure required to empower direct investment in RWAs is offered by Creditcoin, which directly connects DeFi investors to tokenized junior tranche debt opportunities. Its focus is on providing fintech lenders in emerging markets with capital to extend credit to businesses and individuals in emerging markets. Lending partners use the Creditcoin blockchain to record every transaction, creating an immutable record that allows borrowers to build superior credit ratings over time. In this way, it provides transparency in its due diligence process when evaluating fintech lending partners. To date, it has facilitated more than three million RWA transactions.
MakerDAO protocol is one of the most recognizable names in DeFi, building the technology for borrowing, savings and a U.S. dollar-pegged stablecoin called DAI on the Ethereum blockchain. Originally focused on crypto markets, it is actively working on diversifying its offerings to establish new revenue streams. For instance, it partnered with Huntingdon Valley Bank to bridge RWAs that serve as collateral when borrowing DAI. It’s also working with Block Tower to fund $220 million worth of RWAs through Centrifuge.
Another emerging player is Maple Finance, which recently distanced itself from uncollateralized lending following a highly publicized default on one of its loans. It’s now leaning much more heavily on RWAs, eliminating the over-collateralization threshold for borrowers who possess assets that can back their debt.
Little-known Ondo Finance is catering to investors that need to shield themselves from crypto’s volatility and earn sustainable returns with two tokenized funds – the Ondo Short-Term US Government Bond Fund and the Ondo Short-Term Investment Grade Bond Fund. The first invests in short-term US treasuries through the Blackrock US Treasuries ETF, while the latter provides access to investment-grade corporate bonds through the PIMCO Enhanced Short Maturity Active ETF.
A Better Financial System For All
Crypto and DeFi have emerged as a once in a generation opportunity for us to create a superior financial system that benefits every player. It’s a system that will use decentralized ledgers to finance RWAs, crypto and other forms of collateral in a more efficient and open way, with participants afforded credit based on merit as opposed to their status. Real world assets will simply enhance the goals of decentralization, providing resilient, permissionless access to capital markets for all.
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Disclaimer: This content is informational and should not be considered financial advice. The views expressed in this article may include the author's personal opinions and do not reflect The Crypto Basic’s opinion. Readers are encouraged to do thorough research before making any investment decisions. The Crypto Basic is not responsible for any financial losses.