Mar 21, 2023

The Next Generation of Sustainable DeFi Yield: Real World Assets and ReFi

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Decentralized Finance, or DeFi, offers several advantages over Centralized Finance, or CeFi. It is more transparent and secure as it operates on a blockchain, allowing for immutable records and eliminating the need for intermediaries. It offers more financial inclusivity as it is open to anyone with an internet connection, whereas CeFi is often limited to those with access to traditional banking services. And it offers greater control and autonomy to users as they can manage their own assets without relying on centralized institutions.

DeFi generates yield through on-chain activities tied to cryptocurrency assets, where investors earn yield by providing liquidity to borrowers and traders on decentralized exchanges (DEXes) or overcollateralized lending platforms. These rewards for the most part, come in the form of inflationary tokens and can be highly profitable during a bull run, but may be challenging to generate satisfactory yield when asset prices decline and on-chain activity decreases.

The quest for sustainable income within Decentralized Finance (DeFi) has sparked the emergence of protocols that generate yield from real-world assets (RWAs). RWAs are tangible assets or financial primitives with the potential to serve as collateral in the DeFi industry. RWAs can include various items such as cash, metals like gold and silver, real estate, corporate debt, insurance policies, salaries and invoices, consumer goods, credit notes, royalties, and many others. These RWAs have long been used to underpin lending and yield generation activities in traditional finance. By unlocking the significant value of RWAs and the off-chain financial system, DeFi models can achieve sustainable yield without the high volatility that has historically been associated with the relatively new DeFi sector. This enables investors to add non-correlated assets entirely on the blockchain to their portfolios.

To tokenize RWAs on DeFi, blockchains rely on bridges that enable these assets to be represented by digital tokens on the blockchain. Developers create these tokens using smart contracts that establish the rules and conditions for their use, including the rights and obligations of token holders. An off-chain guarantor typically provides an assurance that the tokens issued are always redeemable for the underlying assets, which can include anything from gold and real estate to invoices and intellectual property. This process enables the blockchain to serve as a transparent and secure platform for trading and exchanging RWAs without the need for intermediaries or trusted third parties.

Currently, DeFi offers several examples of RWAs that can be tokenized and traded on blockchain platforms. Stablecoins, which are pegged to the value of a real-world currency, are one such example. Three of the top seven crypto tokens by market capitalization are stablecoins, including USDC, which is minted by Circle and backed by an audited reserve of USD assets. Another example is Synthetix, a DeFi platform that allows on-chain trading of derivatives linked to currencies, stocks, and commodities. 

Yet another protocol called Goldfinch, is a RWA-focused DeFi lending platform that provides services to borrowers with real-world businesses, enabling them to access affordable credit without the need for traditional intermediaries. Goldfinch is a decentralized lending protocol that utilizes real-world assets (RWAs) in a way that demonstrates higher stability and growth compared to other DeFi platforms. By focusing on borrowers with real-world businesses, Goldfinch has been able to generate higher returns on investment, even during times of market volatility. According to LoanScan, its USDC yields have outperformed those of popular DeFi platforms like Aave and Compound. This is because the source of yield for Goldfinch is fundamentally different from those of other lending protocols. Rather than relying on collateralization or lending pools, Goldfinch works with a network of trusted underwriters who evaluate the creditworthiness of borrowers and provide guarantees for their loans. This approach allows Goldfinch to maintain a high degree of risk management while generating significant returns for investors. The use of RWAs on Goldfinch's platform demonstrates the potential for DeFi to expand beyond the limitations of traditional finance and provide new avenues for inclusive economic growth. 

Among the ten most popular lending protocols based on cumulative interest fees paid by users over 180 days, four of them are focused on lending against real-world assets (RWAs). These protocols include TrueFi, Maple Finance, Goldfinch, and Centrifuge. In addition, MakerDAO generates a significant portion of its revenue, approximately 57%, from RWAs.

Another sub segment of Real World Assets in DeFi is Regenerative Finance (ReFi). ReFi is a type of finance that focuses on creating positive social and environmental impacts, similar to impact finance in TradFi. It is the perfect intersection between DeFi and real world impact, making it highly attractive for a wide range of investors, including institutional investors such as pension funds, insurance companies, and asset managers. Institutional investors may be attracted to ReFi due to the potential for both financial returns and positive social and environmental impacts. Many institutions have sustainable investing strategies in place, and ReFi can be a way for them to align their investment activities with their sustainability goals. Combine this with the transparency of DeFi, the outcome is a favorable investment vehicle for institutions. It also allows investor to have more specific and direct impact on the projects that they finance or invest into. Coinchange will be publishing a long form research report on the topic of ‘Impact Finance, Regenerative Finance and Institutional Adoption’ in a few weeks. So keep an eye out for that. 

In conclusion, DeFi offers numerous advantages over CeFi, including greater transparency, financial inclusivity, and control for users. However, generating sustainable income within DeFi can be challenging due to the high volatility associated with on-chain activities tied to crypto assets. To address this issue, protocols that generate yield from RWAs have emerged, offering sustainable yield without the high volatility. These RWAs include a diverse range of assets, such as stablecoins, derivatives, and real estate. Additionally, ReFi is a sub-segment of RWAs in DeFi that focuses on creating positive social and environmental impacts, making it highly attractive for a wide range of investors, including institutional investors. With the transparency of DeFi, ReFi offers a favorable investment vehicle for institutions to align their investment activities with their sustainability goals and have a more direct impact on the projects they finance or invest in.

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