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Real-world assets: Ecosystem overview
In the Terra bear market, a new fixed-income ecosystem focused on real-world lending takes shape.
Reassessing staking risk/reward
The DeFi bull market of 2020-21 created two novel staking/fixed-income products: network staking yield (lending your capital to support a Proof-of-Stake network) and liquidity-pool staking yield, or LP yield (lending your capital to a trading pool, effectively shorting the volatility of that token pool while also providing liquidity).
Network staking offers naked long exposure to an underlying token while also providing seigniorage-based income, basically taxing newer buyers with inflation to pay older buyers compensation for their predictable, mission-critical network support. A “blue-chip” example of this was LUNA (old Terra)’s 21-day staking on the old Terra network (for 5-10% annual yield and governance rights).
LP staking typically promised a more stable income stream, and reduced directional exposure. The classic examples are Uniswap trading pairs, such as wETH/wBTC, currently yielding around 24% APY. These pools have the added benefits of increased yield during high volatility periods, although the user still carries substantial L1 protocol risk if not on Ethereum (juicy LUNA-UST staking yields don’t matter much if the L1 blockchain dies, as LUNA did). LP takers also typically usually carried no duration risk unless they were specifically staking DEXes at inception (eg, staking the Astroport lockdrop on Terra).
With the benefit of 20/20 hindsight, we can draw several harsh lessons.
The market has undercompensated alt-L1 network stakers for duration risk.
LP staking on Ethereum has delivered on its promises, without delivering any particularly nasty surprises.
Non-Ethereum LP staking has not had a sufficient risk premium, due to cross-chain liquidity risk.
Until PoS networks reprice duration risk via much higher staking yields or much shorter duration locks, crypto investors should probably be very cautious about investing in them.
Since staking yields are less reliable and more adversely-selecting the higher they get, the only rational market response to #4 is to drastically shorten the staking duration lock.
The good news is that a new asset class — tokenized & securitized DeFi real-world assets — is taking shape within DeFi. Its risk/reward profile merits close study by crypto investors as an attractive alternative to network staking. And unlike network staking and LP staking, returns have no fundamental correlation with crypto flows.
DeFi-to-RWA lending: the basics
DeFi-to-RWA lending is a much harder problem to solve than crypto-to-crypto lending. Hurdles unique to RWA lending include:
Tokenizing real-world loans and bringing them on-chain. This isn’t technically difficult, but it can get very expensive in terms of gas fees on the Ethereum network.
Fiat legal risks. These loans are almost always tied to regulated assets (eg, a mortgage on a home). Therefore, all crypto transactions are subject to regulations and vulnerable to crypto-hostile regulatory action.
Doxxing. Real-world lending requires real-world identification. Crypto’s hallmark pseudonymity doesn’t apply here. Furthermore, whenever a user pseudonymously funds a real-world asset, they run a growing risk of doxxing their larger subgraph of transactions. Real-world asset-performance risks. For every asset, someone (multiple people) needs to handle the workflows normally handled by a credit fund
Asset quality: is the underlying loan going to be repaid with the promised interest?
What if it isn’t repaid? Is there infrastructure for servicing the loan?
Direct competition with banks. Banks have much greater scale and lower transaction costs in most of these lending lines than DeFi does, creating a competitive disadvantage.
Onboarding RWA borrowers. RWA borrowers don’t care where they get their money. They want it to be easy to convert into fiat. Dealing with a bank feels familiar to them; dealing with all the headaches of an eight-step crypto-to-fiat-to-fiat-to-crypto cash return cycle doesn’t.
Marking RWA tokens. When a loan isn’t repaid, how should the collateral of a vaulted NFT be marked down, in the absence of a liquid secondary market?
Dealing with real-world adjustments to tokenized loans. Tokenizing a loan sounds great, but tokens, once minted, cannot (at the moment) be changed. However, in the real world, lenders and borrowers often make adjustments to loan terms to reflect changing circumstances. Current DeFi RWA infrastructure doesn’t accommodate this need.
Illiquidity. Like real-world business loans, money cannot be withdrawn from an RWA pool unless the loans mature, or a new investor is willing to invest in the pool to replace the liquidity you’re trying to withdraw. This trait in particular diminished RWA attractiveness relative to Anchor and other “mainstream” options during the most recent bull market.
Before the Terra crash, DeFi was completely dominated by low-information, risk-tolerant degen flows. RWA lending, with all its regulatory baggage and high fixed cost per use case, offered 100x the infrastructure headache of crypto-to-crypto DeFi at little marginal reward. Additionally, RWA loans offered very mediocre liquidity-adjusted return relative to other mainstream DeFi yield options (*cough* Anchor *cough*).
Terra’s collapse brought several new realities into focus:
With universally negative funding flows, “XX% APY” staking yields have lost all meaning, unless denominated in ETH or credible stablecoins.
Even being paid in extremely blue-chip L3 (dApp) tokens (eg CRV) are a 2-3 year game of musical chairs unless/until funding flows change. Even though CRV is a universally valued DEX, its token value faces a waterfall of token unlocks over the next 2-3 years. Unless its token value skyrockets relative to
Real-world cashflow is king. Crypto-to-crypto lending is a downstream derivative of crypto funding flows. It works well during a bull market but can’t be relied upon in a bear market.
While real-world assets come with a much higher infrastructure burden, if executed properly, they generally provide stablecoin returns on a stablecoin investment with an L3 token kicker, without the “ponzi risk” (fund-flow dependency) of purely DeFi-native protocols.
RWA infrastructure: Lenders, Intermediaries, and Tokenizers
The RWA-focused protocols are focusing on 3 main functions: lending against RWA collateral, tokenizing RWA collateral, and risk mediation. A fourth role (asset diligencers) is carried out by third-party credit teams, to originate and vet quality assets.
Stablecoin lenders: MakerDAO, Frax, TrueFi, other stablecoin issuers. These protocols’ economic cost of capital is theoretically zero. Outside users come to the protocol, vault their own collateral, and thus mint new DAI, FRAX, etc. into circulation. To the extent that users borrow below protocol limits, the protocols have leeway to mint additional currency against vaulted collateral and lend it against interest-bearing assets. The lender protocols all operate under different protocol constraints depending on the architecture of the stablecoin peg.
Tokenizers: Centrifuge & Goldfinch, presumably other players in the future. These protocols build the infrastructure necessary to create an on-chain representation of real-world collateral, with all the data composability required to maintain an on-chain credit rating. (For example: how much interest on the loan was paid last month? The month before that?)
Intermediaries: Maple and TrueFi. This participant fulfills a similar role to stablecoin lenders, but instead of lending zero-cost-of-capital loans, they operate more like a LendingClub of DeFi, linking pools of investors (lenders) to credit teams which identify credible real-world assets to lend against. The intermediary charges a spread over a negotiated base interest rate (8-12% is the typical total loan cost) to the credit team. Any yield above that spread, net of borrow costs, goes to the credit team.
Intermediaries have also shown a tendency to not tokenize real-world assets, due to the very high gas fees of Ethereum tokenization and the instability of Ethereum alternatives. I think there’s a major opening for a non-Ethereum proof of stake asset tokenizer.
Asset diligencers: Currently, retail investors and TradFi/alternative-credit teams make their own assessments of asset quality and invest accordingly. As RWA infrastructure becomes more sophisticated, this role will concentrate towards highly specialized TradFi credit teams that also have substantial DeFi knowledge, smart-contract awareness, and knowledge of DeFi risks.
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