RWA — Comparative Analysis of On-Chain Lending Projects
Background
One of the emerging trends in the world of blockchain and cryptocurrency is the use of real-world assets to expand the on-chain credit. This involves leveraging blockchain technology to create digital representations of real-world assets, such as real estate, commodities, or art, and using these digital assets as collateral to issue on-chain credit. By doing so, borrowers can access credit more easily and cheaper than traditional lending, while lenders can earn interest on their holdings by providing liquidity to the market. This approach has the potential to democratize access to credit and make it more inclusive, particularly for underserved or marginalized communities who may have limited access to traditional financial services. Additionally, by using real-world assets as collateral, the on-chain credit market can be more stable and less prone to the volatility and speculation that can plague other forms of cryptocurrency lending.
Overview the traditional global bond market
The traditional bond market has a long and rich history, dating back to the 17th century when the Dutch East India Company issued bonds to finance its trade activities. Since then, the market has grown significantly, becoming a crucial source of financing for governments, corporations, and other institutions.
In the modern era, the traditional bond market can be summarized as a decentralized global network of buyers and sellers who trade debt securities, or bonds, issued by borrowers seeking to raise capital. The market is highly diverse, with bonds issued by governments, corporations, municipalities, and other entities, and can be further classified by a range of factors such as the bond’s maturity, credit rating, and currency denomination.
market situation summary
The scale of the traditional bond market is vast, with an estimated $123 trillion*** in outstanding bonds as of 2021, according to the Bank for International Settlements. The distribution of the market is also highly global, with bond issuance and trading taking place in major financial centers such as New York, London, Tokyo, and Hong Kong, as well as in regional markets around the world.
According to data from the Bank for International Settlements, the United States and Japan together accounted for nearly half of global bond issuance in 2020, with Western Europe and China accounting for an additional quarter. This reflects the strong presence of developed countries in the market, which have well-established financial systems, deep pools of capital, and stable political and economic environments that are attractive to borrowers.
In contrast, developing countries have traditionally had a smaller presence in the traditional bond market, due in part to their relative lack of financial infrastructure and political and economic instability. However, in recent years, there has been a trend towards greater participation by emerging markets, with issuers from countries such as Brazil, Mexico, and Indonesia becoming more active in the market.
Despite this trend, there are still significant disparities in the distribution of the traditional bond market.** For example, according to the International Monetary Fund, developing countries account for only around 20% of global bond issuance, despite representing around two-thirds of the world’s population and a significant share of global economic growth.
One factor that contributes to these disparities is the so-called “interest rate gap,” which refers to the difference in interest rates between developed and developing countries. Developed countries typically have lower interest rates, reflecting their stronger financial systems and stable political and economic environments. This makes it more difficult for developing countries to compete in the traditional bond market, as they must offer higher interest rates to attract investors.
The vertical structure of bond market
The financial infrastructure of the traditional bond market includes a range of players, such as issuers, underwriters, dealers, and investors. The process of issuing a bond typically involves several steps, such as selecting the type and structure of the bond, determining the interest rate or coupon, and finding a buyer for the bond. Issuers may work with underwriters, who help to market and sell the bond to investors, or may issue the bond directly to the public through a public offering.
Once a bond is issued, it is typically traded on secondary markets, where investors can buy and sell the bond based on its market value, which is determined by a range of factors such as the bond’s credit risk, liquidity, and prevailing interest rates. The market price of a bond is also influenced by the yield curve, which reflects the relationship between bond yields and maturities, as well as by other macroeconomic factors such as inflation and monetary policy.
The traditional bond market has historically played a critical role in supporting economic growth and development, by providing a reliable source of financing for a wide range of projects and initiatives. However, the market also faces a range of challenges and limitations, such as the risk of default by borrowers, the complexity of some bond structures, and the potential for market volatility. As a result, there has been growing interest in alternative financing models, such as blockchain-based lending platforms that use real-world assets as collateral.
Challenges of traditional lending
Traditional financial lending faces a number of challenges that have contributed to the growing demand for blockchain-based lending solutions. Some of the key challenges include:
- High transaction costs: Traditional financial lending often involves a large number of intermediaries, each of which takes a cut of the transaction. This can result in high transaction costs, making it more difficult for borrowers to access credit and for lenders to generate sufficient returns.
- Lack of transparency: Traditional financial lending can also suffer from a lack of transparency, with borrowers often unaware of the terms and conditions of their loans or the fees and charges associated with their borrowing. This can lead to a lack of trust between borrowers and lenders, making it more difficult to establish long-term relationships.
- Slow and inefficient processes: Traditional financial lending can also be slow and inefficient, with borrowers often required to provide extensive documentation and go through a lengthy approval process. This can be particularly challenging for small businesses and individuals who may not have the resources to navigate these processes.
- Limited access to credit: Finally, traditional financial lending can suffer from limited access to credit, particularly in developing countries or for individuals and businesses with limited credit histories. This can make it difficult for these individuals and businesses to access the financing they need to grow and thrive.
These challenges have contributed to a growing demand for blockchain-based lending solutions, which offer a range of benefits including increased transparency, reduced transaction costs, and faster and more efficient processes. As blockchain technology continues to mature and evolve, it is likely that we will see continued innovation in this area, as developers and entrepreneurs seek to leverage the unique benefits of blockchain technology to create new and innovative lending products and services.
Blockchain lending with real world assets as collateral
DeFi represents a significant shift away from traditional financial systems, offering greater accessibility, transparency, and efficiency. As the technology continues to evolve and mature, we can expect to see continued innovation in this area, with new and innovative products and services that are designed to meet the needs of users around the world.
Definition and characteristics of blockchain lending with real world assets
Blockchain lending with real-world assets (RWAs) involves using blockchain technology to create digital representations of real-world assets, such as real estate, commodities, or art, and using these assets as collateral to issue loans or other forms of credit. This type of lending is often referred to as “asset-backed lending” and offers a number of key characteristics.
Firstly, stability. The use of RWAs provides a more stable and reliable basis for valuing blockchain-based financial products and services, which can help to reduce risk and improve stability in the blockchain ecosystem. This is because RWAs are backed by tangible assets that have intrinsic value and are tied to real-world cash flows, which makes them less prone to volatility and speculation compared to purely crypto-based lending.
Secondly, democrazy. Blockchain lending with RWAs can democratize access to credit and make it more inclusive, particularly for underserved or marginalized communities who may have limited access to traditional financial services. This is because RWAs can be used as collateral to issue loans and other forms of credit that are more accessible and at a lower cost than traditional lending.
Thirdly, transparency. The use of blockchain technology allows for greater transparency and accessibility in the lending process, as all transactions are recorded on a public ledger that is accessible to all participants. This can help to reduce the risk of fraud and improve trust between lenders and borrowers.
Overall, blockchain lending with real-world assets has the potential to revolutionize the lending industry by making credit more accessible, stable, and transparent, while reducing risk for all participants.
B. Advantage of blockchain lending with traditional lending
Blockchain lending with real-world assets represents a significant departure from traditional lending models in several key ways.
Firstly, one of the most notable differences is the international accessibility and global market intergrity. Unlike traditional lending, which is often subject to geographic limitations and regulatory restrictions, blockchain lending is accessible to borrowers and lenders from anywhere in the world. This is because blockchain lending operates on a decentralized network that is not tied to any particular geographic location or jurisdiction. As a result, blockchain lending with real-world assets can provide borrowers and lenders with greater flexibility and access to capital that may not have been available to them through traditional lending channels.
In addition to the international accessibility mentioned earlier, blockchain lending with real-world assets also offers increased accessibility to crypto financial instruments. One example of this is the ability for vouchers issued by RWA loan projects to be refinanced by other DeFi projects. This creates a more interconnected lending ecosystem, allowing borrowers to access funding from a wider range of sources. Furthermore, on-chain activities can serve as evidence for DeFi-based identity (DID) and reputation systems. This means that borrowers’ behavior and payment histories can be tracked and used to build trust and establish creditworthiness in the DeFi ecosystem. Finally, blockchain lending can also offer more flexibility for borrowers, as they can select different borrow assets with varying risk exposures, depending on their individual risk tolerance and investment goals.
Finally, blockchain lending with real-world assets is characterized by consensus and democracy. The decentralized nature of blockchain lending means that all participants in the network have a say in the decision-making process. This is in contrast to traditional lending, which is often controlled by a small group of institutions or individuals who make decisions about who can borrow and at what rates. In the blockchain lending world, decisions about who can borrow and at what rates are made through a consensus-driven process, which ensures that all participants have a voice in the lending process. This democratic approach to lending can help to promote transparency and fairness, while also reducing the risk of bias and discrimination that can be present in traditional lending models.
In summary, blockchain lending with real-world assets offers several key advantages over traditional lending, including greater international accessibility, accessibility to crypto financial instruments, and a more democratic decision-making process. These factors can help to make lending more inclusive, transparent, and accessible to a wider range of borrowers and lenders, while also promoting stability and reducing risk in the lending ecosystem.
C. Limitations of blockchain lending with real world assets
While blockchain lending with real-world assets offers many advantages over traditional lending, there are also several limitations that must be considered.
Firstly, while blockchain technology offers a trustless and transparent platform, blockchain lending with real-world assets introduces credit risks. Even if the assets are backed by real-world assets, the borrowers can choose to default, which can lead to settlement and jurisdiction in real life. Of course, the consensus on the blockchain at this condition is out of power, the aurora of trustless can not shed on real world collateral assets. Additionally, there may be challenges related to the valuation of assets, which can make it difficult to assess the appropriate level of collateral required for a loan.
Secondly, global compliance issues may arise when lending across borders. Different countries have different regulatory frameworks and compliance requirements, which can create legal and operational challenges for blockchain lending platforms that operate across multiple jurisdictions. Compliance with anti-money laundering (AML) and know your customer (KYC) regulations may be particularly challenging for blockchain lending platforms, which may need to work closely with regulators to ensure compliance.
Thirdly, technical risks are still present in blockchain lending. Blockchain technology is still evolving and there may be technical challenges related to security, scalability, and interoperability that can impact the stability and reliability of blockchain lending platforms. There may also be challenges related to smart contract programming and execution, which can impact the performance and accuracy of lending contracts.
Overall, while blockchain lending with real-world assets offers many advantages over traditional lending, it is important to consider the potential limitations and risks associated with this new form of lending. By carefully assessing the risks and implementing appropriate risk management strategies, blockchain lending platforms can work to ensure the continued growth and development of this innovative new industry.
III. Case studies of blockchain lending projects
After the crisis of FTX, the boom of DeFi has gone, as well as the RWA-related DeFi. The major players in the last bull market have shrunk to just for surviving. But their strategies should still be noticed. At least, they made an explosive-scale business in the bull market.
waterfall structure
In order to mitigate credit risks contaminated from real world assets, most of RWA introduce the waterfall structure. And now, it seems become to the mainstream of RWA loan industry.
The waterfall structure in CLOs (Collateralized Loan Obligations) refers to the priority of payments that are made to various parties involved in the CLO. The structure is called a “waterfall” because payments flow downward in a predetermined order, much like water flowing down a waterfall.
The waterfall structure is typically divided into several “tranches,” which are different layers of debt that are issued by the CLO. The tranches are ranked in order of priority, with the most senior tranche receiving payment first, followed by the next most senior, and so on. The payment waterfall starts at the top of the structure and flows down through each tranche until all payments have been made.
This structure was first invented in 1980s, but prevailed after 2000s. The prevailing has three main reasons: 1, the financial technology development makes institutions can measure the risk more accurately; 2, an electronic trading system reduce the trading cost; 3, in lower interest rate circumstance, this structure can provide additional income as long as you have additional risk information.
A. Centrifuge
Product：
Centrifuge holds the largest market of RWA-collateral lending. As it declare: “Centrifuge is the infrastructure that facilitates the decentralized financing of real-world assets natively on-chain, creating a fully transparent market which allows borrowers and lenders to transact without unnecessary intermediaries.”
TVL：192.1M
FDV：112.2M
Backer：
Mechanism:
Characteristics:
onchain-offchain structure
As a OG of RWA loan industry, Centrifuge has both onchain and offchain arrangement to mitigate the credit risk. In its offchain structure,it set SPV structure, the collateral will be easy to be settled when default happen. it use centralized KYC and AML service to comply the jurisdiction across nations.
Financial agreement
Inspite of the signature and transaction record on chain, the investors can also claim get a subscription agreement with issuer.
Various of RWA collateral
The collateral is diversified, from emerging market consumer loan to structure credit. Each project will have an individual SPV wallet to control its fundraising. the interest rate varies from 3+% to 10+%.
High default rate
5.6% is its default rate of its finished loan by the scale. High default rate does not mean that its failed, but it prefers higher risk financial strategy. And since it do not have the process to select the investment projects intentionally, it do not take any responsibilty when project fails.
B. Maple
Product：
Maple is transforming capital markets by combining industry-standard compliance and due diligence with the transparent and frictionless lending enabled by smart contracts and blockchain technology. Maple is the gateway to growth for financial institutions, pool delegates and companies seeking capital on-chain.
TVL: 28.4M
FDV: 78.7M
Backer：
Mechanism:
Maple transforms the traditional CLOs into cypto. Every project has a delegate, who is also the provider of First-Loss Capital. The delegate also take the responsiblity to execute impairment when default happens. The delegate is verified by Maple team.
Characteristics:
Blackbox & Centralized:
The right to determine who can be a delegate is controlled by the Maple team. And now 62% of active loan is given to Maven 11
A resilience plan when default and a legal agreement with borrower
medium default rate
Its defalut rate is 2.935%, but consider the ratio of risk exposure to M11, I feel it is too risky.
C. GoldFinch
Product:
Goldfinch is a decentralized protocol that allows for crypto borrowing without crypto collateral. The Goldfinch protocol has four core participants: Borrowers, Backers, Liquidity Providers, and Auditors. Apart from other protocols, GoldFinch tried to build uniform RWA- corelated risk assets. All of assets in the senior pools expose to the same risk.
FDV：101.6M
TVL：66M
Backer:
Mechanism:
Characteristics:
- Decentralisation:
The project has a decentralized decision-making process, where backers make group decisions on whether a project can successfully raise money and at what scale.
2, Innovated credit model:
The project uses a leverage model and dynamic backer incentives. The leverage model determines how much capital the senior pool allocates to each borrower pool based on the trust level of each borrower pool. When more backers invest in a borrower pool, the borrower pool appears more reliable and can receive more leverage capital.
3, Diversify borrowers:
The project diversifies its borrowers, lending capital across different types of borrowers and lending situations, ranging from fintech in emerging countries to consumption debt-backed loans from developed countries. The decentralized nature of the borrowers means that default risks are also spread out.
4, Uniform risk and liquidity
The project has a uniform senior pool where liability responsibility and interest rates are consistent across the board.
5, low default risk:
So far, the default risk is zero, indicating that the project has low default risk.
D. Credix:
Product:
Credix is a next-generation credit ecosystem, enabling institutional borrowers to access liquidity, and creating attractive risk-adjusted investment opportunities for institutional investors, credit funds, and accredited investors.
Backer:
Mechanism:
Characteristics:
1, Centralization:
The project has a centralized underwriting process where one person is in charge of screening, due diligence, and structuring investments. This is similar to traditional finance where one entity has control over the investment process.
2, Market-specific:
When a new lending project is created, a unique LP token is made to distinguish investments made in different liquidity pools of different markets. However, this may result in weaker liquidity because the liquidity demand and supply are sliced.
3, non-transferable:
The tokens used in the project are non-transferable and can only be traded in compliance accounts. While this design helps with compliance issues, it may make it difficult for individual investors to participate in the market. As a result, many investors may be excluded from participating due to the platform’s strict requirements.
4, Three layer default protection:
Credix use several ways to guarenttee that money in senior trench will be repaired. despite of over-collateral assets and money in junior trench, it also can use the payment gap between Fintech revenue and the interest which Fintech company pays to Credix.
E. TrueFi:
Product:
TrueFi is a protocol for uncollateralized lending with onchain-credit score, and it is controlled by the holder of TRU. Is is a part of ecosystem of TrustToken. There is no clear solution when delinquency or default happens. The quality of each loan project highly depend on the decision of portfolio managers. It is also a centralized structure.
Backer:
Mechanism:
The portfolio manager gives the details of each deal, and lenders to choose whether accept or not. The deal can also be separated into three trenches, with different default responsibility and interest rates.
Characteristics:
In its document, the project want to choose a gradually decentralisation process. Right now, the solution is highly centralized. The default resilience is not taken into consideration in the platform level.Till now, its default rate is 0.258%, relately low. But it is no the result of TrueFi systematic credit solution. No required RWA as collateral, loan purely relies on borrowers’ credit or reputation.
F. Comparative analysis of the projects
1, KYC and compliance
Since the business touches RWA, the cash flow, as well as the settlement when default should be supported by the local government, KYC and complicance issue is essential. All of the projects pays a lot of attension on these matter. Third parties related to these business are introduced. As we told before, the largest part of financial cost for lending is the compliance cost, none of these projects get more advantages against traditional finance at this aspect. In order to satisfy the compliance requirement, the voucher token even be designed as non-transferable.
2, Credit
Onchain credit is a good thing for the open finance. But none of the projects tries to introduce onchain credit into project credit measure. On one part, DeFi only has a short history and onchain activities are limited. On the other hand, the cost to create an anominous account is almost nothing. Onchain data can not some ones reputation. Only GoldFinch tries to let every business entity only can have an unique account in the platform.
3, Resilience in a credit default
Maple finance, GoldFinch, and Centrifuge give a solution when credit defaults happen. For the off-chain collateral, those project prefers special-purpose vehicles to control the right of disposal. Credix tells the user, it has a team to manage the collateral. TrueFi says nothing about the fault. Interesting thing is when the FTX collapse, Justin SUN moved 6 million from Alameda research.
4, Transparency
All of their onchain behaviors are transparent. But the cash flow offchain and those off-chain information correlated to the debt credit need a disclosure regularly. Centrifuge assert there is a peer 2 peer network to share information. But since crypto industry is brand new. whether the information disclosure should be under security law is sill need to discuss.
5, liquidity
Centrifuge set a reserve for other to withdraw money. GoldFinch has a unique credit risk measurement as well as a uniform liquidity pool for capital in the senior pool. Its liquidity will be increase along with its business scale. The design of Credix do not have good liquidaty, especially when its lending pool drain out. Maple finance does not sepecified how to build liquidity.
VIII. Conclusion and recommendations
A. Summary of the findings and key takeaways
It is not a good business, but a big business.
The Real World Finance is much much bigger than DeFi, And decentralised world is still a infant comparing to traditional industry. Even only a tiny part of traditional finance will be onchain, it will be a huge success for DeFi as well as its infrastructure.
Crypto world need RWA to enhance its credit.
There less stable business in the emerging decentralized world. So the haircut rate of collaterals are far more high than RWA. We can see the phenomenon that if USDC & USDT support a blockchain, that blockchain will have much better liquidity and easier to build DeFi. So is RWA for other business.
The imbalance development in the global financial system leaves the RWA lending a surviving space.
In traditional world, especially in those developing countries, financial infrastructures are limited. Many business oppotunites are lost just because of lack of credit system there. Crypto world need real world stable assets to increase its credit, Real world need blockchain help them to build credit. That is why RWA is amasing for crypto industry.
Lack of infrastructure
Even if we know that there are so advangtage to use blockchain. But the process of each lending case related to the world, and jurisdiction in real world will influence the risk of lending. RWA settlement in real world, other financial and ligitimat services are expensive in both time and value.
In my View, GoldFinch is the most innovative and decentralized project in my mind. But even FoldFinch does not introduce the credit score of backers to measure the lending case.And all the solutions to the default risks rely on individual jurisdiction of the traditional world. As long as the jurisdiction is not blockchainlized, most part of the financial cost can not be waived.
KYC and compliance are only with not value for customers
When we read the document of these project, very few lines shows the correlation between KYC and security. All their compliance endeavors look like to obey the law, not for the customer.
All these reasons result in that there is a big RWA-collateral lending market, but crypto project can not touch it in a short period.
Reference：
Financial Infrastructure and Access to Finance: A Global Perspective
Financial Infrastructure, Group Lending and Funding Costs in Developing Countries
