DeFi and the Real World: A trust issue

Scaling Open Finance beyond Crypto

Lucas Vogelsang
Sep 30 · 8 min read

The last few days have seen a lively debate around the risks and benefits of including diversified real-world assets in Maker’s Multi Collateral Dai (MCD) when it launches. At the core of the debate is the question of whether assets that depend on the legal system for custody and security should be included as collateral in a decentralized system.

Opinions are divided between those inclined towards allowing these assets in order to increase liquidity and stability of Dai, and those who view this as an unnecessary risk of outside dependencies. At Centrifuge we are convinced that including tokenized real-world assets as collateral for Dai is key for Dai’s long term stability and adoption.

Why are Real-World Assets important for Open Finance?

Decentralized and open finance aims to bring transparency, cost-efficiency, speed, and accessibility to an industry that has traditionally been opaque with tough barriers of entry.

Currently, the decentralized finance space faces two main challenges: stability and volume.

25th of September was an interesting time in the Dai market (Source:

Firstly, the people and projects using and building on Ethereum are subject to the inherent volatility of the ecosystem; which swings for anything from critical bugs to whales exiting a large CDP (see: the 5% crash in Dai that happened last week).

Correlation in crypto assets is still an issue

With MCD the subjectivity to volatile crypto assets as collateral is mitigated through diversification. A diversified pool of assets with different risk parameters will counter some of the inefficiencies of ETH over-collateralization and would increase the overall volume and value. However, if the only collateral added to MCD are crypto assets, the problem of correlation between the underlying collateral to Dai is not solved. Picking even some of the most diversified reputable crypto assets leaves you with a portfolio of assets that have a correlation factor in the exchange rate of well more than 0.5.

Getting Volume

Secondly, current volume is challenged to provide the scale to reach beyond the use-cases that currently exist in the crypto native world. The volume fails to meet the demand to address all of the real-world assets seeking access to the financial system — for example, the $2.1–2.6 Trillion credit gap faced by small and medium sized businesses around the world*. In addition, globally, $30T is locked up in unpaid invoices at any given time. We think these assets are ripe for inclusion in open finance.

Public and permissionless blockchains and decentralization can only grow and be successful if it also starts impacting the world outside of the Ethereum ecosystem bubble that we live in today. By pushing the boundaries of crypto and focusing our energy on growing the space by bringing new assets and users into it, we will succeed in accomplishing our mission of growing this open finance ecosystem. Staying within crypto and ignoring the world outside sounds purist and clear, but while ideologically aligned, it is not necessarily the most impactful path. Sometimes technology gets adopted in giant steps but more often than not, it is a gradual process; one that involves making compromises to drive adoption.

The Road to Decentralization

Our vision is that someday, every business around the world uses Centrifuge OS to participate in the decentralized economy. That these businesses can fully trust the data that lives on-chain and that the legal system will fully support this vision. The path towards our vision is long. When building, designing, and launching different parts of Centrifuge, we aim to make the best decisions possible, at the right time, to progress on this path. While we are working towards a fully decentralized future, we have had to compromise as we ship our first products and gain valuable insight into user needs and network requirements.

Centrifuge OS is a system built specifically for the financial supply chain and financial documents. With it, off-chain assets, contracts, and agreements that exist between different parties can be converted into cryptographically secured and verifiable objects and tokenized on-chain. An invoice between two parties can be turned into an NFT to be financed on Ethereum.

Current technology and legal frameworks don’t allow for decentralized asset management, and therefore, parts of these processes will need to rely on centralized entities. For the moment, we are using industry partners to do the management of the legal claims. Once the world starts to embrace crypto more fully, the legal system will catch up and will allow for decentralized solutions to these problems. This process will be accelerated by enabling use cases that compromise on these aspects yet show the benefits the technology could bring, like locking up real-world assets in Multi Collateral Dai with Centrifuge Tinlake.

Risk and Valuation of Real-World Assets

How would a tokenized invoice, royalty payment or real estate be reliably valued, and what would liquidation of such an asset look like if it were part of MCD or another decentralized lending protocol?

Centrifuge lets asset originators, such as factoring companies or real estate mortgage brokers create on-chain representations of their assets, such as invoices, royalty revenues, or real estate using Tinlake, which pools these NFTs into a new fungible asset class, as ERC-20 tokens. This ERC-20 token can be used in MCD or any other decentralized lending products as collateral.

Asset underwriting and risk assessment

Each tokenized asset class has its own risk parameters and therefore follows an asset origination process unique to that asset. For our pilots, our partners have carried out this function. For the case of streaming royalties, Paperchain was responsible for assessing the value of the royalties, but in the future, this will be done by a network of decentralized asset underwriters. You can read more about our current setup and this pilot here.

How liquidation works

A Tinlake pool will be overcollateralized, thus providing a buffer for the default of some of the non-fungible illiquid assets in the basket. The secondary market has full transparency of the underlying assets and assesses the risk and price accordingly. In the worst-case scenario, the debt would be sold off to a debt collecting agency off-chain and the proceeds would flow back to the lenders to this instance of Tinlake on-chain in Dai.

Special Purpose Vehicle?

To ensure that the NFTs that exist on-chain have a legal claim, the best way to achieve this is by setting up a legal entity that is the counterparty to the NFT issuer and the party that now has a claim to it, in the example of MCD it would be the individual borrowers and the Keepers. SPV’s in today’s financial system are common and the processes around operating and verifying them are fairly standard processes. While this structure is inherently “trusted” as it relies on off-chain data, there are many ways we can greatly reduce the trust that is needed in it. Several audit firms can attest to the correctness of the books and act as decentralized oracles that attest to the off-chain data. The operating agreements that govern these SPVs can be written in a way that they are obligated to act by what is decided by the decentralized governance that exists on-chain making the SPV merely a framework with very little power itself.

Risk today. Risk tomorrow?

A lot of real-world assets today have variance in price and default risk that is an order of magnitude smaller than today’s top cryptocurrencies. As an example, supply chain finance assets such as invoices in medium-sized businesses quite frequently are offered interest rates by banks of less than 5% annually. Meaning, a bank today can give a business a 5% APR and still make a profit. The default rate of these assets, therefore, must be less than 5% and in reality, are often less than 1%. As long as the on-chain representation of these assets only adds minimal risk, there is little reason to treat them as any riskier than what the market determines today.

Some centralization of assets does not mean a centralized system

The most important thing to understand is that the Maker protocol itself can never become centralized, backdoored or KYCd, regardless of what collateral it uses. And even if Maker governance allows and gives appropriate risk parameters to assets that are regulated and require KYC there is nothing forcing a regular user to use those assets as collateral. They can still use their favorite trustless asset to generate Dai with, but the difference is that Dai holders are not exposed solely to the highly correlated risk of crypto, and as a result it will be more liquid and stable.


I think the above statement by Rune puts it quite well. There’s no reason why these assets can’t coexist in the finance system we are trying to build. Ultimately, I believe the more open, less trusted and less restricted assets will win and therefore assets that are overly reliant on the crutches we use today will slowly be replaced by assets that don’t.

Even the proposed assets that do rely on legal claims such as the examples I made above, we can add a layer of redundancy: by picking different jurisdictions, asset classes and legal structures, the risk of all of them failing at once is mitigated. The only way for all of the collateral to become worthless overnight would be for several countries to overhaul their legal systems all at once with immediate effect.

Real-World Assets: Using Tinlake and Dai

This last month has been extremely eventful at Centrifuge. We launched Tinlake, the first dapp built on the Centrifuge protocol, and conducted several pilots which have seen a total of around 250K Dai extended as loans, simulating a future MCD. For this reason, we are engaged in the debate around MCD and the types of collateral that will be supported.


Centrifuge is a decentralized operating system for the financial supply chain.

Thanks to Cassidy

Lucas Vogelsang

Written by

Cofounder at @centrifuge


Centrifuge is a decentralized operating system for the financial supply chain.

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