Traditional Allocators Guide to DeFi Yield

Real World Assets (or RWAs), have gained serious momentum in the digital asset ecosystem, and for the most part, have remained less challenged by market volatility while the more speculative assets have experienced their ups and downs.

We’re still talking about crypto? Seriously?

2022 was a tough year for crypto. Between security breaches and colossal bankruptcies, this nascent industry went through a hard-core reality check in front of the whole world.

So where is this going? Well, the cryptosphere is a large, dynamic ecosystem with many players and projects, so it’s intellectually dishonest to group all of its verticals into one bucket. Yes, most of the cryptocurrencies have fallen from their highs in terms of price, but digital assets still carry a strong value proposition with notable reliable, institutional-grade investment opportunities proving this point. Today, I’d like to cover Real World Assets (or RWAs), which have gained serious momentum in the digital asset ecosystem, and which (for the most part) have remained steady while the more speculative assets have experienced their ups and downs.

What are Real World Assets?

Real World Assets are, unsurprisingly, tangible assets that exist in the physical world, which are brought on-chain. Think of precious metals (e.g. gold or silver), real estate (e.g. homes or rental income streams), loans (e.g. auto-loans), future cash flows (e.g. short-term receivables, credit card receivables, or invoice factoring), etc. RWAs hold major global financial value, with the total global fixed income market estimated at $125 trillion, not to mention the estimated total value of global real estate coming in north of $350 trillion.

Where tangible assets become particularly interesting in the crypto, and more specifically decentralized finance (or DeFi) context, is the ability to tokenize them, thus converting the ownership of the asset to a digital representation. These tokenized assets benefit from the transparency, interoperability, and efficiency the blockchain offers, while still providing an “off-chain” guarantee that the token issued will at some point be redeemable for the underlying asset, unlike other cryptocurrencies that only exist in a digital form. And just like the traditional finance space, these assets provide yield to investors that share in the ownership of them, which can provide a steady stream of income and diversification to an overall investment portfolio.

Where is this yield coming from?

A couple of years ago, we saw the emergence and rapid growth of “yield farming” strategies occur in the decentralized finance space. Investors could lock their cryptocurrency tokens in a smart contract (a program stored on a blockchain that runs when predetermined conditions are met) for a set period to earn rewards, or yield, for their tokens. Interest rates could vary from single-digit APYs, all the way up to triple-digit APYs. In this case, the yield is derived from participating in the validation of the network. Other strategies include lending out tokens to other users, who need to pay interest on the amount they are borrowing. During the previous bull market, when trading volumes were at all-time highs, and there was seemingly unending demand for crypto-loans, some of these strategies seemed like a perfectly safe and lucrative solution. However, as markets started to slump, crypto yield platforms such as Circle and Crypto.com slashed their rates heavily due to a drop in demand for borrowing.

Obviously, the downfall of crypto lending behemoths negatively affects the industry as a whole, however, those operating in the real-world asset space have had a much different experience these last 12 months, and there are a few reasons why. The main difference between centralized parties like Genesis and Celsius compared to DeFi platforms like Credix, which operates as a private credit marketplace for non-bank lenders in emerging markets, is that demand on the borrower side of the marketplace is uncorrelated to the crypto markets. Credix is connecting investors with real businesses in LatAm that originate loans to small businesses and occasionally consumers, who pay interest directly back to the Credix investors, with the underlying loans pledged as collateral. Regardless of what happens to the price of Bitcoin, or other major cryptocurrencies, these non-bank lenders still need capital to originate loans and still need to pay a financing fee to borrow this capital, which translates to money back in the investor’s pockets.

Institutional traction

New financial products or markets can take a bit of time to get off the ground. You first need to prove that there’s demand from smaller, more nimble investors (HNWIs, Family Offices, etc.) and only then will you start to get traction from the larger players in the space. Tokenizing real-world assets has certainly surpassed the first phase, and is officially on to phase 2: institutionalization.

Credix, for example, has received equity backing from well-known traditional investment managers in the credit space including Victory Park Capital, MGG Investment Group’s Bayhawk fund, and even the chairman of the largest bank in Brazil, Itau. Beyond the equity stack, Credix has also seen significant traction on the debt side of the business, announcing a partnership in Q4 2022 with Mexico-based specialized credit fund Addem Capital to inject $100M into LatAm debt capital markets, and a partnership with Colombian FinTech lender Clave, to finance $150M of originations to help scale the Clave business. Traditional players are realizing the benefits of tokenizing historically illiquid, non-accessible, and opaque investment products. And they want in.

And it’s not just the Credix platform that has experienced significant institutional traction. Blocktower Credit, an institutional investment firm, recently executed a deal to contribute $70M of its own capital to a $220M total fund on Centrifuge, another DeFi protocol tokenizing structured credit. More recently, Hamilton Lane, a $4.5B+ global investment manager focused on private credit, partnered with Securitize, a secondary marketplace, and the Polygon blockchain to tokenize its Equity Opportunities Fund V, leveraging fractionalization to increase access to an investment product that was formerly only available to investors with the ability to write a minimum $5M check.

The bridge that brings it all together

The emergence of stablecoins has been instrumental in the institutional adoption of blockchain technology and specifically the tokenization of assets. If unfamiliar, a stablecoin is a type of cryptocurrency where the value of the digital asset is pegged to a reference asset, most commonly to fiat money (like USD, or EUR). The usage of stablecoins is extremely important because it presents a standard medium of exchange that shouldn’t fluctuate in value like Bitcoin or Ethereum and thus bridges the gap between traditional currencies and crypto-assets.

There are a number of stablecoins out there at this point but the one we at Credix today believe in, and the one which has probably gained the most institutional traction, is Circle’s USDC, or USD Coin. USDC is a fully-reserved stablecoin, meaning every digital dollar of USDC on the blockchain is 100% backed by cash and short-term US treasuries, making it always redeemable 1:1 for US Dollars. Circle has been successful in gaining institutional adoption because of the fully-reserved backing, as well as by partnering with BlackRock and BNY Mellon on custody management, increasing their institutional credibility. On top of this, Circle has been as transparent as it gets, filing annual audits of its reserve since launching back in 2018 and releasing monthly statements of the size and composition of the reserve.

We at Credix use stablecoins to support our payment infrastructure. Investors fund the transactions on our platform using USDC, which is routed through to the end-borrowers, reaching their account in a fraction of the time it would take them to access capital from traditional, international investors. Using stablecoins allows Credix to transact cross-border, 24/7/365, which can provide a ton of value when sourcing capital from investors across various time zones all over the world. If you’ve ever gone to your bank and tried to send a wire internationally, you most likely understand the value of this. Lastly, because every transaction is recorded on an immutable digital ledger connected to the internet, a transaction using stablecoins allows for full transparency and provides the ability to track fund flows efficiently and in real-time.

While stablecoins have been put under some scrutiny as of late, I believe the most institutional players, such as Circle’s USDC, will continue to thrive in a time when the bridge between traditional currencies and cryptocurrencies is ever so important. Transparency and accurate reporting, both at the core of Circle, are fundamental to their resilience.

Moving forward

It is said that technology markets go through product cycles and price cycles. While last year was rough with respect to the pricing of the digital asset markets, the ecosystem has seen a significant amount of new and innovative projects built over the past 18–24 months with marked improvements to the core infrastructure. Highlighting this point, a16z Crypto notes a significant increase in developer activity across all layer 1 chains over the past three years. And this certainly isn’t the first time we’ve seen something like this. If you look back at some of the firms that were built during the global financial crisis, there’s no shortage of great companies that emerged leveraging technological advancements.

Looking specifically at the real-world asset tokenization space, the last few years have been a time for builders, laying the groundwork and infrastructure for platforms that will thrive in the coming decade. The demand from borrowers is already there, so all that is left to put this sector into overdrive is institutional adoption leading to significant liquidity injections. For that reason, institutional-grade-focused players like Credix and Circle are poised for exponential growth as the largest financial institutions start diving in.