EG 719 How does Centrifuge brings real world assets to DeFiReal-World Assets (RWAs) are physical assets that exist outside the blockchain but can be tokenized and brought onto the blockchain for use in decentralized finance (DeFi). Tokenization involves converting the value of an asset into a digital token, enabling its representation and transactional capability on the blockchain.
Stablecoins serve as a common and intuitive example of RWAs, as they represent tokenized versions of fiat currency. However, RWAs can also represent tangible assets like gold or real estate, as well as intangible assets such as government bonds or carbon credits.
The question arises: why do we need RWAs if these assets already exist in the physical world? That’s where Centrifuge comes in.
The answer lies in the cost-effectiveness and inefficiencies present in the real world compared to the digital realm, often referred to as the “metaverse.” DeFi cannot completely replace traditional finance, but it can compete with it, thanks to significantly lower marginal costs.
DeFi aims to minimize or eliminate intermediaries, saving costs and improving efficiency in the process. Despite its own risk factors, such as exploitable code, DeFi compensates for these risks by reducing intermediaries and increasing transaction transparency. As DeFi continues to mature, asset holders are likely to increasingly utilize RWAs to access the benefits provided by DeFi over traditional finance (TradFi).
Centrifuge to DeFi RWA
Similar to many small business owners, Amazon sellers often face challenges in obtaining the necessary credit to expand their operations. They often encounter obstacles because the options available to unlock capital from their assets are either excessively expensive or restricted to larger enterprises. However, the landscape is on the verge of transformation, thanks to the emergence of decentralized finance (DeFi).
Centrifuge, an on-chain ecosystem specializing in structured credit, presents a solution within its array of use cases by allowing small business owners to collateralize their assets on the blockchain and access liquidity from DeFi.
Databased.Finance, an inventory technology provider, leverages the Centrifuge Protocol, enabling assets belonging to Amazon sellers to be pooled, listed on Centrifuge’s marketplace, and utilized as collateral to obtain financing.
Centrifuge, established in 2017, has already facilitated the financing of a total of $317 million worth of assets on its marketplace. This accomplishment has positioned Centrifuge as a frontrunner in this emerging sector, as recognized by the aggregator RWA. The sector itself holds immense potential, with an extensive range of illiquid assets, including real estate, carbon credits, and natural resources, all poised for tokenization.
According to a recent report by the Boston Consulting Group, this sector is projected to grow into a $16 trillion market by 2030.
DeFi’s real-world opportunity
In December 2022, Centrifuge made a significant announcement by unveiling a groundbreaking $220 million fund. This fund stands as the largest on-chain investment ever made in real-world assets, and it was established in collaboration with DeFi fintech MakerDAO and crypto investment firm BlockTower Credit. Notably, BlockTower Credit became the first institutional credit fund to migrate its collateralized lending operations onto the blockchain.
According to Cassidy Daly, product strategy lead at Centrifuge, this move signifies that traditional financial (TradFi) institutions are starting to recognize the future potential of on-chain finance. They are acknowledging the opportunities presented by enhancing accessibility to private credit and the operational efficiencies derived from utilizing a smart-contract marketplace. By leveraging such a marketplace, it becomes possible to streamline the middle and back-office functions of fund management, resulting in significant economic efficiencies for the entire system.
The Centrifuge protocol offers innovative financial infrastructure capable of streamlining and automating asset management processes, while also providing real-time insights into asset performance. As Cassidy Daly highlighted, it also presents a unique opportunity for investors in the realm of decentralized finance (DeFi) to access a diversified portfolio of real-world assets. These assets offer stable yields that are independent of the volatility typically associated with cryptocurrencies—an aspect that becomes increasingly valuable during uncertain times.
Centrifuge acts as a vital link between traditional finance and DeFi, leveraging the respective strengths of both sectors. In doing so, it brings a vast credit market, estimated in the trillions of dollars, into the realm of DeFi. This not only unlocks the limitless growth potential of DeFi but also introduces a stabilizing factor by providing capital that is not correlated solely to crypto assets.
Centrifuge harbors equally ambitious plans for its future. The platform is currently in a scaling phase and actively cultivating a community of credit experts who can leverage the rich data provided by the marketplace for tasks such as scenario analysis and borrower credit scoring.
This emphasis on data-driven insights aims to establish a new institutional ecosystem and facilitate the opening of capital markets, thereby increasing accessibility and efficiency in the realm of private credit. As a result, borrowers stand to benefit from a cheaper cost of capital.
In addition to the cost advantage, borrowers also enjoy the advantages of open access, enhanced security, and greater flexibility that a decentralized platform like Centrifuge provides. In the present financial landscape, large financial institutions predominantly hold sway, leaving most small businesses and lenders on the fringes. However, Centrifuge aims to disrupt this status quo. As Cassidy Daly asserts, the platform endeavors to build a future of finance where every business, regardless of size, can attain affordable access to capital.
Centrifuge, as the pioneering protocol to bring real-world assets (RWA) on-chain
Centrifuge is committed to constructing an improved financial system. The ecosystem offers several key advantages:
Transparency: Centrifuge enables end-to-end transparency by bringing the entire capital structure, securitization, and debt servicing onto the blockchain. This includes multi-tranching, privacy-first tokenization, securitization, reporting, and more.
Lower cost of capital: Through a decentralized infrastructure, Centrifuge reduces the costs associated with traditional off-chain securitization. By utilizing open-source services, it diminishes intermediary costs and simplifies the complexities often found in traditional finance (TradFi).
Equal and open participation: The decentralized on-chain governance of Centrifuge ensures equal and open access to all parties involved in the securitization process. This includes the ability for new issuer proposals, underwriting, servicing, and more.
DeFi liquidity access: Centrifuge facilitates access to senior and super senior capital from
leading DeFi stablecoin protocols, enabling users to leverage the entire capital stack.
Diversification: Users can diversify their stablecoin and treasury collateral by incorporating yield correlated to real-world assets. This helps stabilize long-term value and ensures the health of the protocol.
Security: Centrifuge maintains a robust security framework, including legal recourse, adherence to regulatory and compliance requirements such as KYC, sanctions screenings, accredited investor checks, and rigorous technical audits.
Here’s how Centrifuge operates
Issuers: Borrowers can finance their real-world assets by accessing affordable DeFi capital without the need for banks or intermediaries.
Institutions and DeFi Protocols: Lenders can gain access to a more diversified and stable yield from junior and senior positions, backed by productive real-world assets such as invoices, real estate, revenue-based financing, and more.
CFG Token Holders: Token holders can actively participate in the governance of the Centrifuge protocol. They have the opportunity to shape the future of Centrifuge by voting and contributing to the decision-making process.
Benefits of Incorporating Real-world Assets in DeFi
The incorporation of real-world assets in decentralized finance (DeFi) brings forth several key advantages. By seamlessly integrating tangible assets, DeFi becomes more efficient, accessible, and innovative, streamlining various processes and fostering interoperability.
One significant benefit is the enhancement of stability and credibility within the DeFi ecosystem. Real-world assets provide tangible value to support digital assets, instilling greater trust among participants and bolstering the overall stability of the system.
The inclusion of real-world assets also opens up exciting possibilities for integrating services such as lending, borrowing, trading, and asset management into DeFi. These services can leverage the advantages of DeFi and become excellent candidates for integration, further enhancing the overall potential of decentralized finance.
How does the inclusion of real-world assets enhance the stability and credibility of the DeFi ecosystem?
First, by providing tangible backing for digital assets, the incorporation of real-world assets adds a layer of security and trust. Through tokenization, these assets are accurately represented on a shared ledger, ensuring transparency and accountability. This transparency fosters trust among participants, as they can see the underlying assets supporting the digital tokens.
Additionally, integrating real-world assets into DeFi allows for the emergence of institutional DeFi. This form of DeFi combines the efficiency of decentralized finance with regulatory safeguards. By addressing anti-money laundering (AML) and know-your-customer (KYC) requirements, institutional DeFi ensures compliance and regulatory adherence. This, in turn, leads to a more credible and stable ecosystem, attracting institutional players who require a higher level of regulatory compliance.
What challenges or regulatory considerations arise when incorporating real-world assets into DeFi
One of the key challenges is cybersecurity vulnerabilities. To mitigate these risks, firms must prioritize security measures such as proper key management, implementing on-chain price oracles to prevent market manipulation, and carefully considering cross-chain bridge vulnerabilities.
Another crucial aspect is the establishment of mature governance models. These models should be integrated into DeFi systems, ensuring they align with the quality standards observed in traditional finance. Robust governance and conduct frameworks will enhance transparency, accountability, and the ability to address potential issues effectively.
Proper recourse mechanisms are also essential. Since traditional recourse and dispute management methods may not be readily applicable in DeFi systems, it is crucial to develop mechanisms to address theft and operational errors. Smart contracts with dispute resolution mechanisms can play a role in resolving some of these issues, but additional mechanisms should be developed to handle various challenges that may arise.
Legal clarity is another crucial consideration. Collaboration with regulators is necessary to develop compliance frameworks specific to DeFi. This involves clarifying and classifying different types of transactions, determining their legal and accounting implications, and ensuring regulatory compliance throughout the ecosystem.
Incentivizing adoption is also important. Exploring novel tokenomics models that cater to institutional DeFi can encourage broader participation. Designing tokenomics models that meet institutional needs while remaining compliant with regulatory requirements will be vital in driving adoption.
End-to-end coordination is necessary to ensure seamless integration between DeFi platforms and traditional financial systems. Developing standardized protocols and APIs that enable interoperability and collaboration with financial institutions will facilitate the smooth flow of assets and information. In addition, the adoption of industry-wide standards is crucial in creating a cohesive ecosystem.
Collaboration with industry participants, standards organizations, and regulatory bodies is vital in making appropriate design choices. In addition, defining and implementing common technical standards, including robust identity verification, privacy protection, and data integrity measures, will contribute to the overall security and compliance of the DeFi ecosystem.
Conclusion
Incorporating real-world assets into decentralized finance (DeFi) through the Centrifuge protocol brings numerous benefits, including enhanced stability, credibility, and accessibility. By tokenizing tangible assets, Centrifuge streamlines processes, fosters trust, and opens up new opportunities for borrowing, lending, trading, and asset management within DeFi. However, addressing challenges related to cybersecurity, governance, legal compliance, recourse mechanisms, and industry coordination is crucial to ensure the successful integration of real-world assets into the DeFi ecosystem.
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