The Need for Real-World Assets in DeFi

The recent decision by MakerDAO and other major players to accept Real-World Asset Originators into their ecosystems could be considered as marking the coming of age for Decentralised Finance.

Here is why DeFi desperately needs RWA and how they are going to unlock the full potential of the Open Finance sector.

Real-world assets are unlocking DeFi’s full potential. Finally.

For quite some time, liquidity providers have been increasingly interested in bringing Real-World Assets onto their platforms

MakerDAO opens up to RWA

On the 14th of April 2021, the MakerDAO community passed a vote (executed two days later) to allow ERC-20 tokens, which originated from a pool of real-world assets, into their project’s ecosystem.

This means that, for the first time in an enterprise of this scale, anyone can deposit assets such as real estate, trade invoices and other tangible assets in a pool to receive funding. These assets are used as collateral for a loan paid in the project’s stablecoin, DAI.

This opens up opportunities for a multitude of assets, from music royalties and artwork to any type of physical asset that can be tokenized (which, notably, can essentially be any asset). It also unlocks remarkable opportunities for individuals and SMEs who currently cannot access funding through the traditional finance channels.

Without a doubt, the MakerDAO community has considered all of the above reasons, but there’s another crucial motive behind this decision.

To find it we need to look back at the infamous Black Thursday of March 2020. Following the crypto sell-off, $4.5 million worth of DAI was left unbacked by any collateral, and users lost millions. DAI subsequently lost its peg to the US Dollar and, consequently, MakerDAO’s crypto tumbled.

After that, MakerDAO faced significant sell pressure from some of the project’s early investors, including Polychain, Maker Foundation and Andreessen Horowitz.

It comes with little surprise then that the MakerDAO community tried everything they could to shelter DAI from the high volatility the markets were experiencing by maintaining its peg to the US Dollar.

But more was required to stabilise the project. And the solution was Real-World Assets.

Jack Purdy, an analyst at the cryptocurrency research firm Messari, said that the move to add real-world assets “greatly increases the addressable market for collateralized loans.” This allows for expansion in the supply of DAI, “preventing the price from consistently exceeding the peg.”

It’s clear that the need for stability was behind the decision to diversify the collateral backing DAI. However, the community also saw the opportunity to tap into a multi-trillion-dollar asset class.

The implications of RWA integration

RWA don’t simply allow MakerDAO to gain stability and to access another asset class; the integration of non-crypto-related assets has substantial implications for the whole industry.

A now-$60 billion sector, DeFi sees RWA as the next opportunity to increase its market size exponentially.

Unlocking the lending potential of trillions of dollars of real-world assets puts DeFi in direct competition with banks and traditional lenders.

To top it off, introducing tangible assets and dynamics that are similar to the traditional finance sector’s (whilst removing its limitations) provides peace of mind to the risk-averse players that, until now, have been “watching and waiting” for more secure investment avenues.

How to take up the opportunity

But simply welcoming RWA into the Open Finance world won't be the solution to all problems. Unfortunately, there are other barriers that prevent investors and borrowers from participating in the DeFi ecosystem.

At present, Real World Asset Originators (RWAO) don’t have the time or technical skills needed to access or manage liquidity pools. Due to the lack of efficient tools, their only option is to resort to manual processes to access liquidity in the DeFi space.

On the other end of the spectrum, investors have little visibility on what underpins their investments, and limited access to real-world assets.

These are the problems that Ernesto Vila and Alejandro Gutierrez set out to solve.

The duo has worked in logistics and shipping for over two decades and during that time has been exploring ways to digitise the freight forwarding industry and improve international trade and supply chain finance.

As ConsolFreight’s CSO, Alejandro Gutierrez has been experimenting with blockchain for years. The company has considered different types of private or permissioned networks (such as IBM’s TradeLens and we.trade based on the Hyperledger framework), which in principle make existing infrastructures more efficient.

As a knock-on effect, these solutions should make finance more accessible to small businesses. But Gutierrez believes that: “in reality these networks are backed by big financial institutions, and are expensive as they’re designed for the big players in trade.”

Their experience on the ground has taught them that the road to unlock lending in the traditional finance space is still long and arduous.

In the words of Alejandro Gutierrez: “Large asset originators, like the partners we have, struggle to obtain funding through traditional methods because banks aren’t lending at the scale that is needed and haven’t been doing so for a while. In some countries, banks have been pulling out of certain activities like trade finance and this is a big problem for SMEs that are looking to grow.”

In this context, Ernesto Vila, Alejandro Gutierrez and Bhairav Patel realised that DeFi could be the deus ex machina capable of unlocking the much sought-after new sources of liquidity. But they also knew that the lending potential was not ready to be scaled.

That’s why they started collaborating with MakerDAO and Centrifuge, both committed to solving a tangible business problem and freeing up working capital for SMEs.

And that’s why the three joined forces and started Defactor.

Defactor is the partner who can guide RWAO and investors through the opportunities and challenges of DeFi. It is an easy-to-use platform that enables real-world asset originators to seamlessly access DeFi liquidity while also providing investors with insight into the underlying assets being funded.

Looking ahead

Trade Finance, a critical financial service for international commerce, is at its lowest level of accessibility in years due to Covid-19 and other market-related issues. In 2020, the service gap was $1.5T, and the expectation is that following Covid-19 the service gap will be between $2T and $5T.

Considering this conspicuous need for liquidity, the scalability of lending is crucial. Decentralised finance could very well hold the key to this; if so, it will be firms like Defactor, ConsolFreight and MakerDAO, who will be leading the movement from the front.