In previous years we have seen numerous attempts to bring real-world assets to the crypto market. However, none of them have been proven to be used en masse by crypto users in retail and traditional financial players.
So why hasn’t real-world asset tokenization become a huge trend?
You’ve probably heard how almost anything can be tokenized – effects, art, real estate, to name a few. And there were so many projects that promised to change the way we invest in assets, regardless of type. At the same time, no projects managed to enter the market en masse.
Traditional market professionals haven’t really found evidence that tokenization improved current fundraising processes for them. Although, an overview of real estate tokenization has already been discussed.
You may also struggle to find genuine private investors who have bought the rights to a famous work of art or part of Dracula’s castle. While most of the successful offerings have targeted private investors, in fact nothing has changed in the process for the crypto market, even for the owners of tokenized assets.
Why did these offers fail to be massively adopted? While the concept of tokenization promises a better and cheaper way to raise money for issuers, there are almost no real benefits to the crypto market.
I’ve covered problems of tokenization in the form of offering a security token, but in short it comes down to regulation (tokenized assets are regulated by the traditional rules) and the lack of a secondary market. Retail cryptocurrency investors cannot take advantage of these two issues, and in fact there is no need for them to adapt to anything new, especially now with the emergence of DeFi protocols.
What companies look for while raising funds
Business institutions must exist in a world of complex and outdated rules. Therefore, a clear legal model to raise or borrow money is vital to them. With more than $ 20 billion locked currently in decentralized financing, it can generate some interest from corporate institutions and prompt them to enter the market – especially when we consider that the usual annual percentage in DeFi protocols it is only 2% –10% with no additional cost to raise funding.
Yes, there are currently no off-the-shelf legal models for businesses to raise or borrow money from DeFi protocols. But it’s possible to build one with minimal effort, as the benefits of DeFi borrowing easily cover the efforts of building such a system. DeFi would be able to borrow business institutions on perfect terms, which could lead them to enter the market. Meanwhile, corporate institutions will be willing to provide various types of stable assets that can be used as collateral for their loans.
However, there is a real need for it real assets that can be used as collateral in DeFi protocols to avoid further market declines solve the problem of over-collateralisation on the road in the future.
Can current market players operate like this?
At the moment, there are several attempts to bring real-world assets to the DeFi market. Most of them seem to accept a wide variety of assets, mainly tokenized bills.
The main problem with using those assets in a protocol is the lack of publicly available pricing resources. This is related to the lack of transparency and the need to rely on a centralized party (valuation companies, underwriters, etc.) to determine the price of the collateralised asset. There is also no mechanism to track pricing in real time (as is the case, for example, when using crypto as collateral). These assets are generally illiquid; they are not traded on a marketplace or digital OTC platforms; and there is no source for periodically updating information about their pricing – a crucial point in determining when the collateral will be liquidated.
There is no doubt that some of those assets can be insured, such as payment on invoices, which means that the insurance company will pay in the event of the debtor’s default. But again, the insurance process lacks transparency and lives completely outside the chain, so it does not offer any real guarantees to the investors or know in real time whether or not the insured event happened.
In addition, current solutions allow borrowing strictly in crypto, which is not suitable for everyone. It’s not a bad thing, but it reduces the chance of attracting large institutions that need funding in fiat, which is used for their day-to-day operations.
But the main question that arises is the ability for large protocols to adapt and use real-world assets as collateral. And it will be extremely difficult because they will have to change the lending process, build a system that will update the price of collateral, issue new assets, partner with regulated entities and, in general, get approval from the majority of the current participants. Discussions on Aave and Maker’s approval of such a solution have been ongoing for over six months, with no clear date when it will actually go live.
What kind of infrastructure must be built to bring traditional institutions to the DeFi market?
A perfect solution that allows the tokenization of traditional stable assets and which will be suitable for the DeFi market must meet several criteria.
- Real-world assets used by the protocol must have a transparent source of pricing that is available upon request to any user of the protocol. This requires not only selecting an asset that can meet this requirement, but also building a price oracle that will convey information about the collateral. Such an oracle should be connected to a transparent and trusted source of prices, such as Bloomberg Terminal, rather than receiving ownership data from a centralized party.
- Real-world assets used by the protocol must be as little volatile as possible, generate steady income to provide real cash flows to liquidity pools, and have a certain level of liquidity and real-world market to handle the liquidation event in case it occurs.
- The protocol should enable users to borrow fiat money. For such purposes, there is a need for yet another intermediary to be connected to the protocol, to meet the exchange needs of users seeking to borrow money, and to fulfill the role of paying agent for them.
- Real-world assets used by the protocol must be digitally present, for example on a secure accounting system. In order to achieve that, there is a need for an intermediary who serves such systems that are connected to the protocol.
- To defend the decentralized nature of the protocol and keep trust at the highest achievable level, intermediaries affiliated with the protocol must be regulated, insured, selected and monitored by the protocol community under established requirements. In addition, the community decides on other critical issues for the protocol’s development and economic sustainability, including selecting assets to be admitted as collateral.
What can we expect in the future?
I expect in 2021 we will see several initiatives to build new, real-world, asset-backed protocols, and hopefully they will be the ultimate solution to finally connecting traditional financial and crypto markets. They will only apply existing protocols in their current ecosystems after new protocols appear to be operational.
Another area where real-world asset-based protocols can have a significant impact is stablecoins. There is a current trend among regulators, mainly in the United States, targeting all stablecoins with centralized issuers – such as Tether (USDT) or USD currency (USDC) – with discussions on the possible need to impose a requirement that one of these issuers have a banking license. Decentralized stablecoins backed by real world assets can potentially solve this problem; however, it is a topic for separate discussion.
But what about other tokenization attempts and STOs? Of course there have been successful cases before. Major financial institutions are still somewhat interested in launching such products as they can potentially save money. But most likely, these initiatives will target private offers due to the above shortcomings.
It is naive to believe that many crypto investors will be willing to make long-term investments in unfamiliar markets. Especially with great investment opportunities in the DeFi space. Until new regimes for offering tokenized instruments are built (and there are no clear signals in this direction), I think that real-world asset tokenization in the form of an STO will still be limited to closed offers without the attention of the industry. global market. .
The views, thoughts and opinions expressed here are solely of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Artem Tolkachev is the founder and CEO of Tokenomica. Artem has been a major opinion leader on blockchain and tokenization in the CIS region for over six years. Since 2011 he has been a lawyer and entrepreneur in the field of intellectual property and information technology. In 2016, Artem founded and led the Deloitte CIS Blockchain Lab. As part of that initiative, he led a series of innovative projects related to the implementation of enterprise blockchain solutions, tokenization of real-world assets, tax and legal structuring of security token offerings, cryptocurrency development and blockchain law.